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 Ave World Africa Central and Eastern Europe Middle East China India Other emerging market and developing countries United States 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.

LM i3i2i1i3i2i1 Y 1 Y 2 Y 3 Equilibrium in the Money Market Page 93 iEiE MSMS M MDMD Page 98 Interest Rate Quantity of Money Gross Domestic Product Definition of LM: L M L represents the demand for liquidity and M represents the quantity of money LM curve At all points along the LM curve, the demand for money equals supply. Definition of LM: L M L represents the demand for liquidity and M represents the quantity of money LM curve At all points along the LM curve, the demand for money equals supply.

i3i2i1i3i2i1 Y 3 Y 2 Y 1 IS Product Market Equilibrium PEPE ASAD Y E Y POT Page 94 General Price Level Gross Domestic Product Page 97 Definition of IS: I S I represents the investment spending and S represents savings. IS curve At all points along the IS curve, investment equals savings. Definition of IS: I S I represents the investment spending and S represents savings. IS curve At all points along the IS curve, investment equals savings.

AS Y POT General Price Level Gross Domestic Product Page 97 in the current year Potential GDP in the current year Depression range Normal range Classical range Three Ranges of Aggregate SR Supply Curve aggregate production function 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.

∆PE∆PE ASAD ∆Y E Y POT General Price Level Gross Domestic Product Page 97 ∆PE∆PE ASAD ∆Y E Y POT Gross Domestic Product 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 (∆P E /P E ). Elasticity of SR Aggregate Supply Curve

PEPE ASAD IS LM Y E Y POT iEiE YEYE iEiE MSMS M MDMD Page 97 General Equilibrium in the money and product markets Interest Rate General Price Level Gross Domestic Product Quantity of Money

∆WR E ∆L E L MAX LDLD LSLS Equilibrium in Labor Market ∆PE∆PE AS AD ∆Y E Y POT Product MarketLabor Market General Price Level Gross Domestic Product Employment Wage Rate Page 98 Page 97 The aggregate demand for goods and services in the product market drives the demand for labor in the nation’s labor market. The aggregate demand for goods and services in the product market drives the demand for labor in the nation’s labor market.

UR INF Phillips Curve Tradeoff in Short Run UR INF Expansionary Policy Impact Contractionary Policy Impact Unemployment Rate Inflation Rate This curve initially proposed by the English economist William Phillips short run tradeoff tracks the short run tradeoff between unemployment and inflation. This curve initially proposed by the English economist William Phillips short run tradeoff tracks the short run tradeoff between unemployment and inflation.

IS LM LM* ii YY IS LM YY IS* ii Interest Rate Gross Domestic Product Page 95 Gross Domestic Product Page 96 Hint: Contractionary monetary and fiscal policy actions have the exact opposite effects of expansionary policy actions. Hint: Contractionary monetary and fiscal policy actions have the exact opposite effects of expansionary policy actions. Expansionary Monetary policy Action: increase money supply Expansionary Monetary policy Action: increase money supply Expansionary Fiscal policy Action: cut tax rates and/or raise government spending Expansionary Fiscal policy Action: cut tax rates and/or raise government spending

AD* IS LM LM* ii YEYE Expansionary Monetary policy Action: increase money supply Expansionary Monetary policy Action: increase money supply ∆PE∆PE AS AD ∆Y E Y POT ∆WR E ∆L E L MAX LD*LD* LSLS Interest Rate General Price Level Wage Rate Gross Domestic Product Employment LDLD 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.

IS LM YEYE Expansionary Fiscal policy Action: cut tax rates or raise government spending Expansionary Fiscal policy Action: cut tax rates or raise government spending IS* ∆PE∆PE AS AD ∆Y E Y POT ∆WR E ∆L E L MAX LDLD LSLS ii Interest Rate General Price Level Wage Rate Gross Domestic Product Employment 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.

Full Employment and GDP Gaps PEPE AS AD Y E Y POT Y FE Recessionary GDP Gap Use expansionary policy to eliminate SR recessionary gap: 1. Lower interest rates 2. Cut taxes 3. Increase government spending

PEPE ASAD Y E Y POT Full Employment and GDP Gaps PEPE AS AD Y E Y POT Y FE Recessionary GDP GapInflationary GDP Gap Y FE Use expansionary policy to eliminate SR recessionary gap: 1. Lower interest rates 2. Cut taxes 3. Increase government spending Use contractionary policy to eliminate SR inflationary gap: 1. Raise interest rates 2. Raise taxes 3. Decrease government spending

“Big 5” macro Economic variablesExpansionaryMonetaryPolicyContractionary Monetary Policy ExpansionaryFiscalPolicyContractionaryFiscalPolicy Interest rateLowerHigherHigherLower GDP growth rateHigherLowerHigherLower Unemployment rateLowerHigherLowerHigher Inflation rateHigherLowerHigherLower Exchange rateLowerHigherHigherLower Impact of macroeconomic policy on five variables important to the nation’s food and fiber Industry Impact of macroeconomic policy on five variables important to the nation’s food and fiber Industry Page 101 Policy Impacts on Macro Economy

Macro – Market – Micro

Page 102 Note: This does not occur instantaneously.

Page 103 Note: This does not occur instantaneously.

Farm sector variablesExpansionaryMonetaryPolicyContractionary Monetary Policy ExpansionaryFiscalPolicyContractionaryFiscalPolicy Farm revenueHigherLowerHigherLower Farm expensesHigherLowerHigherLower Net farm incomeHigherLowerHigherLower Farm land valuesHigherLowerHigherLower ExportsHigherLower Higher Impact of macroeconomic policy on five variables important to the nation’s farm sector Impact of macroeconomic policy on five variables important to the nation’s farm sector Page 104 Policy Impacts on the Farm Sector

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?