1. Chapter Topics The Composition of GDP The Demand for Goods
The Determination of Equilibrium Output
Investment Equals Saving
Is the Government Omnipotent?
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2. Introduction
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3. 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)
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4. 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)
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5. The Composition of GDP Billions of Dollars Percent of GDP
GDP (Y)
Consumption (C)
Investment (I)
Nonresidential
Residential
Government Spending (G)
Net Exports
Exports (X)
Imports (Q)
Inventory Investment (IS) 61 1
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6. The Demand for Goods
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7. 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)
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8. 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
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9. The Demand for Goods Consumption (C) C = C0 + C1YD
C0 = C when YD is zero
C = C0 + C1YD
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10. Consumption and Disposable Income
Consumption, c
Consumption
function
C = c0 + C1YD
Slope = c1
Disposable Income,YD
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11. 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
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12. The Demand for Goods C = C0 +- C1YD Consumption (C)
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13. 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)
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14. 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
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15. 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)
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16. 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)
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17. The Determination of Equilibrium Output
The Model and Equation Types
Identity Equations
Behavioral Equations
Equilibrium Equations
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18. The Determination of Equilibrium Output
Finding Equilibrium
Y = supply
Z = Demand =
Y = Z @ equilibrium
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19. 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
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20. The Determination of Equilibrium Output
The Algebra
Equilibrium Condition Y=Z   
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21. The Determination of Equilibrium Output
The Algebra: Y=Z
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22. The Determination of Equilibrium Output
Questions
What determines the size of the multiplier?
What does the multiplier imply?
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23. 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?
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24. 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?
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25. Equilibrium in the Goods Market
45o line
Production
Demand (Z), Production (Y)
Slope = 1 Y1 Y1
Income,Y
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26. Equilibrium in the Goods Market
45o line
Production ZZ
ZZ depends on
1) autonomous spending
2) income
Demand (Z), Production (Y)
Demand
Income,Y
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27. 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
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28. 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?
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29. Equilibrium in the Goods Market
ZZ’
Income,Y
Demand (Z), Production (Y)
45o line Y ZZ A Y1 C D A’
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30. 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

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