Transcript Aggregate supply and demand Chapters 31, 32, and 33

AGGREGATE SUPPLY
AND AGGREGATE
DEMAND
CHAPTERS 31, 32,
AND 33
By Thuy Le
CHAPTER 31
Open-Economy Macroeconomics: Basic
Concepts
CHAPTER 31
 Prior
to this you’ve only studied closed
economies

economies that do not interact with other
economies in the world
 In
macroeconomics, many new situations
arise when studying open economies

economies that interact freely with other economies
around the world
CHAPTER 31
 An
open economy allows for a greater flow
of goods and services. Some terms to know
are:
Exports: goods and services that are produced
domestically and sold abroad
 Imports: goods and services that are produced
abroad and sold domestically
 Net exports/Trade balance: the value of a nation’s
exports minus the value of its imports

CHAPTER 31
 More
terms to know:
balanced trade: a situation in which exports equal
imports
 trade deficit: an excess of imports over exports
 trade surplus: an excess of exports over imports

CHAPTER 31
 There
are many variables which can affect
international trade. Some of them are:






Consumers’ preferences for foreign and domestic
goods
Prices of goods at home and abroad
Incomes of consumers at home and abroad
The exchange rates at which foreign currency trades
for domestic currency
Transportation costs
Government policies
CHAPTER 31
 Residents
of an open economy participate
in the market for goods and services, but
they can also participate in the world
financial market.
 When talking about the flow of financial
resources economists use the term net
capital outflow, formerly known as net
foreign investment.

the purchase of foreign assets by domestic residents
minus the purchase of domestic assets by foreigners
CHAPTER 31
 There
are many terms related to a country’s
NCO. Some are:

Foreign direct investment: Domestic residents
actively manage the foreign investment

Ex: Thuy, a U.S. resident, is the owner of the H.B. Reese
Company and builds a plant in China so she can
produce Reese’s cups on the cheap

Foreign portfolio investment: Domestic residents
purchase foreign stocks or bonds, supplying loanable
funds to a foreign firm.

Ex: Nick, a U.S. resident, purchases stocks of Adidas, his
favorite German shoe company
CHAPTER 31
NCO
measures the imbalance in a country’s
trade in assets:
When
NCO > 0, there is capital outflow
When
NCO < 0, there is capital inflow
 It
is important to remember that NCO will
always equal NX.

Every transaction that affects NX also affects NCO by
the same amount
CHAPTER 31
 Earlier,
you learned about GDP equaling C
+ I + G + NX. This identity can now be used
with NCO so we can relate the flow of trade
to savings and investment.
Y = C + I + G + NX is also true when written as
Y – C – G = I + NX , and this can be rearranged to
be
S = I + NX
means
since S = Y – C – G, which
S = I + NCO
since NX = NCO
CHAPTER 33
 When
S > I, the excess loanable funds flow
abroad in the form of positive net capital
outflow.
 When
S < I, foreigners are financing some
of the country’s investment, and NCO < 0.
CHAPTER 31
 In
addition to NX and NCO, economists also
look at two other variables when studying
international transactions. They are:
nominal exchange rate: the rate at which a person
can trade the currency of one country for the
currency of another
and
 real exchange rate: the rate at which a person can
trade the goods and services of one country for the
goods and services of another


exP
P*
P = domestic price
P* = foreign price (in foreign currency)
e = nominal exchange rate
CHAPTER 31
 Exchange
rates change from time to time.
When they do, a nation’s currency is said to
be appreciating or depreciating.
Appreciation: an increase in the value of a currency
as measured by the amount of foreign currency it can
buy
 Depreciation: a decrease in the value of a currency
as measured by the amount of foreign currency it can
buy

CHAPTER 31
 The
simplest theory of exchange rates is the
purchasing power parity, which is based on
the law of one price.

The purchasing power parity: a theory of exchange
rates whereby a unit of any currency should be able
to buy the same quantity of goods in all countries
CHAPTER 32
A Macroeconomic Theory of the Open
Market
CHAPTER 32
 The
previous chapter explained the basic
concepts and vocabulary of the open
economy.
 This chapter ties these concepts together
into a theory of the open economy.
 To understand open economies you have to
focus on two main markets.
The loanable funds market
 The foreign-currency exchange market

CHAPTER 32
 The
Market for Loanable Funds
r
S = saving
r1
D = I + NCO
LF
CHAPTER 32
 The
E
Foreign Currency Exchange Market
S = NCO
E1
D = NX
Dollars
CHAPTER 32
 The
link between the two markets is NCO,
which is included in two important identities
S = I + NCO
 NCO = NX

 NCO
is part of the demand in loanable
funds market and is the source of supply in
the foreign currency exchange market.
 All three graphs are commonly drawn
together to show this relationship.
CHAPTER 32
 Many
policies and events can affect the
open market and in turn affect all three
graphs.
 Some possible things are:
Government budget deficits
 Trade policies
 Political instability/Capital flight

CHAPTER 32
 Budget





deficits
Decreases the supply of loanable funds
Increases the RIR
Reduces NCO
Decreases the supply of dollars
Causes the dollar to appreciate
CHAPTER 32
 Trade
policies: a government policy that
directly influences the quantity of goods and
services that a country imports or exports.
Some examples are:

Tariff : a tax on imports

Import quota : a limit on the quantity of imports

“Voluntary export restrictions”: the government
pressures another country to restrict its exports which
is essentially the same as an import quota
CHAPTER 32
 Capital
flight: a large and sudden reduction
in the demand for assets located in a
country.
 Capital flight





Increases NCO
Increases the demand for loanable funds
Increases the RIR
Increases the supply of dollars
Causes the dollar to depreciate
CHAPTER 33
Aggregate Demand and Aggregate
Supply
CHAPTER 33
 Over
the long run, real GDP grows about
3% per year on average.
 In
the short run, GDP fluctuates around its
trend.

Recessions: periods of falling real incomes
and rising unemployment

Depressions: severe recessions
 Short-run
economic fluctuations are often
called business cycles.
CHAPTER 33
 There
are three facts about economic
fluctuations
Economic fluctuations are irregular and
unpredictable.
 Most macroeconomic quantities fluctuate together.
 As output falls, unemployment rises.

CHAPTER 33
 Explaining
these fluctuations is difficult, and
the theory of economic fluctuations is
controversial.
 Most economists use the model of
aggregate demand and aggregate supply
to study fluctuations.
 This model differs from the classical
economic theories economists use to
explain the long run.
CHAPTER 33
 The
previous chapters are based on the
ideas of classical economics
 The
Classical Dichotomy is the separation
of variables into two groups:
Real: quantities, relative prices
 Nominal: measured in terms of money

 The
neutrality of money:
Changes in the money supply affect nominal
but not real variables.
CHAPTER 33
 Most
economists believe classical theory
describes the world in the long run,
but not the short run.
 In
the short run, changes in nominal
variables (like the money supply or PL) can
affect real variables (like Y or
unemployment).
 To
study the short run, we use a new model.
CHAPTER 33
 The
model of aggregate demand and
aggregate supply
P
SRAS
P1
AD
Y1
Y
CHAPTER 33
 Terms
to know:
aggregate-demand curve: a curve that shows the
quantity of goods and services that households,
firms, the government, and customers abroad want to
buy at each price level
 aggregate-supply curve: a curve that shows the
quantity of goods and services that firms choose to
produce and sell at each price level

CHAPTER 33
 The
aggregate demand curve is downward
sloping because of
The wealth effect
 The exchange-rate effect
 The interest-rate effect


AD will shift if there is a change in
GDP
 Money supply

CHAPTER 33
 The
aggregate supply curve is
Upward-sloping in the short run
 Vertical in the long run P

LRAS
SRAS
Y
CHAPTER 33
 LRAS
is vertical because
YN determined by the economy’s
stocks of labor, capital,
P
and natural resources,
and on the level of
technology.
 An increase in P does
not affect
any of these,
so it does not
affect YN.

LRAS
YN
Y
CHAPTER 33
 LRAS
will shift if there is a change in
Any factors of production
 Natural resources
 Technology

 SRAS
will shift if
LRAS shifts
 There is a change in price level/expectations
 There is a supply shock

CHAPTER 33
 There
are 3 theories of SRAS
The sticky wage theory
 The sticky price theory
 The misperceptions theory

 The
imperfections in these theories are
temporary. Over time,
sticky wages and prices become flexible
 misperceptions are corrected

 In
the LR,
PE = P
 AS curve is vertical

Congratulations!
You’ve learned
everything there is to
know in
Chapters
31-33!