ECN 203 1nd Edition Lecture 25Outline of Last Lecture II. Trade Balance III. Foreign Exchange Markets IV. Analyzing the Foreign Exchange Market V. The Relationship VI. Changing Exchange Rates VII. International capital flowsOutline of Current Lecture VIII. Transition to Policy IX. The Purpose and Problems of Policy X. Intervention Current LectureLecture 3/25/15- Transition to Policyo Why is there unemployment? If the economy is initially at full employment any shock that shifts AS up or any demand that shifts AD down causes the real GDP to fall below full GDP.  If this happens the unemployment rate will be above the natural rate, ultimatelycreating demand-deficient unemployment. o Will unemployment persist or do market adjustments help eliminate the problem? If micro assumptions hold, unemployment will not continue. Markets that adjustsmooth and quickly will eliminate unemployment in the micro market therefore eliminating unemployment in the whole macro economy.  However, if the nice assumptions do not hold because they are unrealistic, the non-existing adjustment in the micro economy will ultimately lead to macro economy unemployment.  It is crucial to recognize the relationship between the micro foundation and the macro implications. These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.- Policy: the Purpose and the Problems o The Promise: The micro level’s nice assumptions are: no market failure and no market power. These assumptions ensure Pareto optimal. In other words, when these nice assumptions hold strongly they allow the macro economy to have a stable price level and full employment. o The Problems: Demand deficient unemployment. - As stated earlier, any macro condition is simply an aggregation of the conditions in thousands of individual micro markets. So if the macro economy is experiencing demand deficient unemployment, then there must be a problem at the micro level. - What do the micro conditions look like when these is unemployment? The individual markets must have an excess supply of workers – the quantity demanded cannot absorb the quantity supplied. - Under the nice assumptions, an excess supply of workers will cause the price (wage) to fall as unemployed workers bid for employment. - The wage will continue to adjust down until they reach equilibrium and there is no more excess supply. - Falling wages will shift AS down but when all the nice assumptions are fulfilled the AS will be at LAS and the macro will be at Y f.  Inflation, Deflation, Stagflation - Is Intervention Necessary?o The power of the invisible hand is determined by how accurate the nice assumptions are. o If the nice assumptions are realistic then the micro economy works efficiently which allows macro problems are eliminated. o If the nice assumptions are a problem, then the micro economy will not work and the macro will not adjust towards full employment. o Basically, if the micro system isn’t working than neither is the macro (high unemployment). o Non-Interventionists: those who believe our nice assumptions are weak assumptions. They believe that adjustments of wages in micro labor will bring AS to Yf. They believe there is no need for gov’t intervention. These people believe gov’t intervention is part ofthe problem, not a solution. This is also called Laissez-Faire. Believes the long run adjustments will occur with time.  Friedrich Hayeko Interventionists: Those who believe our nice assumptions are strong. They do not believe that adjustments of wages in the macro market will bring AS to Yf. They feel that gov’t intervention is necessary and can be part of the solution. Believes that long run adjustments occur too slowly or not at all and too many will suffer while waiting for these adjustments.  John Maynard