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

MACRO SUPPLY and DEMAND The Product Market

Macro Markets The Product Market (1) 1. A box in the Circular Flow Diagram PrM Spending (X) Income (Y) = Wages + Profit

Macro Markets The Product Market (3) 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) xpq 633 An increase of spending raises x, causing p and q to rise That is, AD increases => p and q rise An example of an AS decrease (a cost increase) xpq An increase of cost raises p. With no change of x, q falls That is, AS decreases => p rises and q falls

Macro Markets The Product Market (2) 3. A Supply and Demand Graph q = real growth p = inflation AD = x AS 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).

Macro Markets The Product Market (2) 2. A Supply and Demand Graph q p AD 1 AS 3% AD 0 An increase of Aggregate Demand occurs when people in total want to spend more p and q both rise

Macro Markets The Product Market (2) 2. A Supply and Demand Graph q p AS 1 AS 0 3% AD 0 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

MACRO SUPPLY and DEMAND 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

Macro Markets The Credit Market (2) 2. A Supply and Demand Graph 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 L 0 = S + K + ΔMS L 1 Z,x i B 1 L B = I + Def An increase of Demand could be caused by: Demand increase 1. an increase of Saving 2. increased foreign capital 3. an increase of the money supply 1. greater Investment demand (greater business optimism) 2. a larger Gov’t Deficit

Macro Markets The Credit Market (3) 3. The Credit Market Equation An example: printing money raises AD. x = m + v Spending (x) can grow if: xmv An example: a spending increase without printing money. xmv (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.

MACRO SUPPLY and DEMAND The Labor Market

THE LABOR MARKET describes the process of offering and hiring workers n w DLDL SLSL w0w0 n0n0 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 DLDL SLSL w0w0 n0n0 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 D1D1 w1w1 n1n1 D0D0

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 capital Unskilled 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 DLDL SLSL w0w0 n0n0 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 S0S0 S1S1 w1w1 n1n1 n w DLDL SLSL w1w1 n1n1 S0S0 w0w0 n0n0 S1S1 a. more births b. more immigration c. higher labor force participation

MACRO SUPPLY and DEMAND 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 + K S = 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 dollar A “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 e0e0 $0$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. S0S0 S1S1 $1$1 e1e1 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 S e $ D0D0 D1D1 $0$0 e0e0 e1e1 $1$1

Two demand shifters in the Foreign Exchange Market: Two reasons that foreigners would want dollars. 1. To buy our exports. S e $ D0D0 $0$0 e0e0 D1D1 e1e1 $1$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.

MarketDemand ShiftersSupply Shifters ProductTotal 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 rates 3. Money Supply Changes (ΔMS) Foreign Exchange 1.Foreign Capital (K) 2.Imports (F) Exports Labor1.Labor Productivity 2.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