The Goods MarketEcon 302 Macroeconomic Analysis Slide #1 Introduction Changes in the demand for...

The Goods Market Slide #1Econ 302 Macroeconomic Analysis

IntroductionIntroduction

Changes in the demand for goods lead to….

Changes in production, which leads to….

Changes in income, which leads to…

Changes in demand

IntroductionIntroduction

The Composition of GDPThe Composition of GDP

C -- Consumption Goods and services purchased by

consumers (68% of GDP)

I -- Fixed Investment Nonresidential and residential investment

(15% of GDP)

The Components of Aggregate Production (GDP)The Components of Aggregate Production (GDP)

G -- Government Spending Purchases by federal, state, and local

governments. Excludes transfer payments (18% of GDP)

X - Q -- Net Exports Exports (X) (11% of GDP) - Imports (Q)

(13% of GDP) X > Q -- trade surplus X < Q trade deficit (2% of GDP)

IS -- Inventory Investment Production - sales (1% of GDP)

The Demand for GoodsThe Demand for Goods

Q- X G I C Z

Total DemandTotal Demand

1. All firms produce the same good (The Goods Market)

2. The supply of goods is completely elastic at price P

3. The economy is closed. (X - Q = 0)

AssumptionsAssumptions

G I C Z

Therefore,Therefore,

The main determinant of C is disposable income (YD)

The consumption function

• C = C(YD)

Consumption (C)Consumption (C)

(+) -- increases in disposable income (YD) leads to increases in consumption (C)

C = C(YD) is a behavioral equation

C = C0 + C1YD

C1 = propensity to consume

• Change in C from a dollar change in income

0 < C1 < 1

C = C0 + C1YD

C0 = C when YD is zero

How can people consume when YD is zero?

Consumption and Disposable IncomeConsumption and Disposable Income

Disposable Income,YD

ConsumptionfunctionC = c0 + C1YD

Slope = c1

C = C0 + C1YD

)(consumers)by received trasfers - (Taxes

( income ( Income Disposable

- Y)YD )

T- YYD ( )

In the U.S., the main taxes paid by individuals are: Income Social Security

The main sources of government transfers are Social Security Medicare Medicaid

Consumption is a function of Y & T

Higher Y increases C, but less than 1 for 1

Higher T decreases C, but less than 1 for 1

ObservationsObservations

or I does not respond to changes in production (Y)

Investment (I) (assume exogenous)Investment (I) (assume exogenous)

Endogenous Variables Variables that depend on other variables in

the model C is endogenous because it responds to

production (Y) C = C0 – C1 (Y – T)

G & T describe fiscal policy

Government Spending (G)Government Spending (G)

Fiscal PolicyFiscal Policy

The choices of taxes and government spending by the government

G & T are exogenous no reliable behavioral role for G & T G & T are determined outside the model

Government Spending (G)Government Spending (G)

The Determination ofThe Determination ofEquilibrium OutputEquilibrium Output

0) Q- (X G I C Z

) T- YCC C 10 (

G I T)- YC C 10 ( Z

Demand for Goods (Z)Demand for Goods (Z)

Demand for Goods (Z) depends on income (Y), taxes (T), investment ( ), and government spending (G)

Assume Firms do not hold inventories Y = supply of goods

EquilibriumEquilibrium

Supply of goods (Y) = Demand for goods (Z)

Equilibrium occurs when:Equilibrium occurs when:

Identity Equations

• Behavioral Equations

• Equilibrium Equations

T- YYD

) T-YCC C 10 (

The Model and Equation TypesThe Model and Equation Types

Y = supply Z = Demand = Y = Z @ equilibrium

G I T)- YC C_

10 ( Y

Finding EquilibriumFinding Equilibrium

Recall Demand determines income (production)

and income determines demand

Finding EquilibriumFinding Equilibrium

1) Algebra to confirm the logic

2) Graphs to build the intuition

3) Words to explain the results

Three Steps to Solving a ModelThree Steps to Solving a Model

The AlgebraThe Algebra

Equilibrium Condition Y=Z

G I T)- YC C Z_

G I T)- YC C Y_

• Subtracting C1Y from both sides gives:

G I TC- YC C Y_

G I TC C YC- Y_

TC- G I C )C-Y(1 1

• Dividing both sides by (1 - C1) gives

TC- G I C )C-Y(1 1

TC- G I C

)C-Y(1

TC- G I C

The Algebra: Y=ZThe Algebra: Y=Z

TC- G I C

) of nt(independe

spending autonomous

TC- G I C 1

Is positive?

C0 and I are positive

G - C1T

• If

TC- G I C 1

positive is then 1, TC- GC and G T 11

TC- G I C

multiplier the is and 1 C-1

What determines the size of the multiplier?

What does the multiplier imply?

QuestionsQuestions

The larger the propensity to consume, C1, the larger the multiplier

A change in autonomous spending will change output more than the direct change in autonomous spending

AnswersAnswers

C0 increases by $1 billion

C1 = 0.6

AssumeAssume

Change Y = change C0 x multiplier

= $1 billion x

= $1 billion x 2.5

= $2.5 billion

Equilibrium in the Goods MarketEquilibrium in the Goods Market

Income,Y

Horizontal Axis:Measures Income, (Y)

Income,Y

Vertical Axis:Plots demand (Z) & production (Y)

as a function of income

Income,Y

Recall:Production (Y) income (Y)

Graphically:Production (Y) income (Y)

on a 45o line

Income,Y

)45o line

Production

Slope = 1

Income,Y

)45o line

Production

Demand

ZZ depends on1) autonomous spending2) income

Income,Y

)45o line

Production

Demand

Autonomousspending

Equilibrium point:Y = Z

Slope = 1

What is the relationship between Z and Y at income levels less than Y and greater than Y?

Question for DiscussionQuestion for Discussion

Income,Y

)45o line

The Goods MarketEcon 302 Macroeconomic Analysis Slide #1 Introduction Changes in the demand for...

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