Macroeconomics Lecture 2 A

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    THE GOODS MARKET

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    THE COMPOSITION OF GDP

    Consumption (C) refers to the goods and services

     purchased by consumers.

     Investment (I), sometimes called fixed

    investment, is the purchase of capital goods. It is

    the sum of nonresidential investment  and

    residential investment. 

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    THE COMPOSITION OF GDP

    !  Government Spending (G) refers to the purchases ofgoods and services by the national, state, and localgovernments. It does not include government transfers,nor interest payments on the government debt.

    !  Imports (IM) are the purchases of foreign goods andservices by consumers, business firms, and the U.S.government.

     Exports (X) are the purchases of goods and services byforeigners.

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    THE COMPOSITION OF GDP

    !  Net exports (X - IM) is the difference betweenexports and imports, also called the trade balance.

     Inventory investment  is the difference between production and sales.

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    THE MODEL - ASSUMPTIONS

    Variables that depend on other variables within the

    model are called endogenous.

    Variables that are not explain within the model are

    called exogenous.

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    THE DEMAND FOR GOODS IDENTITY

    !  The total demand for goods is written as:

     Z C I G X IM !   + + +   "!  Under the assumption that the economy is

    closed, X = IM  = 0, then:

     Z C I G!   + +

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    CONSUMPTION

     Disposable income, (Y  D) 

    C C Y  D

    =   ( )( )+

    !  The function C (Y D) is called the consumption

    function.  It is a behavioral function, that is,it captures the behavior of consumers.

    Y Y T  D

      ! "

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    CONSUMPTION (C )

    !  A more specific form of the consumptionfunction is this linear relation:

    C c c Y   D

    = +0 1

    This function has two parameters:

    !  c 1 - propensity to consume 

    c 0 - intercept of the consumption function

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    CONSUMPTION (C )

    Consumption increases

    with disposable income,

    but less than one for

    one.

    C C Y  D

    =   ( )

    Y Y T  D   ! "

    C c c Y T  = +   !0 1 ( )

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    INVESTMENT ( I )

    !  Investment here is taken as given (an exogenous

    variable):

     I I =

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    GOVERNMENT SPENDING (G)

    !  Government spending, G, together with taxes, T ,

    describes fiscal policy.

    !  We shall assume that G and T  are also exogenous.

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    THE DETERMINATION OF EQUILIBRIUM

    OUTPUT

    !  Equilibrium in the goods market  requires that production, Y , be equal to the demand for goods,

     Z :

    Y c c Y T I G= +  !

      + +0 1 ( )

    Y Z =

    Then:

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    USING ALGEBRA

    How many endogenous variables?!  How many equations?

    !  Can we solve this?

    Y c

    c I G c T  =!

      + +   !11 1

    0 1[ ]

    multiplier autonomous spending

    Y c c Y T I G= +   !   + +0 1 ( )

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    USING A GRAPH

     Equilibrium in theGoods Market

    Equilibrium output is

    determined by the

    condition that production

    be equal to demand.

     Z c I G c T c Y = + +   !   +( )0 1 1

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    USING A GRAPH

    The Effects of an Increase in AutonomousSpending on Output

     An increase in

    autonomous spending

    has a more than one-

    for-one effect on

    equilibrium output.

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    JOHN MAYNARD KEYNES, 1883-1946

    !  The General Theory of

     Employment, Interest

    and Money (1936).!  “The Objective of

    International Price

    Stability” ( EJ , 1943)

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    THE KEYNESIAN MULTIPLIER

    An increase in demand leads to an increase

    in production and a corresponding increase

    in income.

    The end result is an increase in output that is

    larger than the initial shift in demand, by a

    factor equal to the multiplier.

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    USING A GRAPH

    The Effects of an Increase in AutonomousSpending on Output

     An increase in

    autonomous spending

    has a more than one-

    for-one effect on

    equilibrium output.

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    HOW LONG DOES IT TAKE FOR OUTPUT TO

    ADJUST?!  The speed of adjustment depends on how and

    how often firms revise their production schedule.

    !  Describing formally the adjustment of output

    over time is what economists call the dynamics of

    adjustment.

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    AN ALTERNATIVE WAY OF THINKING ABOUT

    GOODS-MARKET EQUILIBRIUM

     Saving  is the sum of private plus public saving.  Privatesaving  (S ), is saving by consumers. Public saving  equals taxes minus government spending.

    S Y T C  ! " "

    Y C I G= + +

    Y T C I G T  ! !   = +   !

    S I G T  = +   !

     I S T G= +   !( )

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    INVESTMENT EQUALS SAVING

    !  Investment equals saving—the sum of

     private plus public saving.!  This equilibrium condition for the goods

    market is called the IS relation: what firms

    want to invest must be equal to what peopleand the government want to save.

     I S T G= +   !( )

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    SAVINGS = INVESTMENT

    !  Consumption and saving decisions are oneand the same.

    S Y T C  =   ! !

    S Y T c c T T  =  ! ! ! !

    0 1 ( )S c c Y T  =   !   +   ! !

    0 11( )( )

    In equilibrium: 

    c

    c I G c T  =

    !

      + +   !

    1

    1 10 1[ ]

     I c c Y T T G=  !

      +  ! !

      +  !

    0 11( )( ) ( )Rearranging terms, we get the same result as

    before: 

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    SAVING AND INVESTMENT AROUND THE

    WORLD