Macroeconomics
December 23 2011
Demand for Money

2
Aggregate Supply

»What is money and why do people want it?
»Medium of exchange
»Store of value
»Income
»Wealth
»Why do fi...
Aggregate Supply

»What is money and why do people want it?
»Medium of exchange
»Store of value
»Income
»Wealth
»Why do fi...
Components of Money Stock

»Currency
»Demand Deposits
»Traveler’s checks (non-banks)
»Other checkable deposits
»MMMFs
»MMD...
Components of Money Stock

»Repurchase Agreements (RP)
»Eurodollars
»Large denomination time deposits
»Institutional holdi...
Components of Money Stock

»M1 = Currency + DD + TCs + Other
checkable deposits

»M2 = M1 + MMMFs + MMDAs + Savings
Deposi...
Functions of money

»Store of value
»Asset that maintains value over time
»Makes purchases at a future date
»Unit of accou...
Functions of money

»Standard of deferred payment
»Asset that is used in long-term
transactions such as loans

»Indexed lo...
Demand for Money

»Demand for money is a demand for real
balances

»Real money demand is unchanged when
price level increa...
Demand for Money

»Demand for money is a demand for real
balances

»Real money demand is unchanged when
price level increa...
Income Velocity of Money

»Number of times the stock of money is
turned over per year in financing the annual
flow of inco...
Quantity Theory of Money

»M x V = P x Y
»Equation links price level and the level of
output to money stock

»‘Classic’ ec...
Aggregate Supply
Analysis – Classical View

14
Aggregate Supply

»Role of Aggregate Demand in determining
the economy’s output

»What does the AD curve signify?
»What is...
Aggregate Supply curve

»Classical Supply curve:
»Vertical – indicating that the same
amount of goods will be supplied
wha...
Production Function

»Technological relation between the rates of
input of productive resources and the
maximum rate of ou...
Production Function

»Output’s relationship to capital stock and
labor employed?

»Recall diminishing returns!
»Assumption...
Demand for Labor Function

»Assumption: Given capital stock, pure
competition

»Demand for labor curve consists of the MP ...
Demand for Labor Function

»W/P = MP

L

»To obtain the demand curve, the
relationship between real wage and the
amount of...
Supply of Labor Function

»Real wages play a key role!
»N

S

= f(W/P)

»Relationship between real wages and labor
supplie...
Summary of labor demand and supply

» Production is entirely a function of the quantity
of labor: Y = f(N)

» Amount of la...
Keynesian Aggregate Supply Model

» Criticism of assumptions made in Classical
model

» Similarity of views on Aggregate P...
Classical Analysis of Income Determination

» Say’s Law of Markets: Supply creates its own
demand

» Exchange between part...
Equilibrium in the Classical Model

» Economy consists of 3 markets: Labor, money
and goods

» Labor Market:
» Y = f(N)
» ...
Equilibrium in the Classical Model

» Money Market:
» M = KPY
» Goods Market:
» S = f(r)
» I = f(r)
»S = I

26
Case Discussion – Should
Energy be Subsidized?

27
Questions???
Have a happy Sunday!
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Macroeconomics 23 dec

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Macroeconomics 23 dec

  1. 1. Macroeconomics December 23 2011
  2. 2. Demand for Money 2
  3. 3. Aggregate Supply »What is money and why do people want it? »Medium of exchange »Store of value »Income »Wealth »Why do firms/individuals hold money? »What assets constitute money? 3
  4. 4. Aggregate Supply »What is money and why do people want it? »Medium of exchange »Store of value »Income »Wealth »Why do firms/individuals hold money? »What assets constitute money? 4
  5. 5. Components of Money Stock »Currency »Demand Deposits »Traveler’s checks (non-banks) »Other checkable deposits »MMMFs »MMDAs »Savings by deposits »Small time deposits 5
  6. 6. Components of Money Stock »Repurchase Agreements (RP) »Eurodollars »Large denomination time deposits »Institutional holdings of MMMFs »Savings Bonds »Banker’s acceptances »Commercial Paper »Short-term Treasury Securities 6
  7. 7. Components of Money Stock »M1 = Currency + DD + TCs + Other checkable deposits »M2 = M1 + MMMFs + MMDAs + Savings Deposits + Small time deposits »M3 = M2 + RPs + Eurodollars + Large denomination TDs + Institutional holdings of MMMFs »M4 = M3 + Savings bonds + Banker’s acceptances + CPs + Treasury securities 7
  8. 8. Functions of money »Store of value »Asset that maintains value over time »Makes purchases at a future date »Unit of account »Unit in which prices are quoted and books kept »For high-inflation countries, dollars serve as the unit of account 8
  9. 9. Functions of money »Standard of deferred payment »Asset that is used in long-term transactions such as loans »Indexed loans »Money is usually whatever is generally accepted in exchange – if sea shells work, so be it! »Money is accepted only because it would be accepted by others later 9
  10. 10. Demand for Money »Demand for money is a demand for real balances »Real money demand is unchanged when price level increases »Nominal money demand increases in proportion to the increase in price level »3 motives for holding money: Transactions motive, precautionary motive, speculative motive 10
  11. 11. Demand for Money »Demand for money is a demand for real balances »Real money demand is unchanged when price level increases »Nominal money demand increases in proportion to the increase in price level »3 motives for holding money: Transactions motive, precautionary motive, speculative motive 11
  12. 12. Income Velocity of Money »Number of times the stock of money is turned over per year in financing the annual flow of income »Ratio of nominal GDP to nominal money stock »Income Velocity: »V = (P x Y)/M = Y/(M/P) »What does high velocity indicate? 12
  13. 13. Quantity Theory of Money »M x V = P x Y »Equation links price level and the level of output to money stock »‘Classic’ economists’ view: Economy was at full employment and real output was fixed; velocity was expected to be stable »What happens if ‘V’ an ‘Y’ are fixed? »Theory of inflation 13
  14. 14. Aggregate Supply Analysis – Classical View 14
  15. 15. Aggregate Supply »Role of Aggregate Demand in determining the economy’s output »What does the AD curve signify? »What is Aggregate Supply and how does the curve look like? »Combinations of output and the price level at which firms are willing, at the given price level, to supply the given quantity of output 15
  16. 16. Aggregate Supply curve »Classical Supply curve: »Vertical – indicating that the same amount of goods will be supplied whatever be the price level »Assumption: Labor market equilibrium »Long term possibility »Why should supply curve be vertical in long run? Recall how it was in microeconomics! 16
  17. 17. Production Function »Technological relation between the rates of input of productive resources and the maximum rate of output that can be had from the inputs, given the technology of production »Example? »What does production function mean in the microeconomic context? »Y = f(K, N) 17
  18. 18. Production Function »Output’s relationship to capital stock and labor employed? »Recall diminishing returns! »Assumption for the model: Constant capital stock and technology »New production function: Y = f(N) »The production function graph »Reason why the slope reduces? 18
  19. 19. Demand for Labor Function »Assumption: Given capital stock, pure competition »Demand for labor curve consists of the MP of labor curve »The condition of W = P * MP L »Cost of hiring an additional worker vis-à-vis the revenue associated with the employment of the additional laborer 19
  20. 20. Demand for Labor Function »W/P = MP L »To obtain the demand curve, the relationship between real wage and the amount of labor is used »Slope of the production function »Downward sloping demand curve for labor: ND = f(W/P) »Shifts in demand for labor 20
  21. 21. Supply of Labor Function »Real wages play a key role! »N S = f(W/P) »Relationship between real wages and labor supplied 21
  22. 22. Summary of labor demand and supply » Production is entirely a function of the quantity of labor: Y = f(N) » Amount of labor supplied depends only on real wage and increases with real wage » Amount of labor demanded also depends only on real wage rate and decreases with it » Real wages perfectly flexible (“flex price”) » Economy is made up of efficiently operating − markets that are very flexible (N = N = N) D 22 S
  23. 23. Keynesian Aggregate Supply Model » Criticism of assumptions made in Classical model » Similarity of views on Aggregate Production Function and demand for labor » Keynesian Assumptions: » Nominal wage is exogenous (No rapid adjustment) » Labor market is not always in equilibrium 23
  24. 24. Classical Analysis of Income Determination » Say’s Law of Markets: Supply creates its own demand » Exchange between parties involves two transactions of the counteractive nature » No overproduction of goods » Possibility of preference of total output surpassing total demand » Extension of this theory: Money is not preferred for money! 24
  25. 25. Equilibrium in the Classical Model » Economy consists of 3 markets: Labor, money and goods » Labor Market: » Y = f(N) » dY/dN = W/P »N = f(W/P) »N = f(W/P) »N = NS D S D 25
  26. 26. Equilibrium in the Classical Model » Money Market: » M = KPY » Goods Market: » S = f(r) » I = f(r) »S = I 26
  27. 27. Case Discussion – Should Energy be Subsidized? 27
  28. 28. Questions???
  29. 29. Have a happy Sunday!

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