Supply and Demand

Supply and Demand • Prices • Supply • Demand • Movements along curves • Shifts of curves • Equilibrium and disequilibrium • Predictions of the S & D model

Supply and Demand Supply 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 questions • 8 fundamental ideas • 3 processes to understand the above

5 big questions • What to produce • How to produce • When to produce • Where to produce • Who consumes/produces

8 fundamental ideas • Choices are tradeoffs because of scarcity • 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 • Voluntary tradeoffs make transacting parties better off because of rationality • Markets are very efficient ways of organizing this sort of exchange • When incentives conflict with marginal choices, markets may fail and alternative mechanisms designed and employed (contracts, government, clubs).

8 fundamental ideas • Income = expenditure = gross value • Productivity gains enhance living standards

8 fundamental ideas (4) • inflation occurs when production grows at a slower rate than the quantity and use of money in the economy • unemployment is a necessary evil

3 processes used in 2 approaches • Approaches • Positive • How things are • Normative • How things ought to be • Tasks: • Observing and measuring • Modeling • Testing

Macroeconomic issues, by approach • Positive Issues • Growth • tradeoff consumption today for more future consumption • Employment • +/ - • Inflation • +/ - • Budget Deficits • +/ - • Normative Issues • Fiscal Policy • Monetary 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 Investment • Example 2: Wealth and Saving

Expenditure=income=value • National Income and Product Accounting • Y = C + I + G + X - M • Households are … Y - (C + S + T) • Governments are … G - T + (T - G) • Firms are (C+I+G+NX) + (S-G-I-(M-X)) - Y • Rest of the world are (X-M) - (S-G-I)

Measuring GDP • Expenditure Approach: C+I+G+NX • Income 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

Inflation • CPI = % chg. in price index. • Tendency for upward bias in consumption • GDP Deflator = (GDP/realGDP) * 100 • Bias injected via use of CPI in calculation of volume of goods produced.

Synthesis • Aggregate Supply (AS) • Aggregate Demand (AD) • General Economic Equilibrium • “Positive” Effects of changes in AS and AD on Economic Growth • “Normative” Directions

CPI AS Potential GDP GDP 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 AD 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 AD AS Potential GDP GDP 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. GE

Movements along the AS, in the short run

Shifts in short run AS

Movements along the AD, in the short run

Shifts in AD

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?

Money • Definition • Uses • Medium of exchange • Unit of Account (“numeràire”) • Store of value • Measuring money (M1, M2, …)

Financial intermediaries • Firms that manage the flow of financial funds from households and firms to other households and firms. • Commercial banks • S&L’s • Savings Banks and Credit Unions • Money Market Mutual Funds

Money and Banking • Liabilities + Net worth = Assets • (deposits + owner’s equity = loans made) • deposits = reserves + loans made • reserves = 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

Regulation • Deposit insurance • FDIC • Balance sheet rules • capital requirements • reserve requirements • deposit rules • lending rules

Money “creation” • The deposit-loan-reserve chain. • International Effects: • Reverse Repurchase Agreements - Foreign Official and International Accounts

RepurchaseAgreements • A 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.

ReserveBalances • 11% 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 Swaps • A 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 efffects • Shifts AD right or left

Long term AD - AS effects • Shift of the SAS right of left

Supply and Demand