Resource Market

Resource Market

Demand for Resources: Business firms demand resources (labor and capital) because they contribute to the production of goods the firm expects to sell at a profit.

The demand curve for resources slopes down and to the right.

Supply of Resources:

Households supply resources in exchange for income.

Higher prices increase the incentive to supply resources; thus, the supply curve slopes up and to the right.

Equilibrium in the Labor Market

Loanable Funds Market

The interest rate coordinates the actions of borrowers and lenders.

From the borrower’s viewpoint, interest is the cost paid for earlier availability.

From the lender’s viewpoint, interest is a premium received for waiting, for delaying possible current expenditures into the future.

The Money and Real Interest Rates

The money interest rate is the nominal price of loanable funds. The real interest rate is the real price of loanable funds.

The difference between the money rate and real interest rate is the inflationary premium.

This premium reflects the expected decline in the purchasing power of the dollar during the period the loan is outstanding.

i = r + inflation

Inflation & Interest Rate

Foreign Exchange Market

When Americans buy from foreigners or make investments abroad, they demand foreign currency in the foreign exchange market.

When Americans sell products and assets (including bonds) to foreigners, they generate a supply of foreign currency (in exchange for dollars) in the foreign exchange market.

The exchange rate will bring the quantity of foreign exchange demanded into equality with the quantity supplied.

Appreciation & Depreciation

Appreciation: Increase in the value of the domestic currency relative to foreign currencies

Depreciation: Reduction in the value of the domestic currency relative to foreign currencies

Capital Flows and Trade Flows

When equilibrium is present in the foreign exchange market, the following relation exists:

Imports + Capital Outflows=Exports + Capital Inflows

This relation can be written as:

Imports – Exports= Capital Inflows – Capital Outflows

Trade Balance = Net Capital Flows

Capital Flows and Trade Flows

◦ When imports exceed exports, a trade deficit occurs. ◦ If, instead, exports exceed imports, a trade surplus is present.

When the exchange rate is determined by market forces, trade deficits will be closely linked with a net inflow of capital.

Conversely, trade surpluses will be closely linked with a net outflow of capital.


Comments are closed.