Chapter Topics The Composition of GDP The Demand for Goods The Determination of Equilibrium Output Investment Equals Saving Is the Government Omnipotent? Blanchard: Macroeconomics

Introduction Blanchard: Macroeconomics

The Composition of GDP C -- Consumption I -- Fixed Investment Goods and services purchased by consumers (68% of GDP) I -- Fixed Investment Nonresidential and residential investment (15% of GDP) G -- Government Spending Purchases by federal, state, and local governments. Excludes transfer payments (18% of GDP) Blanchard: Macroeconomics

The Composition of GDP X - Q -- Net Exports IS -- Inventory Investment 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) Blanchard: Macroeconomics

The Composition of GDP Billions of Dollars Percent of GDP GDP (Y) 8509 100 Consumption (C) 5806 68 Investment (I) 1308 15 Nonresidential 939 11 Residential 369 4 Government Spending (G) 1488 18 Net Exports -154 -2 Exports (X) 958 11 Imports (Q) -1112 -13 Inventory Investment (IS) 61 1 Blanchard: Macroeconomics

The Demand for Goods Blanchard: Macroeconomics

The Demand for Goods Assumptions 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) Blanchard: Macroeconomics

The Demand for Goods Consumption (C) The main determinant of C is disposable income (YD) The consumption function C = C(YD) C = C0 + C1YD C1 = propensity to consume 0 < C1 < 1 Blanchard: Macroeconomics

The Demand for Goods Consumption (C) C = C0 + C1YD C0 = C when YD is zero C = C0 + C1YD Blanchard: Macroeconomics

Consumption and Disposable Income Consumption, c Consumption function C = c0 + C1YD Slope = c1 Disposable Income,YD Blanchard: Macroeconomics

The Demand for Goods Consumption (C) In the U.S., the main taxes paid by individuals are: Income Social Security The main sources of government transfers are Medicare Medicaid Blanchard: Macroeconomics

The Demand for Goods C = C0 +- C1YD Consumption (C) Blanchard: Macroeconomics

The Demand for Goods Investment is an exogenous variable Endogenous Variables C is endogenous because it responds to production (Y) C = C0 – C1 (Y – T) Blanchard: Macroeconomics

The Demand for Goods G & T describe fiscal policy G & T are exogenous Government Spending (G) G & T describe fiscal policy G & T are exogenous no reliable behavioral role for G & T G & T are determined outside the model Blanchard: Macroeconomics

The Determination of Equilibrium Output Demand for Goods (Z) Demand for Goods (Z) depends on income (Y), taxes (T), investment ( I ), and government spending (G) Blanchard: Macroeconomics

The Determination of Equilibrium Output Assume Firms do not hold inventories Y = supply of goods Equilibrium occurs when: Supply of goods (Y) = Demand for goods (Z) Blanchard: Macroeconomics

The Determination of Equilibrium Output The Model and Equation Types Identity Equations Behavioral Equations Equilibrium Equations Blanchard: Macroeconomics

The Determination of Equilibrium Output Finding Equilibrium Y = supply Z = Demand = Y = Z @ equilibrium Blanchard: Macroeconomics

The Determination of Equilibrium Output Three Steps to Solving a Model 1) Algebra to confirm the logic 2) Graphs to build the intuition 3) Words to explain the results Blanchard: Macroeconomics

The Determination of Equilibrium Output The Algebra Equilibrium Condition Y=Z    Blanchard: Macroeconomics

The Determination of Equilibrium Output The Algebra: Y=Z Blanchard: Macroeconomics

The Determination of Equilibrium Output Questions What determines the size of the multiplier? What does the multiplier imply? Blanchard: Macroeconomics

The Determination of Equilibrium Output Assume C0 increases by $1 billion C1 = 0.6 Question What is the change in Y due to the change in C0? Blanchard: Macroeconomics

The Determination of Equilibrium Output Questions for Discussion Would a change in I, G, or T have the same impact on Y? If I fell by $100 and C1=.8, what is the change in Y? If G increases by $75 and C1=.9, what is the change in Y? If T increases by $75 and C1=.9, what is the change in Y? If both G and T increase by $75, what is the change in Y? Blanchard: Macroeconomics

Equilibrium in the Goods Market 45o line Production Demand (Z), Production (Y) Slope = 1 Y1 Y1 Income,Y Blanchard: Macroeconomics

Equilibrium in the Goods Market 45o line Production ZZ ZZ depends on 1) autonomous spending 2) income Demand (Z), Production (Y) Demand Income,Y Blanchard: Macroeconomics

Equilibrium in the Goods Market 45o line Production Slope = 1 ZZ A Demand (Z), Production (Y) Demand Equilibrium point: Y = Z Autonomous spending Income,Y Blanchard: Macroeconomics

The Determination of Equilibrium Output Question for Discussion What is the relationship between Z and Y at income levels less than Y and greater than Y? Blanchard: Macroeconomics

Equilibrium in the Goods Market ZZ’ Income,Y Demand (Z), Production (Y) 45o line Y ZZ A Y1 C D A’ Blanchard: Macroeconomics

Equilibrium in the Goods Market 45o line 45o line ZZ’ A’ Y1 B ZZ ZZ Demand (Z), Production (Y) Demand (Z), Production (Y) Y Y A A Y Y Y1 Income,Y Income,Y

Leakages and Injections Another way to equilibrium Income = Expenditure C + S + T = C + I + G S + T = I + G