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8/18/2019 Macroeconomics Lecture 2 A
1/23
THE GOODS MARKET
8/18/2019 Macroeconomics Lecture 2 A
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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.
8/18/2019 Macroeconomics Lecture 2 A
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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:
Y
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