Supply and Demand Prices Supply Demand Movements along curves Shifts of curves Equilibrium and disequilibrium Predictions of the S & D model
Jan 05, 2016
Supply and Demand
PricesSupplyDemandMovements along curvesShifts of curvesEquilibrium and disequilibriumPredictions of the S & D model
Supply and DemandSupply is the term we
assign to the description of the relationship between the quantity supplied of a good and its price, ceteris paribus.
Demand is the term we use to express the relationship between the quantity demanded of a good and its price , ceteris paribus.
Supply and Demand:movement along the curves:As the price of a good
increases, the quantity supplied increases, ceteris paribus.
The above effect is shown graphically as an upward movement along the Supply curve.
As the price of a good increases, the quantity demanded decreases, ceteris paribus.
The above effect is shown graphically as a downward movement along the Demand curve.
Supply and Demand:shifts of the curves
Supply depends on: Price of the good Number of Firms Capital Base Prices of the inputs Prices of substitutes Prices of complements Expectations about
future prices of all of the above
Firm Mission
Demand depends on: Price of the good Income Population Prices of substitutes Prices of complements Expectations about
future prices of all of the above, and income
Buyer preferences
Market in Equilibrium
The market price is referred to as the equilibrium price when the quantity demanded at such price = quantity supplied at such price.
Market out of equilibriumcomparative statics
When prices exceed the equilibrium price, market is in excess supply.
When prices are lower than the equilibrium price, market is in excess demand.
Summary of Macroeconomics
5 big questions8 fundamental ideas3 processes to understand the above
5 big questions
1. What to produce2. How to produce3. When to produce4. Where to produce5. Who consumes/produces
8 fundamental ideas1. Choices are tradeoffs because of
scarcity
2. Choices are made at the margin because of incentives
Diminishing marginal returns: “What have you done for me lately?” “It’s never as good as the last time”
8 fundamental ideas
3. Voluntary tradeoffs make transacting parties better off because of rationality
Markets are very efficient ways of organizing this sort of exchange
4. When incentives conflict with marginal choices, markets may fail and alternative mechanisms designed and employed (contracts, government, clubs).
8 fundamental ideas
5. Income = expenditure = gross value
6. Productivity gains enhance living standards
8 fundamental ideas (4)
7. inflation occurs when production grows at a slower rate than the quantity and use of money in the economy
8. unemployment is a necessary evil
3 processes used in 2 approaches Approaches
1. Positive How things are
2. Normative How things ought
to be
Tasks:1. Observing and
measuring
2. Modeling
3. Testing
Macroeconomic issues, by approach
Positive Issues Growth
tradeoff consumption today for more future consumption
Employment +/ -
Inflation +/ -
Budget Deficits +/ -
Normative IssuesFiscal PolicyMonetary Policy
Economics Measurements:Stocks versus flows
A stock is a measurement at a point in time.A flow is a measurement over time -per unit
of time.Example 1: Capital stock and InvestmentExample 2: Wealth and Saving
Expenditure=income=valueNational Income and Product Accounting
Y = C + I + G + X - MHouseholds are … Y - (C + S + T)Governments are … G - T + (T - G)Firms are (C+I+G+NX) + (S-G-I-(M-X)) - YRest of the world are (X-M) - (S-G-I)
Measuring GDPExpenditure Approach: C+I+G+NXIncome Approach:
Employee compensation + Net Interest + Rental Income + Corporate profits + Proprietor’s Income = net domestic income @ factor cost + adjustments from factor cost to market prices + adjustment to gross product = GDP
InflationCPI = % chg. in price index.
Tendency for upward bias in consumptionGDP Deflator = (GDP/realGDP) * 100
Bias injected via use of CPI in calculation of volume of goods produced.
SynthesisAggregate Supply (AS)Aggregate Demand (AD)General Economic Equilibrium“Positive” Effects of changes in AS and AD
on Economic Growth“Normative” Directions
Aggregate Supply (AS) is ...
The sum total of all production activity in an economy, expressed as a relation between:price levels (CPI on
vertical axis) and output (GDP on
horizontal axis)
CPI AS
Potential
GDP
GDP
Aggregate Demand (AD) is ...
The sum total of all expenditure activity in an economy, expressed as a relation between:price levels (CPI on
vertical axis) and output (GDP on
horizontal axis)
CPI
Potential
GDP
GDP
ADAS
General Equilibrium (GE) is ...The “consensus”
point between AD and AS, where production and consumption sectors find agreement in the general level of prices and output for the economy at a point in time.
CPI
Potential
GDP
GDP
ADAS
GE
Movements along the AS, in the short run
Short Run, real GDP increases when …
CPI rises but resource/factor prices rise at a slower rate, or
do not change.
Short Run, real GDP decreases when …
CPI falls but resource (factor) prices fall at a faster rate, or
do not change.
Shifts in short run ASSRAS shifts to the left when SRAS shifts to the right when
Prices of factors of production (resources) rise faster than the CPI (prices at which the goods sell in the economy)
Prices of factors of production (resources) fall faster than the CPI (prices at which the goods sell in the economy)
Amount (stock) of resources in the economy decreases (LF, K, Natural)
Amount (stock) of resources in the economy grows (LF, K, Natural)
Technological innovation occurs.
Protections of intellectual property are forgone globally.
Intellectual property becomes better protected globally.
Movements along the AD, in the short run
Quantity of real GDP demanded increases if …
The general level of prices (CPI) decreases, ceteris paribus … because of wealth and substitution effects
Quantity of real GDP demanded decreases if …
The general level of prices (CPI) increases, ceteris paribus … because of wealth and substitution effects
Shifts in AD
AD DECREASES IF AD INCREASES IF
Expected Y, inflation, or profits
Expected Y, inflation, or profits
Gov't Demand , Taxes , Transfers (Fiscal Policy changes)
Gov't Demand , Taxes , Transfers (Fiscal Policy changes)
Money , and/or Interest Rates (Monetary Policy changes)
Money , and/or Interest Rates (Monetary Policy changes)
Exchange rates Exchange Rates
Foreign income Foreign Income
Normative directions in policy
Is AD “flat” or “steep” --i.e., is demand responsive to changes in CPI or not in the short run?
Is AD “flat” or “steep” --i.e., is demand responsive to changes in CPI or not in the long run?
Which is more effective in the short run, Monetary or Fiscal policy?
Which is more effective in the long run, Monetary or Fiscal policy?
MoneyDefinitionUses
Medium of exchangeUnit of Account (“numeràire”)Store of value
Measuring money (M1, M2, …)
Financial intermediariesFirms that manage the flow of financial
funds from households and firms to other households and firms.Commercial banksS&L’sSavings Banks and Credit UnionsMoney Market Mutual Funds
Money and Banking Liabilities + Net worth = Assets(deposits + owner’s equity = loans
made)
deposits = reserves + loans madereserves = vault cash + FRB account
Economic functions of financial intermediaries
Create ‘liquidity’Minimize the ‘cost of obtaining funds’Minimize the ‘cost of lending funds’Pooling risks in order to maximize profits
RegulationDeposit insurance
FDICBalance sheet rules
capital requirementsreserve requirementsdeposit ruleslending rules
Money “creation”
The deposit-loan-reserve chain.International Effects:
Reverse Repurchase Agreements - Foreign Official and International Accounts
Repurchase
AgreementsA Repurchase Agreement is a contract to sell an asset and repurchase it in the future. It is a money-market instrument . For the party on the other end of the transaction , (buying the security and agreeing to sell in the future) it is a Reverse Repurchase Agreement. RRAs are usually used to raise short-term capital.
Reserve Balances11% of deposits at U.S. Banks
Balances are the sum total of all reserves held by the Fed for Banks in the Banking System
Liquidity SwapsA swap arrangement involves two
transactions. A foreign central bank draws on (obtains funding
under) the swap line, thus selling a certain amount of its currency to the Federal Reserve at the prevailing market exchange rate in exchange for dollars. This market rate becomes the swap exchange rate.
At the same time, the Federal Reserve and the foreign central bank enter into a binding agreement for a second transaction in which the foreign central bank is obligated to repurchase the foreign currency at a specified future date. The second transaction is done at the swap exchange rate—that is, the same exchange rate as in the first transaction
Short term AD - AS efffectsShifts AD right or left
Long term AD - AS effects
Shift of the SAS right of left