ECONOMICS: Principles and Applications 3e HALL & LIEBERMAN © 2005 Thomson Business and Professional Publishing The Stock Market and the Macroeconomy

Table 1 The Performance of Three Stock Market Indexes

Figure 1 The Market for Shares of FedEx Corporation Number of Shares Price per Share E S $ D 298 million

Figure 2 Shifts in the Demand for Shares Curve

Figure 3 The Two-Way Relationship Between the Stock Market and the Economy Stock MarketMacroeconomy

Figure 4 The Effect of Higher Stock Prices on the Economy (a)(b) Y1Y1 Y2Y2 Real GDP Aggregate Expenditure AE higher stock prices Real GDP Price Level Y1Y1 Y3Y3 Y2Y2 AS 45° AE lower stock prices AD higher stock prices AD lower stock prices P1P1 P2P2

The Wealth Effect and Equilibrium GDP Stock prices Autonomous consumption spending Both real GDP and price level Household wealth Multiplier effect

How the Economy Affects The Stock Market: Expansion Real GDP Expected future profits Current profits Demand curves for stocks shift rightward Current stock prices

How the Economy Affects The Stock Market: Recession Real GDP Expected future profits Current profits Demand curves for stocks shift leftward Current stock prices

Figure 5 Three Types of Shocks Shock to both stock market and macroeconomy Shock to macroeconomy Shock to stock market Stock MarketMacroeconomy

A Shock to the Economy Real GDP Government purchases Multiplier effect

A Shock to the Economy Real GDP Corporate profits Stock prices

A Shock to the Economy Stock prices Real GDP Autonomous consumption spending Multiplier effect

Figure 6 The Fed’s Problem in 2000: An AS–AD View Real GDP Price Level Y1Y1 Y2Y2 (a) P1P1 AD 2 A B P2P2 AD 1 AS AS 1 AS 2 A AD 2 AD 1 (b) Real GDP P1P1 P2P2 Y1Y1 Y2Y2 B C P3P3 Price Level If output exceeds potential, the self-correcting mechanism will raise the price level further Wealth effect of rising stock prices shifts AD rightward, raising real GDP and the price level

Figure 7 The Fed’s Problem In 2000: A Phillips Curve View A C B D 4%5% 2.5% 5.0% 1.5% PC 1 PC 2... or recession Unemployment Rate Inflation Rate A 4% 2.5% PC 1 UN?UN? (a)(b) Inflation Rate If the natural rate of unemployment is 4%, the Fed can keep the economy at point A in the long run Unemployment Rate UN?UN? But if the natural rate is above 4% the Phillips curve will shift upward and the Fed must choose between higher inflation...