Markets, Prices, Supply & Demand!

EC4004 Lecture 4www.stephenkinsella.net

Today

Markets: RecapMacroeconomic Markets

1. Supply and Demand Recap

Supply & Demand

2. Markets in the Macroeconomy

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Markets in the Macroeconomy

• Assuming that households perform all of the functions in the economy.

• Each household runs a family business and uses Labour, L, and capital, K, to produce goods, Y, through the production function.

Y= A! F( K, L)

Goods MarketLabour MarketRental MarketBond Market

Goods Market.

Labour/Rental Markets

Bond Markets

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Money as a Medium of Exchange

Money

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Constructing the Budget Constraint

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Constructing the Budget Constraint

–Household Budget Constraint

–nominal value of assets= M+ B+ P K

–nominal saving to be the change over time in the nominal value of assets.

–nominal saving= (!nominal assets)

= !M + !B + P!!K

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Constructing the Budget Constraint

Total income

Household nominal income= nominal profit + nominal

wage income + nominal net rental income+ nominal interest income

Household nominal income = ! + wL + (R/P " ") ! PK + iB

Household nominal income= ! + wL + i # ( B+ P K )

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nominal saving= nominal income" nominal consumption

nominal saving= " + wL + i ! ( B+ P K ) " P C

!B + P !!K = " + wL + i!( B+ PK ) " P C

Household Budget Constraint real terms

C + ( 1/ P)#$B+ $K = !/ P + ( w/P)#L + i#(B/P+K)

consumption + real saving = real income

Household Budget Constraint

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Profit Maximization

Real Profit

"/P = A!F(Kd,Ld) " (w/P) ! Ld " (R/P) ! Kd

real profit= output

"real wage payments"real rental payments

Clearing of the Markets for Labour and Capital Services

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Clearing of Markets for Labour & Capital Services

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Clearing of the Markets for Labour and Capital Services

Profit in Equilibrium

"/P = A! F(K,L) " (w/P)!L " ( R/P)! K

w/P = MPL

R/P = MPK

"/P = A! F(K, L) " MPL! L " MPK! K

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The market clearing approach assumes that:

a. people are not able to affect prices that influence their decisions.

b. firms are able to affect prices that influence their decisions.

c. prices change very slowly.

d. all of the above.

If the nominal wage rate is #10 per hour and the price level is 2, then the real wage a worker earns is:

a. five units of goods per hour.

b. twenty units of goods per hour.

c. eight units of goods per hour.

d. one-fifth unit of goods per hour.

Individual household nominal income includes:

a.nominal interest income, iB.

b. nominal wage income, wL.

c. nominal net rental income, [(R/P) - PK]•PK.

d. all of the above.

Read Barro Chapter 7: Consumption/Savings/

Investment