The Goods MarketEcon 302 Macroeconomic Analysis Slide #1 Introduction Changes in the demand for goods lead to…. Changes in production, which leads to…

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

Co

nsu

mp

tio

n,

c

ConsumptionfunctionC = c0 + C1YD

Slope = c1



C = C0 + C1YD

)(consumers)by received trasfers - (Taxes

( income ( Income Disposable

T

- 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)

_

I I

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)

_

I



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 (

Z Y


The Model and Equation TypesThe Model and Equation Types


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


G I T)- YC C_

10 (

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_

10 (

G I T)- YC C Y_

10 (


• Subtracting C1Y from both sides gives:


G I TC- YC C Y_

110

G I TC C YC- Y_

101

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

_

01



• Dividing both sides by (1 - C1) gives



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

_

01

1

1

_

0

1

1

C-1

TC- G I C

C-1

)C-Y(1

TC- G I C

C-1

1 Y 1

_

01



The Algebra: Y=ZThe Algebra: Y=Z

TC- G I C

C-1

1 Y 1

_

01

) of nt(independe

spending autonomous

Y

TC- G I C 1

_

0


Is positive?

C0 and I are positive

G - C1T

• If


TC- G I C 1

_

0

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




TC- G I C

C-1

1 Y 1

_

01

multiplier the is and 1 C-1

1

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

= $1 billion x 2.5

= $2.5 billion


11

1

C

6.1

1

4.

1


Equilibrium in the Goods MarketEquilibrium in the Goods Market

Income,Y

Horizontal Axis:Measures Income, (Y)



Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)

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

as a function of income



Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)

Recall:Production (Y) income (Y)

Graphically:Production (Y) income (Y)

on a 45o line



Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line

Production

Slope = 1

Y1

Y1



Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line

Production

ZZ

Demand

ZZ depends on1) autonomous spending2) income



Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line

Production

ZZ

Demand

Autonomousspending

Equilibrium point:Y = Z

Slope = 1

A


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


Question for DiscussionQuestion for Discussion


B

ZZ’


Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line

Y

ZZ

AY

Y1

Y1

C

DA’

Documents

The Goods MarketEcon 302 Macroeconomic Analysis Slide #1 Introduction Changes in the demand for goods lead to…. Changes in production, which leads to…