Chapter 9
An Introduction to Basic Macroeconomic Markets
OUTLINE
I. Understanding Macroeconomics: Our Game Plan
A. As a basic macroeconomic model is developed, we will have some assumptions.
2. Taxes and expenditures are constant.
B. Thus, there is a circular flow of output and income between these two key sectors:
businesses and households.
II. Four Key Markets Resources, Goods and Services, Loanable Funds And Foreign
Exchange Markets Coordinate the Circular Flow of Income
A. Goods and Services Market: In this market, businesses supply goods and services in
exchange for sales revenue. Households, investors, governments, and foreigners (net
exports) demand goods.
B. Resource Market: Highly aggregated market where business firms demand resources
because of their contribution to the production of goods and services; households
supply labor and other resources in exchange for income.
III. Aggregate Demand for Goods and Services
A. Aggregate demand curve indicates the various quantities of domestically produced
goods and services that purchasers are willing to buy at different price levels.
B. AD curve slopes downward to the right, indicating an inverse relationship between the
amount of goods and services demanded and the price level.
C. Why Does the Aggregate Demand Curve Slope Downward?
1. A lower price level will increase the purchasing power of the fixed quantity of
money.
2. The Interest Rate Effect: a lower price level will reduce the demand for money and
3. Other things constant, a lower price level will make domestically produced goods
less expensive relative to foreign goods.
IV. Aggregate Supply of Goods and Services
A. When considering the AS curve, it is important to distinguish between the short run
and the long run.
1. Short run: time period during which some prices, particularly those in labor
markets, are set by prior contracts and agreements. Therefore, in the short run,
2. Long run: a time period of sufficient duration that people have the opportunity to
modify their behavior in response to price changes.
B. Short-Run Aggregate Supply (SRAS)
1. Indicates the various quantities of goods and services that domestic firms will
3. The upward slope reflects the fact that in the short run an unanticipated increase in
the price level will improve the profitability of firms. They will respond with an
expansion in output.
C. Long-Run Aggregate Supply (LRAS)
1. Indicates the relationship between the price level and quantity of output after
2. LRAS curve is vertical.
3.
V. Equilibrium in the Goods and Services Market
A. Short-run Equilibrium.
1. Short-run equilibrium is present in the goods and services market at the price level
3. At the market-clearing price, the amount that buyers want to purchase is just equal
B. Long-run Equilibrium.
1. A second condition is required for long-run equilibrium: the buyers and sellers
must have correctly anticipated the consequences of their prior choices.
2. Thus, long-run equilibrium requires that decision makers who agreed to long-term
C. When Long-run Equilibrium is present:
2. Economy is operating at full employment.
D. -Run Potential?
1. An unexpected change in the price level (rate of inflation) will alter the rate of
3. An unexpected decline in the price level will cause output and employment to fall
in the immediate future.
VI. Resource Market
A. The demand for resources: Business firms demand resources because they
contribute to the production of goods the firm expects to sell at a profit.
B. The demand for resources slopes downward to the right.
firms into balance with the amount supplied by resource owners.
VII. Loanable Funds Market
A. Interest rate coordinates the actions of borrowers and lenders.
B.
From the lender s viewpoint, interest is a premium received for waiting, for
delaying possible expenditures into the future.
C. Money and real interest rate
1. When the inflation rate is anticipated, lenders will demand (and borrowers will
D. Real interest rate = Money interest rate Inflation premium
VIII. Foreign Exchange Market
A. When Americans buy from foreigners and make investments abroad (an outflow of
capital), their actions will generate a demand for foreign currency in the foreign
exchange market.
B. On the other hand, when Americans sell products and assets (including bonds) to
IX. Long Run Equlibrium
A. Macroeconomic equilibrium requires that equilibrium be achieved in all four key
macroeconomic markets and that they be in harmony with one another.
OBJECTIVES
This chapter presents the basic model that will be utilized throughout the macroeconomics section
of the text. The model consists of three basic, interrelated markets: (1) goods and services, (2)
resources, and (3) loanable funds. In contrast with the analysis of Chapter 3, the basic markets of
108 Chapter 9/An Introduction to Basic Macroeconomic Markets
IMPORTANT POINTS AND TEACHING TIPS
1. The circular flow diagram of Exhibit 1 illustrates the three basic macroeconomic markets. Use
2. Initially, we make two important assumptions as the basic macroeconomic model is developed.
First, we assume that government expenditure and taxation policies are unchanged. This
3. Of course, the aggregate demand curve is inversely related to price (the price level) for different
4. When discussing saving and the supply of loanable funds, be sure to emphasize that saving is a
5. Other things constant, an increase in the price level in the goods and services market will (a)
improve profit margins since many components of costs are temporarily fixed and (b) lead many
6.
8. Go over Exhibit 5 carefully making sure students understand that long-run equilibrium in the
9. Students have difficulty understanding the connection between interest rates and bond prices. A
10. A useful way of reinforcing the relationship between bond prices and interest rates is with a
11. It is worth emphasizing that aggregate supply and demand analysis reflects the generally
different speeds of adjustment in different macroeconomic markets. Financial markets tend to
12. To help cement student understanding of why the long-run aggregate supply curve is vertical
with respect to the price level, it is often useful to ask them whether a law halving the official
HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS
2. In the long run, the major factors influencing aggregate supply are: (1) the size of the resource
base, (2) technology, and (3) the institutional arrangements of the economy. The long-run
8. When the price level is higher than decision makers had anticipated, real wages will be lower
and the level of employment higher than would have been the case if the price level had been
9. 4 percent; 4 percent; it will fall to 1 percent.
16. a. Real GDP = $5,400