Transcript Chapter 3

The
Goods Market
Chapter 3
3-1 The Composition of GDP
Table 3-1 The Composition of U.S. GDP, 2010
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The composition of GDP
• Consumption (C): The goods and services
purchased by consumers.
• Nonresidential Investment: The purchase by firms
of new plants or new machines.
• Residential Investment: the purchase by people of
houses or apartments.
• Government Spending (G): The purchases of goods
and services by the state and local governments. G
does not include transfer payments.
• Net Exports: The difference between exports and
imports.
• Inventory Investment: The difference between
production and sales
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The Demand for Goods
Three assumptions:
• There is only one good.
• Firms are willing to supply any amount of
the good at a given price.
• The economy is closed.
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Consumption
The function is a linear relation.
c1, is (marginal) propensity to consume, the increase in
consumption for every extra unit of disposable income.
c0, which represents how much consumption would occur even if
disposable income were zero, is called autonomous
consumption.
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3-2 The Demand for Goods
Figure 3-1 Consumption and disposable income
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3-2 The Demand for Goods
C is a function of income and taxes. Higher income and lower
taxes increases consumption, but less than one for one.
I is an exogenous variable, which is not explained in the model
but are instead taken as given. C is endogenous variable
because it depends on other variables in the model.
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3-3 The Determination of
Equilibrium Output
In equilibrium, production, Y, is equal to demand. Demand in
turn depends on income, Y, which is itself equal to production.
3-8
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3-3 The Determination of
Equilibrium Output
Equation (3.8) is the algebraic solution. The second term is autonomous
spending. It is positive, assuming budget surplus (T-G) is not very
large. First term is multiplier.
An increase in c0 increases demand. The increase in demand then
leads to an increase in production. The increase in production leads
to an equivalent increase in income. The increase in income further
increases consumption, and so on.
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3-3 The Determination of
Equilibrium Output
Figure 3-2 Equilibrium
in the goods market
1. Plot production as a
function of income,
45-degree line.
2. Plot demand as a
function of income,
ZZ.
3. In equilibrium,
production equals
demand.
When income
increases by 1,
demand increases
by c1. ZZ is upward
sloping but has a
slope less than 1.
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3-3 The Determination of
Equilibrium Output
Figure 3-3 The effects
of an increase in
autonomous spending on
output
The increase in output is
larger than the initial
increase in consumption
of 1 billion. This is the
multiplier effect.
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Multiplier Effect
• The first round increase in demand of 1
billion (AB)
1 billion increase in
production (AB)
1 billion increase in
income (BC)
the second round of
increase in demand is 1 billion multiplied by
c1 – hence, $c1 billion (CD)
equal
increase in production (CD) and income
(DE)
the third round of increase in
demand is $c1 billion multiplied by c1, which
is $c12 billion.
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Multiplier
• The total increase in production after n+1
rounds is 1 billion multiplied by:
1+ $c1 + $c12 + ... + $c1n
• The eventual increase in output is $1/(1- c1)
billion.
• The size of the multiplier depends on the
value of propensity to consume.
• The higher the propensity, the higher the
multiplier.
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Focus: The Lehman Bankruptcy, Fears of Another
Great Depression, and Shifts in the Consumption
Function
Figure 1 Disposable income, consumption, and consumption of
durables in the United States, 2008:1 to 2009:3
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Focus: The Lehman Bankruptcy, Fears of Another
Great Depression, and Shifts in the Consumption
Function
Figure 2 Google search volume for “Great Depression,” January
2008 to September 2009
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3-4 Investment Equals Saving: An Alternative
Way of Thinking about Goods—Market Equilibrium
S= YD - C
S=Y –T - C.
Y=C + I+ G
Y–T–C=I+G-T
Equilibrium in the goods market requires that investment
equal saving- the sum of private saving and public saving.
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S= YD - C
S=Y –T - C.
=Y – T - c0 - c1 ( Y –T )
S= 1-c1 is the propensity to save
Equation (3.8) is equivalent to equation (3.12).
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