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

2. The Goods MarketEcon 302 Macroeconomic Analysis Slide #2 Introduction

3. The Goods MarketEcon 302 Macroeconomic Analysis Slide #3 The 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)

4. The Goods MarketEcon 302 Macroeconomic Analysis Slide #4 The Composition of GDP G -- Government Spending  Purchases by federal, state, and local governments. Excludes transfer payments (18% of GDP) The Components of Aggregate Production (GDP)

5. The Goods MarketEcon 302 Macroeconomic Analysis Slide #5 The Composition 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) The Components of Aggregate Production (GDP)

6. The Goods MarketEcon 302 Macroeconomic Analysis Slide #6 The Composition of GDP I S -- Inventory Investment  Production - sales (1% of GDP) The Components of Aggregate Production (GDP)

7. The Goods MarketEcon 302 Macroeconomic Analysis Slide #7 The Demand for Goods Total Demand

8. The Goods MarketEcon 302 Macroeconomic Analysis Slide #8 The Demand for Goods 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) Assumptions

9. The Goods MarketEcon 302 Macroeconomic Analysis Slide #9 The Demand for Goods Therefore,

10. The Goods MarketEcon 302 Macroeconomic Analysis Slide #10 The Demand for Goods  The main determinant of C is disposable income (Y D )  The consumption function C = C(Y D ) (+) Consumption (C)

11. The Goods MarketEcon 302 Macroeconomic Analysis Slide #11 The Demand for Goods  (+) -- increases in disposable income (Y D ) leads to increases in consumption (C)  C = C(Y D ) is a behavioral equation Consumption (C)

12. The Goods MarketEcon 302 Macroeconomic Analysis Slide #12 The Demand for Goods  C = C 0 + C 1 Y D  C 1 = propensity to consume Change in C from a dollar change in income  0 < C 1 < 1 Consumption (C)

13. The Goods MarketEcon 302 Macroeconomic Analysis Slide #13 The Demand for Goods  C = C 0 + C 1 Y D  C 0 = C when Y D is zero  How can people consume when Y D is zero? Consumption (C)

14. The Goods MarketEcon 302 Macroeconomic Analysis Slide #14 Consumption and Disposable Income Disposable Income,Y D Consumption, c Consumption function C = c 0 + C 1 Y D Slope = c 1

15. The Goods MarketEcon 302 Macroeconomic Analysis Slide #15 The Demand for Goods  C = C 0 + C 1 Y D  Consumption (C)

16. The Goods MarketEcon 302 Macroeconomic Analysis Slide #16 The Demand for Goods In the U.S., the main taxes paid by individuals are:  Income  Social Security Consumption (C)

17. The Goods MarketEcon 302 Macroeconomic Analysis Slide #17 The Demand for Goods The main sources of government transfers are  Social Security  Medicare  Medicaid Consumption (C)

18. The Goods MarketEcon 302 Macroeconomic Analysis Slide #18 The Demand for Goods 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 Observations

19. The Goods MarketEcon 302 Macroeconomic Analysis Slide #19 The Demand for Goods or I does not respond to changes in production (Y) Investment (I) (assume exogenous)

20. The Goods MarketEcon 302 Macroeconomic Analysis Slide #20 The Demand for Goods Endogenous Variables  Variables that depend on other variables in the model  C is endogenous because it responds to production (Y) C = C 0 – C 1 (Y – T)

21. The Goods MarketEcon 302 Macroeconomic Analysis Slide #21 The Demand for Goods G & T describe fiscal policy Government Spending (G) Fiscal Policy The choices of taxes and government spending by the government

22. The Goods MarketEcon 302 Macroeconomic Analysis Slide #22 The Demand for Goods G & T are exogenous  no reliable behavioral role for G & T  G & T are determined outside the model Government Spending (G)

23. The Goods MarketEcon 302 Macroeconomic Analysis Slide #23 The Determination of Equilibrium Output       Demand for Goods (Z)

24. The Goods MarketEcon 302 Macroeconomic Analysis Slide #24 Demand for Goods (Z) depends on income (Y), taxes (T), investment ( ), and government spending (G) The Determination of Equilibrium Output

25. The Goods MarketEcon 302 Macroeconomic Analysis Slide #25 Assume  Firms do not hold inventories  Y = supply of goods The Determination of Equilibrium Output Equilibrium

26. The Goods MarketEcon 302 Macroeconomic Analysis Slide #26 Supply of goods (Y) = Demand for goods (Z) The Determination of Equilibrium Output Equilibrium occurs when:

27. The Goods MarketEcon 302 Macroeconomic Analysis Slide #27  Identity Equations  Behavioral Equations  Equilibrium Equations The Determination of Equilibrium Output The Model and Equation Types

28. The Goods MarketEcon 302 Macroeconomic Analysis Slide #28  Y = supply  Z = Demand =  Y = Z @ equilibrium  The Determination of Equilibrium Output Finding Equilibrium

29. The Goods MarketEcon 302 Macroeconomic Analysis Slide #29 Recall  Demand determines income (production) and income determines demand The Determination of Equilibrium Output Finding Equilibrium

30. The Goods MarketEcon 302 Macroeconomic Analysis Slide #30 1) Algebra to confirm the logic 2) Graphs to build the intuition 3) Words to explain the results The Determination of Equilibrium Output Three Steps to Solving a Model

31. The Goods MarketEcon 302 Macroeconomic Analysis Slide #31 The Determination of Equilibrium Output The Algebra Equilibrium Condition Y=Z

32. The Goods MarketEcon 302 Macroeconomic Analysis Slide #32  Subtracting C 1 Y from both sides gives:  The Determination of Equilibrium Output The Algebra

33. The Goods MarketEcon 302 Macroeconomic Analysis Slide #33 Dividing both sides by (1 - C 1 ) gives The Determination of Equilibrium Output The Algebra

34. The Goods MarketEcon 302 Macroeconomic Analysis Slide #34 The Determination of Equilibrium Output The Algebra: Y=Z

35. The Goods MarketEcon 302 Macroeconomic Analysis Slide #35  Is positive?  C 0 and I are positive  G - C 1 T If The Determination of Equilibrium Output The Algebra: Y=Z

36. The Goods MarketEcon 302 Macroeconomic Analysis Slide #36 The Determination of Equilibrium Output The Algebra: Y=Z

37. The Goods MarketEcon 302 Macroeconomic Analysis Slide #37 What determines the size of the multiplier? What does the multiplier imply? The Determination of Equilibrium Output Questions

38. The Goods MarketEcon 302 Macroeconomic Analysis Slide #38  The larger the propensity to consume, C 1, the larger the multiplier  A change in autonomous spending will change output more than the direct change in autonomous spending The Determination of Equilibrium Output Answers

39. The Goods MarketEcon 302 Macroeconomic Analysis Slide #39  C 0 increases by $1 billion  C 1 = 0.6 The Determination of Equilibrium Output Assume

40. The Goods MarketEcon 302 Macroeconomic Analysis Slide #40 Change Y = change C 0 x multiplier = $1 billion x = $1 billion x 2.5 = $2.5 billion The Determination of Equilibrium Output

41. The Goods MarketEcon 302 Macroeconomic Analysis Slide #41 Equilibrium in the Goods Market Income,Y Horizontal Axis: Measures Income, (Y)

42. The Goods MarketEcon 302 Macroeconomic Analysis Slide #42 Equilibrium in the Goods Market Income,Y Demand (Z), Production (Y) Vertical Axis: Plots demand (Z) & production (Y) as a function of income

43. The Goods MarketEcon 302 Macroeconomic Analysis Slide #43 Equilibrium in the Goods Market Income,Y Demand (Z), Production (Y) Recall: Production (Y) income (Y) Graphically: Production (Y) income (Y) on a 45 o line

44. The Goods MarketEcon 302 Macroeconomic Analysis Slide #44 Equilibrium in the Goods Market Income,Y Demand (Z), Production (Y) 45 o line Production Slope = 1 Y1Y1 Y1Y1

45. The Goods MarketEcon 302 Macroeconomic Analysis Slide #45 Equilibrium in the Goods Market Income,Y Demand (Z), Production (Y) 45 o line Production ZZ Demand ZZ depends on 1) autonomous spending 2) income

46. The Goods MarketEcon 302 Macroeconomic Analysis Slide #46 Equilibrium in the Goods Market Income,Y Demand (Z), Production (Y) 45 o line Production ZZ Demand Autonomous spending Equilibrium point: Y = Z Slope = 1 A

47. The Goods MarketEcon 302 Macroeconomic Analysis Slide #47 What is the relationship between Z and Y at income levels less than Y and greater than Y? The Determination of Equilibrium Output Question for Discussion

48. The Goods MarketEcon 302 Macroeconomic Analysis Slide #48 B ZZ’ Equilibrium in the Goods Market Income,Y Demand (Z), Production (Y) 45 o line Y ZZ A Y Y1Y1 Y1Y1 C D A’