chapter 3 the goods market. chapter 3: the goods marketblanchard: macroeconomics slide #2 chapter...

Chapter 3Chapter 3

The Goods MarketThe Goods Market

Chapter 3: The Goods Market Slide #2Blanchard: Macroeconomics

Chapter TopicsChapter Topics

The Composition of GDP

The Demand for Goods

The Determination of Equilibrium Output

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)

The Components of Aggregate Production (GDP)The Components of Aggregate Production (GDP)

G -- Government Spending Purchases by federal, state, and local

governments. Excludes transfer payments (18% 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 Demand for GoodsThe Demand for Goods

Q- X G I C Z

Total DemandTotal Demand

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

Therefore,Therefore,

The main determinant of C is disposable income (YD)

The consumption function

• C = C(YD)

Consumption (C)Consumption (C)

C = C0 + C1YD

C1 = propensity to consume

• Change in C from a dollar change in income

0 < C1 < 1

Consumption and Disposable IncomeConsumption and Disposable Income

Disposable Income,YD

ConsumptionfunctionC = c0 + C1YD

Slope = c1

C = C0 + C1YD

)(consumers)by received trasfers - (Taxes

( income ( Income Disposable

- Y)YD )

T- YYD ( )

C = C0 + C1YD

T- YYD ( )

T)- (Y CC C 10

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

ObservationsObservations

Investment is an exogenous variable

Exogenous variables Variables that are assumed to be given and

are not explained within the model

Investment (I)Investment (I)

or I does not respond to changes in production (Y)

Investment (I)Investment (I)

Endogenous Variables Variables that depend on other variables in

the model C is endogenous because it responds to

production (Y) C = C0 – C1 (Y – T)

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

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

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

Equilibrium occurs when:Equilibrium occurs when:

Identity Equations

• Behavioral Equations

• Equilibrium Equations

T- YYD

) T-YCC C 10 (

The Model and Equation TypesThe Model and Equation Types

Y = supply Z = Demand = Y = Z (equilibrium)

G I T)- YC C_

10 ( Y

Finding EquilibriumFinding Equilibrium

The AlgebraThe Algebra

Equilibrium Condition Y=Z

G I T)- YC C Z_

G I T)- YC C Y_

• Subtracting C1Y from both sides gives:

G I TC- YC C Y_

G I TC C YC- Y_

TC- G I C )C-Y(1 1

• Dividing both sides by (1 - C1) gives

TC- G I C )C-Y(1 1

TC- G I C

)C-Y(1

TC- G I C

The Algebra: Y=ZThe Algebra: Y=Z

TC- G I C

) of nt(independe

spending autonomous

TC- G I C 1

TC- G I C

multiplier the is and 1 C-1

The Algebra: Y=ZThe Algebra: Y=Z

Would a change in I, G, or T have the same impact on Y?

Question for DiscussionQuestion for Discussion

Equilibrium in the Goods MarketEquilibrium in the Goods Market

Income,Y

)45o line

Production

Slope = 1

Income,Y

)45o line

Production

Demand

Autonomousspending

Equilibrium point:Y = Z

Slope = 1

Income,Y

)45o line

End of ChapterEnd of Chapter

The Goods MarketThe Goods Market

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