Chapter 3: The Goods MarketBlanchard: Macroeconomics Slide #1 Chapter Topics The Composition of GDP The Demand for Goods The Determination of Equilibrium.

Chapter 3: The Goods Market Slide #1Blanchard: Macroeconomics

Chapter TopicsChapter Topics

The Composition of GDP

The Demand for Goods

The Determination of Equilibrium Output

Investment Equals Saving

Is the Government Omnipotent?


IntroductionIntroduction


The Composition of GDPThe 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)


The Composition of GDPThe 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)


The Composition of GDPThe 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


The Demand for GoodsThe Demand for Goods

Q- X G I C Z



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)

AssumptionsAssumptions

G I C Z



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

Consumption (C)Consumption (C)



C = C0 + C1YD

C0 = C when YD is zero

C = C0 + C1YD


T- YYD ( )


Consumption and Disposable IncomeConsumption and Disposable Income

Disposable Income,YD

Co

nsu

mp

tio

n,

c

ConsumptionfunctionC = c0 + C1YD

Slope = c1



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




C = C0 +- C1YD

T- YYD ( )

T)- (Y CC C 10 -




Investment is an exogenous variable

Endogenous Variables C is endogenous because it responds to

production (Y) C = C0 – C1 (Y – T)

Investment (I)Investment (I)

_

I I



G & T describe fiscal policy

G & T are exogenous no reliable behavioral role for G & T G & T are determined outside the model

Government Spending (G)Government Spending (G)


The Determination ofThe Determination ofEquilibrium OutputEquilibrium Output

Demand for Goods (Z) depends on income (Y), taxes (T), investment ( I ), and government spending (G)

0) Q- (X G I C Z

) T- YCC C 10 (

G I T)- YC C 10 ( Z

Demand for Goods (Z)Demand for Goods (Z)


Assume Firms do not hold inventories Y = supply of goods


EquilibriumEquilibrium

Equilibrium occurs when:Equilibrium occurs when:

Supply of goods (Y) = Demand for goods (Z)


Identity Equations

• Behavioral Equations

• Equilibrium Equations

•

T- YYD

) T-YCC C 10 (

Z Y


The Model and Equation TypesThe Model and Equation Types


Y = supply Z = Demand = Y = Z @ equilibrium


G I T)- YC C_

10 (

G I T)- YC C_

10 ( Y

Finding EquilibriumFinding Equilibrium


1) Algebra to confirm the logic

2) Graphs to build the intuition

3) Words to explain the results


Three Steps to Solving a ModelThree Steps to Solving a Model



The AlgebraThe Algebra

Equilibrium Condition Y=Z

G I T)- YC C Z_

10 (

G I T)- YC C Y_

10 (



The Algebra: Y=ZThe Algebra: Y=Z

TC- G I C

C-1

1 Y 1

_

01

spending autonomous TC- G I C 1

_

0

multiplier the is and 1 C-1

1

1


What determines the size of the multiplier?

What does the multiplier imply?


QuestionsQuestions


C0 increases by $1 billion

C1 = 0.6


AssumeAssume

QuestionQuestion

What is the change in Y due to the change in C0?


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?


Questions for DiscussionQuestions for Discussion


Equilibrium in the Goods MarketEquilibrium in the Goods Market

Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line

Production

Slope = 1

Y1

Y1



Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line

Production

ZZ

Demand

ZZ depends on1) autonomous spending2) income



Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line

Production

ZZ

Demand

Autonomousspending

Equilibrium point:Y = Z

Slope = 1

A


What is the relationship between Z and Y at income levels less than Y and greater than Y?


Question for DiscussionQuestion for Discussion



B

ZZ’

Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line

Y

ZZ

AY

Y1

Y1

C

DA’


B

ZZ’

Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line

Y

ZZ

AY

Y1

Y1

A’


Y

ZZ

AY

Income,Y

Dem

and

(Z

), P

rod

uct

ion

(Y

)45o line


Leakages and InjectionsLeakages and Injections

Another way to equilibrium

Income = Expenditure

C + S + T = C + I + G

S + T = I + G

Chapter 3: The Goods MarketBlanchard: Macroeconomics Slide #1 Chapter Topics The Composition of GDP The Demand for Goods The Determination of Equilibrium.

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