ECN202: Macroeconomics

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ECN202 Macroeconomics

• Circular Flow Aggregate Supply-Aggregate Demand

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Circular Flow Diagram

• The Circular flow diagram is comparable to a
  wiring or plumbing diagram for a house. Here is
  shows the flow of money in a modern economy, and
  in it you can see the four key players
  (Households, Firms, Government, and Foreigners)
  and the four macro markets in which these players
  conduct their business (labor, output, capital,
  and foreign exchange). For each market there is a
  S D curve and price and quantity measures that
  we look into later. In the circular flow you
  just need to follow the money to understand how
  the macro economy functions and how shocks in any
  market spread to the other markets.

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Macro Markets, Players, Indicators
Markets Demanders Suppliers Key Concepts
Outputcars Firms GDP, NI / CPI / Productivity
Labor job Firms / Government Employment / Earnings / Unemployment
Capital loan Money supply / Interest Rates
Foreign Capital travel Foreign Trade balances / Exchange Rates
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Each Market has one of these
Supply
Price
Headlines are about Price Output changes
P
Demand
Q
Quantity
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Foreigners
Four Players
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Four Markets
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An overview of macro environment
Markets Demanders Suppliers Key Concepts
Output Firms / Households / Government / Foreign Firms GDP, NI / CPI / Productivity
Labor
Capital Firms / Households / Government / Foreign Firms / Households / Fed / Foreign Money supply / Interest Rates
Foreign Capital Buyers of US stuff Sellers of US stuff Exchange rate
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Foreign Exchange Market (US s)
Price Exchangerate
Supply
P
Demand
Q
Quantity units of currency
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What is happening to the value of the US in
these two graphs
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An overview of macro environment
Markets Demanders Suppliers Key Concepts
Output Firms / Households / Government / Foreign Firms GDP, NI / CPI / Productivity
Labor Firms / Government Households Employment / Earnings / Unemployment
Capital Firms / Households / Government / Foreign Firms / Households / Fed / Foreign Money supply / Interest Rates
Foreign Capital Foreign US Trade balances / Exchange Rates
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Labor Market
Supply
Price wage
P
Demand
Q
Quantity Employment
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An overview of macro environment
Markets Demanders Suppliers Key Concepts
Output Firms / Households / Government / Foreign Firms GDP, NI / CPI / Productivity
Labor Firms / Government Households Employment / Earnings / Unemployment
Capital Firms / Households / Government / Foreign Firms / Households / Fed / Foreign Money supply / Interest Rates
Foreign Capital Foreign US Trade balances / Exchange Rates
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Capital Market
Supply
Price Interestrate
P
Demand
Q
Quantity Funds s
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What is happening here to interest rates?
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Output Market
Supply
P
Demand
Q
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An overview of macro environment
Markets Demanders Suppliers Key Concepts
Output Firms / Households / Government / Foreign Firms GDP, NI / CPI / Productivity
Labor Firms / Government Households Employment / Earnings / Unemployment
Capital Firms / Households / Government / Foreign Firms / Households / Fed / Foreign Money supply / Interest Rates
Foreign Capital Foreign US Trade balances / Exchange Rates
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What is happening to real GDP growth rate?
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How does WW II seem to divide the two periods?
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Aggregate Supply Aggregate Demand

• You have now looked at the labor and output
  markets, and now we are going to look at the
  picture of the output market more carefully.
  This is the market for ALL goods and services
  cars, lawyers, school, milk and while it looks
  like the SD graph, it is not. One thing is the
  same if you follow the rules you will be OK.
  Now we will look at the AS-AD model economists
  use to understand the macro economy.

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AS-AD Analysis Cookbook Approach

• Identify the participants
• AS Suppliers (firms)
• AD Demanders ( firms, households, government,
  foreigners)
• Identify the determinants of behavior
• Identify the appropriate curves
• KNOW the AXES (variables)
• Identify any special situation

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Determinants of aggregate supply (AS)

• Number of inputs
• Capital, labor, resources
• Costs of production
• Price of inputs / resources
• Productivity / efficiency of resources
• Price level

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Aggregate Supply Curve
AS has positive slope since higher prices coax
out more supply
AS (depends on and price of inputs their
productivity
Price Level
P1
P0
Q1
Q0
GDP
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What shifts the Aggregate Supply curve?

• Change in any of the factors (other than price
  level) that affect Aggregate Supply will change
  the AS curve.
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  

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Aggregate Supply Curve
When productivity increases _at_ each price
Aggregate Supply has increased and curve shifts
to the right
Price Level
AS
P1
P0
Q1
Q0
Quantity GDP
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Components of aggregate demand (AD)

• Who buys American stuff in the output market?
• (Households) Consumption Spending
• (Firms) Investment spending
• (Government) Government spending
• (Foreigners) Export Import spending

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Determinants of aggregate demand (AD)

• What affects demand for American stuff?
• Consumption Spending (Households)
• Income, expectations, interest rate
• Investment spending (Firms)
• Profit, expectations, interest rate
• Government spending (Government)
• Policies, state-of-economy, interest rate
• Export spending (Foreigners)
• Income, expectations, exchange rate in ROW
• Import spending (US firms Householde)
• Income, expectations, exchange rate in US

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Aggregate Demand Curve
AD has negative slope since higher prices mean
there is less money to purchase stuff
P1
P2
AD CIGX-M
Q2
Q1
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Aggregate Demand Curve
When interest rates fall and demand for cars
increases _at_ each price increases Aggregate
Demand and the curve shifts to the right
P1
P2
AD CIGX-M
Q2
Q1
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AS-AD Model of Output Market
AS( and price of inputs, productivity)
P
AD (CIGX-M)
Q
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We now have a model that helps us understand
changes in the price level (CPI) and national
output (GDP). We can use it to explain past
changes or forecast future changes in these
variables and it looks very much like the
analysis of SD. We need to look at how the
economy adjusts to shocks to the system using
the same technique.
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Use AS-AD model to explain the following headlines

1. a decrease in US consumer confidence that pushes
   consumption spending lower
2. a significant expansion in Asia that raises Asian
   demand for US exports
3. an increase in the productivity of American
   workers
4. China growth pushes oil prices higher

Get out that pad and draw the diagrams for each
question before reading on
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a. Impact of decrease in US confidence that
pushes consumption spending lower.
AS
AD

• Cookbook approach
• Identify the participants - US consumers AD
• Identify the determinants of behavior Consumer
  confidence decrease reduced consumption spending
• Identify the appropriate curves - AD curve
  shifts in
• Result lower GDP (recession) and lower inflation
  (price level)

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b. a significant expansion in Asia that raises
Asian demand for US exports.
AS
AD

• Cookbook approach
• Identify the participants - Asian demand for US
  exports AD
• Identify the determinants of behavior Expansion
  in Asia means more income more demand for US
  exports
• Identify the appropriate curves - AD curve
  shifts out
• Result higher GDP and higher inflation (price
  level)

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c. an increase in the productivity of American
workers.
AS
AD

• Cookbook approach
• Identify the participants - productivity of
  workers AS
• Identify the determinants of behavior Increase
  productivity lower costs of production
  increase AS
• Identify the appropriate curves - AS curve
  shifts out
• Result higher GDP and lower inflation (price
  level)

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d. China growth pushes oil prices higher.
AS
AD

• Cookbook approach
• Identify the participants - oil prices AS
• Identify the determinants of behavior higher
  oil prices raise costs of production reduces AS
• Identify the appropriate curves - AS curve
  shifts in
• Result lower GDP (recession) and higher
  inflation (price level)

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• Note on oil price shock
• In a more complete analysis you need to account
  for the fact the US imports a good deal of its
  oil and that demand for oil is inelatic so when
  the price goes up we do not cut demand much. In
  this case if the price of oil rises then US
  imports rise so we get the inward shift of the AS
  curve from higher production costs AND an inward
  shift in the AD curve because imports rise. In
  exams you should not worry about the more
  detailed analysis.

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Here are a few more examples

1. A rise in the value of the US pushes US imports
   higher
2. A rise in interest rates slows housing sales
3. Rise in housing prices raises household wealth
4. Business confidence falls lower spending on new
   equipment

Get out that pad and draw the diagrams for each
question before reading on
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1. A rise in the value of the US pushes US imports
   higher

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b. A rise in interest rates slows housing sales

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c. Rise in housing prices raises household wealth

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d. Business confidence falls lower spending on
new equipment

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See how you did

1. A rise in the value of the US pushes US imports
   higher higher US imports affects AD but be
   careful since Imports have a negative sign so
   higher imports reduces demand for US stuff so
   AD decreases and shifts left.
2. A rise in interest rates slows housing sales-
   higher interest rates reduce demand for housing
   reduce home building reduce investment spending
   shift AD in
3. Rise in housing prices raises household
   wealth-households feeling wealthier increase
   consumption spending shift AD out
4. Business confidence falls lower spending on new
   equipment-lower equipment spending lower I
   spending shift AD in

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Generalization Single Shift
Based on what you have done, fill in the
following table
Price Level GDP
AD -
AD -
AS -
AS -
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Questions
a. What happens when oil prices rise and war
spending rises?
Get out that pad and draw the diagram before
reading on
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Questions
b. What happens when productivity rises and
exports rise due to growth in China?
Get out that pad and draw the diagram before
reading on
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See how you did

• What happens when oil prices rise and war
  spending rises?
• Oil prices rise decrease in AS shift AS
  inward
• War spending increases increase in AD (G)
  shift AD outward

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See how you did

• b. What happens when productivity rises and
  exports rise due to growth in China?
• Productivity rises increase in AS shift AS
  outward
• Exports grow increase in AD (X) shift AD
  outward

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Generalizations Double Shift
Fill in this table and see what you get Remember
Double shifts mean only predict price of output
Price Level Quantity (GDP)
AD AS
AD AS    
AD AS    
AD AS