1. Macroeconomics
December 23 2011

2. Demand for Money
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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?
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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. Components of Money Stock
»Currency
»Demand Deposits
»Traveler’s checks (non-banks)
»Other checkable deposits
»MMMFs
»MMDAs
»Savings by deposits
»Small time deposits
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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
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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
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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
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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
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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
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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
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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?
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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
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14. Aggregate Supply
Analysis – Classical View
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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
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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!
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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)
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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?
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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
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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
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21. Supply of Labor Function
»Real wages play a key role!
»N
S
= f(W/P)
»Relationship between real wages and labor
supplied
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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
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S

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
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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!
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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
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26. Equilibrium in the Classical Model
» Money Market:
» M = KPY
» Goods Market:
» S = f(r)
» I = f(r)
»S = I
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27. Case Discussion – Should
Energy be Subsidized?
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28. Questions???

29. Have a happy Sunday!