Macroeconomic
Fundamentals
1. Aggregate demand product
market equilibrium
2. Aggregate money market
3. General equilibrium
Above average global GDP growth
rates in 6 of last 8 years
1988-97
Ave.
1998
1999
2000
2001
2002
2003
2004
2005
2006
World
3.4
2.8
3.7
4.9
2.6
3.1
4.1
5.3
4.9
5.1
Africa
2.3
2.8
2.7
3.1
4.2
3.6
4.6
5.5
5.4
5.4
Central and Eastern
Europe
0.9
2.9
0.7
5.1
0.3
4.5
4.7
6.5
5.4
5.3
Middle East
4.0
3.7
1.8
5.3
3.0
4.1
6.4
5.5
5.7
5.8
China
9.9
7.8
7.1
8.4
8.3
9.1
10.0
10.1
10.2
10.0
India
6.0
5.9
6.9
5.3
4.1
4.3
7.2
8.0
8.5
8.3
Other emerging
market and
developing countries
4.1
3.0
4.1
6.1
4.4
5.1
6.7
7.7
7.4
7.3
United States
3.0
4.2
4.5
3.7
0.8
1.6
2.5
3.9
3.2
3.4
Sources: US Department of Commerce and International Monetary Fund.
Components of Aggregate Demand:
Aggregate demand is defined as the sum of consumption
spending (C), investment spending (I), Government
spending (G), and net exports (X-M); X represents
exports and M represents imports.
Aggregate demand, referred to as Gross domestic
product or GDP, is therefore given by:
AD = GDP = C + I + G + X – M
The economy is said to be in general equilibrium when
the money, labor and product markets are all in
equilibrium. Focus here is on the short run.
Equilibrium in the Money Market
Interest Rate
MD
MS
LM
i3
i2
iE
i1
M
Quantity of Money
Page 98
Y1
Y2
Y3
Gross Domestic Product
Page 93
Definition of LM:
L represents the demand for liquidity and M represents the quantity of money
At all points along the LM curve, the demand for money equals supply.
Product Market Equilibrium
General Price Level
IS
AD
AS
i3
i2
i1
PE
YE YPOT
Y3
Y2
Y1
Gross Domestic Product
Gross Domestic Product
Page 97
Page 94
Definition of IS:
I represents the investment spending and S represents savings.
At all points along the IS curve, investment equals savings.
Three Ranges of Aggregate SR Supply Curve
Normal
range
General Price Level
Depression
range
AS
Classical
range
YPOT
Gross Domestic Product
Page 97
Potential GDP in the current year
Note: The aggregate production
function for the general economy is:
Y = f(L,K) where L is the employed labor
force, and K is the capital stock.
General Price Level
Elasticity of SR Aggregate Supply Curve
AD
AS
AD
AS
∆PE
∆PE
∆YE YPOT
∆YE
YPOT
Gross Domestic Product
Gross Domestic Product
Page 97
Page 97
Elasticity of the short run aggregate supply curve in the normal range
will help determine the rate of demand pull inflation in the economy,
given by the percent change in the general price level or (∆PE/PE).
Interest Rate
MD
IS
MS
LM
iE
iE
YE
Quantity of Money
General Equilibrium
in the money and
product markets
General Price Level
M
AD
AS
PE
YE YPOT
Gross Domestic Product
Page 97
Equilibrium in Labor Market
Labor Market
AD
LD
AS
LS
Wage Rate
General Price Level
Product Market
∆PE
∆YE YPOT
Gross Domestic Product
Page 97
∆WRE
∆LE
LMAX
Employment
Page 98
The aggregate demand for goods and services in the product market
drives the demand for labor in the nation’s labor market.
Phillips Curve Tradeoff in Short Run
Unemployment Rate
Expansionary Policy Impact
UR
Contractionary Policy Impact
UR
INF
Inflation Rate
INF
Inflation Rate
This curve initially proposed by the English economist William Phillips
tracks the short run tradeoff between unemployment and inflation.
Expansionary Fiscal policy
Action: cut tax rates and/or
raise government spending
Expansionary Monetary policy
Action: increase money supply
Interest Rate
IS
IS
LM
IS*
LM
LM*
i
i
Y
Gross Domestic Product
Page 95
Y
Gross Domestic Product
Page 96
Hint: Contractionary monetary and fiscal policy actions have the
exact opposite effects of expansionary policy actions.
Expansionary Monetary policy
Action: increase money supply
Interest Rate
IS
Expansionary monetary policy
lowers interest rates, stimulates
investment spending, increases
aggregate demand for goods
and services, can increase the
general price level, increases
the need for additional labor to
produce additional goods and
services, and can increase the
wage rates. Does not occur
instantaneously.
LM
LM*
i
AD
AD*
AS
LD
Wage Rate
General Price Level
YE
∆PE
∆YE YPOT
Gross Domestic Product
LD*
LS
∆WRE
∆LE
LMAX
Employment
Expansionary Fiscal policy
Action: cut tax rates or raise
government spending
Interest Rate
IS
IS*
Expansionary fiscal policy leads
to government borrowing, raising
interest rates, but stimulates
aggregate demand for goods and
services, can increase the
general price level, increases the
need for additional labor to
produce additional goods and
services, and can increase the
wage rates. Does not occur
instantaneously.
LM
i
YE
LD
AS
LS
Wage Rate
General Price Level
AD
∆PE
∆YE YPOT
Gross Domestic Product
∆WRE
∆LE
LMAX
Employment
Full Employment and GDP Gaps
Recessionary GDP Gap
AS
AD
PE
YE YPOT
YFE
Use expansionary policy to
eliminate SR recessionary gap:
1. Lower interest rates
2. Cut taxes
3. Increase government spending
Full Employment and GDP Gaps
Recessionary GDP Gap
Inflationary GDP Gap
AD
AS
AD
AS
PE
PE
YE YPOT
YE YPOT
YFE
Use expansionary policy to
eliminate SR recessionary gap:
1. Lower interest rates
2. Cut taxes
3. Increase government spending
YFE
Use contractionary policy to
eliminate SR inflationary gap:
1. Raise interest rates
2. Raise taxes
3. Decrease government spending
Policy Impacts on Macro Economy
“Big 5” macro
Economic
variables
Expansionary
Monetary
Policy
Contractionary
Monetary Policy
Expansionary
Fiscal
Policy
Contractionary
Fiscal
Policy
Interest rate
Lower
Higher
Higher
Lower
GDP growth rate
Higher
Lower
Higher
Lower
Unemployment rate
Lower
Higher
Lower
Higher
Inflation rate
Higher
Lower
Higher
Lower
Exchange rate
Lower
Higher
Higher
Lower
Impact of macroeconomic policy on five variables important to
the nation’s food and fiber Industry
Page 101
Macro – Market – Micro
Note: This does not occur instantaneously.
Page 102
Note: This does not occur instantaneously.
Page 103
Policy Impacts on the Farm Sector
Farm sector
variables
Expansionary
Monetary
Policy
Contractionary
Monetary Policy
Expansionary
Fiscal
Policy
Contractionary
Fiscal
Policy
Farm revenue
Higher
Lower
Higher
Lower
Farm expenses
Higher
Lower
Higher
Lower
Net farm income
Higher
Lower
Higher
Lower
Farm land values
Higher
Lower
Higher
Lower
Exports
Higher
Lower
Lower
Higher
Impact of macroeconomic policy on five variables important to
the nation’s farm sector
Page 104
What is Next?
 We have covered the
topic of market
equilibrium for a specific
commodity.
 We have also covered
the topic of general
equilibrium and GDP
gaps.
 Let’s now look at policy
actions we would expect
from policymakers and
their impact on individual
markets at the economy
level.
Any Questions?