TWO VIEWS OF THE RELATIONSHIP
BETWEEN GOVERNMENT AND MARKETS
1. Markets are inherently unstable,
and government policy is stabilizing.
2. Markets are inherently stable,
and government policy is destabilizing.
A FUNDAMENTAL DIFFERENCE BETWEEN
MICROECONOMICS AND MACROECONOMICS
Microeconomics focuses
on a particular market
(say, the market for
oranges). It puts the
rest of the economy “on
hold” by invoking the
ceteris paribus
assumption. Showing
how a particular market
works is based on the
assumption that all
other markets are
working fine.
Macroeconomics focuses
on a large sectors of the
economy (say, the
market for inputs, such
as labor). It deals with
the interaction among
the different sectors.
Under certain
assumptions, it shows
that disturbances or
malfunctions in one
sector can infect all
other sectors.
PART I:
From Supply and Demand
to Circular Flow
PART I
From Supply and Demand to Circular Flow
Supply and demand curves keep track of prices and quantities.
Multiply the p times the q for output markets to get expenditures (e).
Sum the expenditures in output markets to get total expenditures (E)
Multiply the w times the n for input markets to get income (y).
Sum the incomes in all input markets to get total income (Y)
Macroeconomic equilibrium requires that Y = E.
“Market clearing” in the
microeconomic sense is
consistent with—and
allows for—the natural
rate of unemployment.
The equality here of Y and E does not deny the possibility
of saving—which can get spent, too, by someone else.
E = Y = 3000 is just for illustration. For actual data,
check the Federal Reserve Economic Data (FRED).
PART II:
The Macroeconomics
of Depression
PART II:
The Macroeconomics of Depression
Suppose the economy suffers a weakening of demand for output.
Prices do not adjust--at least not immediately.
Output adjusts, as do expenditures: PQ becomes PQ’
With E less than Y, excess inventories accumulate.
The demand for labor (and other resources) falls.
Wages do not adjust--at least not immediately.
The level of employment adjusts: WN becomes WN’
Y is brought into line with E through adjustments in N.
MID-SHOW QUIZ:
According to microeconomists,
equilibrium (in the market for
a particular good) is a balance
between quantity supplied and
quantity demanded and is
achieved by the appropriate
change in the good’s price.
MID-SHOW QUIZ:
According to microeconomists,
equilibrium (in the market for
a particular good) is a balance
between quantity supplied and
quantity demanded and is
achieved by the appropriate
change in the good’s price.
MID-SHOW QUIZ:
According to microeconomists,
equilibrium (in the market for
a particular good) is a balance
between quantity supplied and
quantity demanded and is
achieved by the appropriate
change in the good’s price.
MID-SHOW QUIZ:
According to macroeconomists,
equilibrium (for the economy
as a whole) is a balance
between income and
expenditures and is achieved
by a change in the level of
employment.
MID-SHOW QUIZ:
According to macroeconomists,
equilibrium (for the economy
as a whole) is a balance
between income and
expenditures and is achieved
by a change in the level of
employment.
MID-SHOW QUIZ:
According to macroeconomists,
equilibrium (for the economy
as a whole) is a balance
between income and
expenditures and is achieved
by a change in the level of
employment.
PART III:
The Macroeconomics
of Inflation
PART III
The Macroeconomics of Inflation
Suppose the economy experiences a strengthening of demand for output.
Output cannot rise (except temporarily) above the full-employment level.
Prices begin to rise
The demand for labor increases
Wages begin to rise.
The supply of labor shifts as workers demand cost of living adjustments.
The supply of output shifts to reflect the increased labor costs.
Y and E are finally brought into balance through adjustments in P and W.
PART IV:
The L-Shaped
Supply Curve
PART IV
The L-Shaped Supply Curve
Suppose the economy is in deep depression.
Imagine that the demands for output (and hence for input) are rising.
From deep depression to full employment, Q and N rise.
From full employment onward, P and W rise.
The path traced out by P and Q (and by W and N) forms a backwards L.
Query: can the economy now move backwards along the backwards L?
Does the “path traced out” constitute a genuine supply curve?
PART V:
From P and Q
to Y and E
= PQ
(P )Q
(W )N
P(Q )
W(N )
= WN
PART VI:
The Components of
Income and Expenditures
INCOME
AND
EXPENDITURES
Wages (salaries) earned by labor
Rents earned by land owners
Interest earned by capitalists
Profits earned by entrepreneurs
INCOME
AND
EXPENDITURES
Consumption
Investment
Government
INCOME
AND
Wages
Consumption
Rents
Investment
Interest
Government
Profits
Y
EXPENDITURES
=
C+I+G