Saturday, June 19, 2010

Do you self correct?? If so, then your sign is Microeconomics. If not, then it is Macroeconomics...Here's your sign...

Microeconomic and Macroeconomic Excess Supply

A rather simple (by that I mean in layman's terms) explanation of how markets clear, or don't clear, in a Microeconomic vs Macroeconomic sense from Professor Brad Delong.  The writer is suggesting, in a microeconomics sense, markets clear pretty well on their own as business and workers adjust to changes in market conditions, whether it is from creative destruction, out-sourcing, off-shoring, etc.  Resources (land, labor, capital, entrepreneurship) shift to production more desired by society through the mechanism of supply and demand. 
  
""...Overall unemployment may rise a bit or for a while as this process of adjustment takes place--it depends whether entrepreneurs and producers in the expanding industry where excess demand emerges are more or less on the ball, keen-eyed, and keen-witted than those in the industry where excess supply emerges and where businesses shrink. But the process of adjustment, even with frictional unemployment while it takes place, is a good thing--it makes us all richer. Attempts to stop it in its tracks or short-circuit its mechanisms are counterproductive and harmful. The end of the process comes and excess demand and supply are eliminated when there are more people making the things that are wanted more and fewer people making the things that are wanted less...."""
However, he suggests as you move to the Macroeconomic level this relationship breaks down.
""...But in macroeconomics things are different. The excess supply is economy-wide--throughout all commodity markets, producing supply in excess of demand for goods, services, labor, and capacity. Producers and entrepreneurs respond to an aggregate demand shortfall just as individual producers respond to a particular shortfall of demand for their products: they hold sales to liquidate inventories, they cut prices, they cut wages to try to preserve margins, they fire workers. In the macroeconomic case, the dynamic process that leads to the elimination of excess supply and its counterbalancing excess demand in the microeconomic case gets underway--or, rather, half of it gets underway.
The problem is that the set of industries that are shrinking is made up of pretty-much-everybody. There are no industries that are expanding. The excess demand is not for the products of a goods-and-services producing industry that can rapidly ramp-up production by employing lots more labor. The excess demand is in finance: for means-of-payment, or safe high-quality assets, or for long-duration sales vehicles. There is a rise in unemployment from the flow out of goods-and-services producing industries where the excess supply has appeared. But there is no countervailing flow out of unemployment. How do you put large numbers of people to work making more Federal Reserve notes or increasing the supply of liquid assets that are means-of-payment that are the reserve deposits of banks? How do you shift the flow of production to instantaneously raise the stock of long-duration assets, of claims to wealth that are shares in companies with secure long-run prospects that are vehicles for moving purchasing power across time from the present to the future? You can't...""
In microeconomics, the market "self-corrects" when the economy is expanding and there is room for resources and labor to move to a new level of product/service mix with no net decrease in overall employment.  However in a macroeconomics view when WHOLE industries (vertically and horizontally) experience a slow-down there is no where for productive resources to go---sort of in a holding pattern. and remain idle  He does not come right out and say it, but his premise, I believe, is that the macoeconomy does not "self-correct" and that when the "free-market" (interaction between buyers and sellers) breaks down, then the only other game in town is for government to step in to "prime the pump" with spending, and perhaps an industrial policy (i.e. alternative energy), to get things moving again.
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