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Chapter Topics

Chapter Topics. The Composition of GDP The Demand for Goods The Determination of Equilibrium Output Investment Equals Saving Is the Government Omnipotent?. Introduction. The Composition of GDP. C -- Consumption Goods and services purchased by consumers (68% of GDP)

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Chapter Topics

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  1. Chapter Topics • The Composition of GDP • The Demand for Goods • The Determination of Equilibrium Output • Investment Equals Saving • Is the Government Omnipotent?

  2. Introduction

  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) • G -- Government Spending • Purchases by federal, state, and local governments. Excludes transfer payments (18% of GDP)

  4. 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) IS -- Inventory Investment • Production - sales (1% of GDP)

  5. 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

  6. The Demand for Goods

  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)

  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

  9. The Demand for Goods Consumption (C) • C = C0 +C1YD • C0 = C when YD is zero • C = C0 + C1YD

  10. Consumption and Disposable Income Consumption function C = c0 + C1YD Consumption, c Slope = c1 Disposable Income,YD

  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 • Social Security • Medicare • Medicaid

  12. The Demand for Goods Consumption (C) • C = C0 +- C1YD

  13. The Demand for Goods Investment (I) Investment is an exogenous variable • Endogenous Variables • C is endogenous because it responds to production (Y) C = C0 – C1 (Y – T)

  14. The Demand for Goods 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

  15. The Determination ofEquilibrium Output Demand for Goods (Z) • Demand for Goods (Z) depends on income (Y), taxes (T), investment ( I ), and government spending (G)

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

  17. The Determination ofEquilibrium Output The Model and Equation Types • Identity Equations • Behavioral Equations • Equilibrium Equations

  18. The Determination ofEquilibrium Output Finding Equilibrium • Y = supply • Z = Demand = • Y = Z @ equilibrium

  19. The Determination ofEquilibrium 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

  20. Equilibrium Condition Y=Z    The Determination ofEquilibrium Output The Algebra

  21. The Determination ofEquilibrium Output The Algebra: Y=Z

  22. The Determination ofEquilibrium Output Questions • What determines the size of the multiplier? • What does the multiplier imply?

  23. The Determination ofEquilibrium Output Assume • C0 increases by $1 billion • C1 = 0.6 Question • What is the change in Y due to the change in C0?

  24. The Determination ofEquilibrium 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?

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

  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

  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

  28. The Determination ofEquilibrium Output Question for Discussion • What is the relationship between Z and Y at income levels less than Yand greater than Y?

  29. 45o line ZZ’ A’ Y1 D B ZZ C Demand (Z), Production (Y) Y A Y Y1 Income,Y Equilibrium in the Goods Market

  30. Equilibrium in the Goods Market ZZ’ 45o line 45o line 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

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