MACRO SUPPLY and DEMAND The Four Macro Markets The Product Market The Credit Market The Labor Market...

MACRO SUPPLY and DEMAND

The Four Macro Markets

The Product Market

The Credit MarketThe Labor Market

The Foreign Exchange Market


The Product Market

Macro Markets The Product Market (1)

1. A box in the Circular Flow Diagram

PrM Spending (X)

Income (Y) =

Wages + Profit


2. The Product Market Equation

An example of an AD (spending) increase

x = p + q

The growth of nominal GDP (x, spending) is split between inflation (p) and real growth (q)

x p q

6 3 3 An increase of spending raises x, causing p and q to rise

9 4 5 That is, AD increases => p and q rise

An example of an AS decrease (a cost increase)

x p q

6 3 3

6 7 -1

An increase of cost raises p. With no change of x, q falls

That is, AS decreases => p rises and q falls


3. A Supply and Demand Graph

q = real growth

p = inflation

AD = x

AS

3%

3%

Aggregate Demand is shifted by changes of spending by any of the economy’s sectors.

SHIFTERS

Aggregate Supply is shifted by changes of the costs of production (e.g. input costs and technology).



q

p

AD1

AS

3%

3%

AD0

An increase of Aggregate Demand occurs when people in total want to spend more

p and q both rise



q

p

AS1

AS0

3%

3%

AD0

An increase of Aggregate Supply occurs when there is an increase in the quantiy or quality of some FOP or a decreased price of some FOP.

p falls and q rises


The Credit Market

Macro Markets The Credit Market (1)

1. A box in the Circular Flow Diagram

CrM BB (deficit)

Saving (S)

Government Treasury

K (Capital inflow)

Foreign Exchange Market

Investment (I)

Federal Reserve

ΔMS

Cash

ΔMD



Demand for Borrowing (B) shifters: the “out” arrows from the Circular flow diagram: These are Investment and the Gov’t Deficit.

SHIFTERS

Z = credit used

i = interest rate

B

L

x = spending growth

Supply of Lending (L) shifters: the “in” arrows from the Circular flow diagram: These are Saving, Capital inflows and changes of the money supply. Z,x

i

B = I + Def

L = S + K + ΔMS

Credit Market Shifts

Supply increase

An increase of Supply could be caused by:

Z,x

i

B

L0 = S + K + ΔMS L1

Z,x

i

B1

L

B = I + Def

An increase of Demand could be caused by:

Demand increase

1. an increase of Saving2. increased foreign capital3. an increase of the money supply

1. greater Investment demand (greater business optimism)2. a larger Gov’t Deficit


3. The Credit Market Equation

An example: printing money raises AD.

x = m + v

Spending (x) can grow if:

x m v

6 6 0

8 8 0

An example: a spending increase without printing money.

x m v

6 6 0

8 6 2

(b) money is spent faster – v increases – corresponding to a decrease of the demand for liquidity (Cash)

(a) there is more money – m increases -- and/or

In this case there has been a decrease of the demand for liquidity.


The Labor Market

THE LABOR MARKET describes the process of offering and hiring workers

n

w

DL

SL

w0

n0

The quantity variable (n) measures (the rate of growth of) employment

The price variable (w) measures (the rate of growth of) wages

Although we will depict the labor market as being in equilibrium, it is worth noting that the Labor Market is the macro market that is most often not in equilibrium.

THE LABOR MARKET – demand shifters

n

w

DL

SL

w0

n0

The business sector is the demander (buyer) in this market.

An increase of demand would be caused by businesses wanting to hire more employees.

Some causes of an increased demand for labor:

1. output in the Product Market (q) is rising. In order to produce more goods, more people must be hired.

2. worker productivity has risen. This assumes that labor and capital are complements, not substitutes.*

*see next page

D1

w1

n1

D0

Labor and Capital – Substitutes or complements?

Labor and Capital are Substitutes if machines replace workers: Capital increases => Demand for labor falls => wages fall

Labor and Capital are Complements if/when workers are needed to operate, maintain and design the machines: Capital increases => Demand for Labor rises => wages rise

History suggests that Labor and Capital are, in the long run, complements: the times and places that have the most capital have the highest wages.

Skilled labor is generally a complement to capitalUnskilled labor is a substitute for capital

Two Generalizations:

The greatest source of increased worker productivity is in the increased use of Capital.

THE LABOR MARKET – supply shifters

n

w

DL

SL

w0

n0

Workers are the supply (seller) in this market.

An increase of supply is caused by having more workers available, due to:

Some causes of a decreased supply of labor:

a. restricted immigration

b. the retirement of the baby boom

S0

S1

w1

n1

n

w

DL

SL

w1

n1

S0

w0

n0

S1

a. more birthsb. more immigrationc. higher labor force participation


The Foreign Exchange Market

THE FOREIGN EXCHANGE MARKET 1. A box on the Circular Flow diagram

FxM

Imports (F)

Exports (E)

Foreign Capital

Inflow* (K)

CrM

* This illustrates a capital inflow, the current US case.

For the market to be in equilibrium, we need F = E + K

That is: $in = $out. ($in = $out is the same trick as was used in the credit market)

Using “Dollars In” as Supply and “Dollars Out” as Demand, we can say that Imports

are the world’s Supply of dollars while Exports and Capital Flows are the world’s

demand for dollars.

D = E + KS = F

We pay for imports with dollars. Those dollars return to us either as purchases

of our exports or as capital inflows to our credit market.

The Exchange Rate (e). The international value of a dollarA “strong dollar” describes a high exchange rate. In this case a dollar buys a lot of foreign currency (e.g. pesos). That means: a. foreign goods are cheap to the US and b. US goods are expensive to foreigners.

A “weak dollar” describes a low exchange rate. In this case a dollar buys only a little foreign currency (e.g. pesos). That means: a. foreign goods are expensive to the US, and b. US goods are cheap to foreigners.

So –

a. A strong dollar is good for Americans who want to import. They can buy a lot of foreign goods cheap. Note that “import” includes “take a trip to Mexico. “

b. A weak dollar is good for our export industries. They can sell goods cheaper abroad. A special case again, is foreign tourists in the US. A weal dollar makes it cheaper for someone from Mexico to visit the US. Our tourist industry is happy.

THE FOREIGN EXCHANGE MARKET

We can now draw this as a supply and demand graph

S = F

D = E + K

e

$

On the “quantity” axis we will put the quantity of dollars ($). Dollars are what is being bought and sold in the market in order to permit foreign trade to occur.

On the “price” axis we will put the “exchange rate” (e), the price of a dollar in terms of another currency. An example of an exchange rate would be “12 pesos per dollar” or “0.8 euros per dollar.”

As always we would like to know the demand shifters and the supply shifters. Fortunately we almost have that already.

The supply shifter is our desire to import.

D

e

$

S

e0

$0

If we decide we like foreign goods more than we did, we will buy

more imports.

The supply curve shifts right and the exchange rate -- the international

value of a dollar-- falls.

S0

S1

$1

e1

S = FS

Two demand shifters in the Foreign Exchange Market: Two reasons that foreigners would want dollars.

1. To buy our exports.The world needs dollars to

buy US products. If the demand for our products

rises, so will the demand for dollars. The increased

demand for dollars will raise the exchange rate.

D = E + K

Se

$

D0

D1

$0

e0

e1

$1

D = E + K

Two demand shifters in the Foreign Exchange Market: Two reasons that foreigners would want dollars.

1. To buy our exports.Se

$D0

$0

e0

D1

e1

$1

2. For US Capital Inflows (interest rates). This is the demand for dollars to put into the US Credit Market. (A significant part of this demand is for US Treasury bonds).

D = E + K

The main cause for a higher demand for US dollars for capital inflows would be higher US interest rates, providing a higher return on money in the US. US interest rates (relative to the rest of the world) therefore shift the demand for dollars.

Market Demand Shifters Supply Shifters

Product Total Spending (X)X = Cd + E + I + G

Changes of the quantity, quality or price of FOPs

Credit* 1. Investment (I)2. Gov’t Deficit (Def)

1. Saving (S)2. Foreign Capital (K) --- interest rates3. Money Supply Changes (ΔMS)

Foreign Exchange

1. Foreign Capital (K)2. Imports (F)

Exports

Labor 1. Labor Productivity2. Real GDP (q)

Size of the working Population (the Labor Force)

SUMMARY OF MACRO DEMAND and SUPPLY SHIFTERS

* We will omit ΔMD from these lists

MACRO SUPPLY and DEMAND The Four Macro Markets The Product Market The Credit Market The Labor Market...

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