Macro 3/12

Exam Format Overview

• The exam format will likely resemble the combined structure of two quizzes.

• Duration: Approximately 1 hour and 15 minutes total.

• Breakdown of Questions:

  • 10 multiple choice questions

  • 3-4 true or false questions

  • 2 written answer questions

  • 1 graph interpretation question

Introduction to Inflation

• Inflation refers to the general increase in prices and fall in the purchasing value of money.

• Two main theories of inflation discussed: cost push and demand pull.

Cost Push Inflation

• Defined as when production costs rise, leading businesses to increase prices to maintain profit margins.

• Key Concepts:

  • Input Goods: Labor and capital needed for production.

  • Total Sales: Results from combining inputs and production, divided between costs and profits.

  • Profit Margin: Businesses aim to maintain a certain profit-to-cost ratio.

  • If input costs increase (e.g., capital goods prices rise), companies may raise market prices to maintain their profit margins.

• Graphical Representation:

  • Illustrates the relationship between costs, profits, and the need to adjust sale prices.

Equation Framework

• Total output (Y) consists of:

  • Expected surplus: Profits expected to be earned from sales.

  • Capital costs: Determined by the capital-output ratio times the price of capital.

  • Labor input: Affected by real wages and the market price.

Demand Pull Inflation

• Happens when aggregate demand exceeds aggregate supply.

• Key Concept: Excess Demand (DE) is defined as Aggregate Demand minus Aggregate Supply.

• Example Scenario:

  • A restaurant with a unique dish experiences high demand but limited supply.

  • To capitalize on demand and maintain profits, the restaurant increases prices.

• Combination of Inflation Types: A rapid demand increase for inputs due to economic growth can lead to both cost-push and demand-pull inflation.

Economic Development vs. Economic Growth

• Economic growth involves increased output, while economic development refers to improvements in living standards and infrastructure.

• Developing nations face inflation barriers more rapidly than developed countries due to supply rigidities and structural challenges.

• Monetary Sovereignty: Many third-world countries lack stable currencies, which exacerbates inflation issues.

Market Power and Sellers Inflation

• Market power refers to firms' ability to set prices due to varying levels of competition and goods elasticities.

• Perfect Competition vs. Real Markets:

  • Perfect competition assumes many firms with no single firm's market influence.

  • Actual markets feature varying competition levels, allowing some firms to influence prices.

Impact of Elasticities on Market Power

• Goods elasticity relates to how demand changes with price changes.

  • Essential goods have low elasticity (e.g., food staples), while luxury goods have higher elasticity.

• Changes in consumer expectations can impact pricing, as demonstrated during health crises affecting food markets (e.g., egg prices).

Role of Government Controls

• In situations where market power leads to price gouging, external interventions, like government price controls, may be necessary to protect consumers and prevent exploitative pricing.

• Price controls have historically been controversial but may be needed to stabilize markets during crises.