product markets and national output
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Product Markets and National Output. Chapter 12. Discussion Topics. Circular flow of payments Composition and measurement of gross domestic product Consumption, saving and investment Equilibrium national income and output. Circular Flow Diagram for the General Economy. - PowerPoint PPT PresentationTRANSCRIPT
Product Markets and
National Output
Chapter 12
Discussion TopicsCircular flow of paymentsComposition and measurement of gross
domestic productConsumption, saving and investmentEquilibrium national income and output
Circular Flow Diagramfor the
General Economy
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Financial Markets
Circular Flow of PaymentsWe can measure macroeconomic
activity in either: Resource markets (Expenditures) Product markets (Income) Result is the same
There are 4 major sectors to the overall economy
4
Government
HouseholdsBusinesses
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Financial Markets
Circular Flow of Payments
5
NetSaving
NetBorrowing
Financial Markets Businesses are net borrowers Households are net savers Government is a net borrower
Government
HouseholdsBusinesses
Net GovernmentBorrowing
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Government
Circular Flow of Payments
6
NetSaving
NetBorrowing
Financial Markets Businesses are net borrowers Households are net savers Government is a net borrower
Government Receives net tax inflows from businesses
and households
Net GovernmentBorrowing
Net TaxesNet Taxes
Businesses HouseholdsFinancial Markets
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HouseholdsFinancial MarketsBusinesses
Government
Circular Flow of Payments
7
NetSaving
NetBorrowing
Expenditures Businesses: Investment expenditures Gov’t makes expenditures Households: Consumption expenditures
Net GovernmentBorrowing
Net TaxesNet Taxes
Total Expenditures(National Product) C
onsumer E
xpenditures
Gov’t Exp.Business Expenditures
Product Markets
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Businesses
Government
Circular Flow of Payments
8
NetSaving
NetBorrowing
Income Businesses: Receive total expenditures from Product Markets Households: Receive wages, rents, interest and profits in
resource markets for labor and capital services
Net GovernmentBorrowing
Net TaxesNet Taxes
Total Expenditures(National Product) C
onsumer E
xpenditures
Tota
l Exp
endi
ture
s
Gov’t Exp.Business Expenditures
Resource Markets
Product Markets
Wages + Rents + Interest + Profits
Financial Markets Households
Retained Earnings
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Measurement of U.S. Output
9
A nation’s annual output is referred to as the Gross Domestic Product (GDP)
Two approaches to measure GDP levels Expenditures Approach: Measures activity
in the product market Consume Expenditures, Investment,
Government Expenditures, Net Exports Income Approach: Measures activity in the
resources market Wages, Rents, Interest, Profits
Measurement ofGross Domestic Product
10
11
Bil. $ GDP %
Gross Domestic Product (GDP) 14,660.2
Personal Consumption Expenditures
Total 10,351.9 70.6 Goods 3,427.6 23.4
Services 6,924.3 47.2
Gross Private Domestic Investment
Total 1,821.4 12.4 Fixed Invest. Total 1,752.8 12.0
Nonresidential Structures 381.8 2.6
Producers Durable Equip. 1,030.7 7.0
Residential 340.4 2.4 Δ Inventory 68.5 0.4
Net Exports of Goods and Services
Net exports -515.5 -3.5 Exports 1,837.1 12.5 Imports 2,352.6 -16.0
Government Consumption
Expenditures and Gross Investment
Total 3,002.3 20.5 Federal Total 1,214.4 8.3
Defense 817.8 5.6 Nondefense 396.6 2.7State & Local 1,788.0 12.2
2010 U.S. Gross Domestic Product
GDP = C + I + G + (X – M)
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Measurement of U.S. Output
12
Recession: A general slowdown in economic activityGDP, employment, investment spending,
capacity utilization, household incomes business profits and inflation all ↓
One definition: 2 consecutive quarters of declines in real GDP
NBER definition: a significant ↓ in economic activity spread across the economyLasting more than a few months↓ in real GDP, real income, employment,
industrial production, and wholesale-retail sales
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-3.00
-1.75
-0.50
0.75
2.00
3.25
4.50
5.75
7.00
8.25
Real % Change in U.S. GDP
Measurement of U.S. Output
A % change below zero represents a recession
0
1974-75
1981-82
1990-91
2008-09
13
What’s in GDP?
14
15 Page 226
Types of consumerexpenditures…
Types of investmentexpenditures…
16 Page 226
Calculation of net exports…
Not inGDP…
Types of governmentexpenditures…
Understanding the Domestic
Determinants of GDP,C, I and G
17
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Autonomous orfixed consumption
Aggregate Consumption Function
Disposable personal income (DPI) = personal income after payment of taxes
Aggregate consumption function slope defined as the marginal propensity to consume (MPC) whereMPC = C ÷ YD
and YD is disposable incomeMPC = $2,100 ÷ $3,000 = 0.70
18
GDP = C + I + G + (X – M)
Aggregate: Total U.S. economy
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Aggregate Consumption Function
The consumption functionin this graph can beexpressed mathematically as:C = AC + MPC x DPI→ C = $1,500 + 0.70 x $3,000 = $3,600 (Bil)(consumers would be dis-savingby $600 (Bil))
19
GDP = C + I + G + (X – M)
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An ↑ in DPI to $4,000 (Bil) would ↑ expenditures to $4,300 (Bil)(Dis-saving would ↓ to $300 (Bil))
Aggregate Consumption Function
C = $1,500 + .70 x $4,000 = $4,300 (Bil)
20
GDP = C + I + G + (X – M)
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Aggregate Consumption Function
C = $1,500 + .70 x $5,000 = $5,000 (Bil)
An ↑ in DPI to $5,000 (Bil) would ↑ expenditures to $5,000 (Bil)
(Dis-saving would ↓ to 0)
21
GDP = C + I + G + (X – M)
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Aggregate Consumption Function
How can we determine what DPI results in dis-savings being 0? Intersection of 450 line
from the origin with the aggregate consumption function
Line shows where DPI = consumption expenditures
22
450
GDP = C + I + G + (X – M)
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Aggregate Consumption Function
23
What would happen if aggregate income ↑ to $6,000 (Bil)
C = $1,500 + .70 x $6,000 = $5,700 (Bil)→a savings of $300 Bil. Not surprising given that only 70% of
DPI is being used for consumer expenditures
Aggregate Savings
24
As noted above, the slope of the aggregate consumption function is the MPC (= C ÷ DPI)
Savings is defined as: S = DPI – CAssumes that DPI can either be spent
or saved
→ The Marginal Propensity to Save (MPS) is defined as: MPS = 1.0 – MPCThe % of DPI that will put towards
savings Page 228 and 230
When the savings rate ↑ significantly, a recession is often near
25
GDP = C + I + G + (X – M)
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Aggregate Consumption Function
Example of fiscal policy: A ↓ in the tax rate ↑
consumption as DPI (= PI – Taxes) ↑
26
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Aggregate Consumption Function
Alternatively: An ↑ in the tax rate
↓ consumption as DPI is ↓
27
GDP = C + I + G + (X – M)
Concept of Wealth
28
Wealth is the net worth of a person, household, or nationNet worth is the value of all assets owned net
of all liabilities owedNet Worth = Assets - Liabilities
Assets = Anything tangible or intangible that is capable of being owned or controlled to produce value
Liabilities = an obligation of an entity arising from past transactions or events Liabilities are debts and obligations of an
economic agent and represent creditors claim on assets
For national wealth calculations net liabilities are those owed to the rest of the world
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Real Wealth Effect on Consumption
Suppose stock market prices ↑, ↑ real wealth of consumers by $700 (Bil)
29
GDP = C + I + G + (X – M)
This would ↑ AC by $700
C = $2,200 + .70 x DPI
C = $1,500 + .70 x DPI
30 Page 230
Real Wealth Effect
C = $2,200 + .70 x $4,000 = $5,000
Wealth effect:Shifts the curve
upward for each income level
At $4,000 (Bil)↑ consumer spending to $5,000 (Bil)
↑ dis-saving to $1,000 (Bil) from $300 (Bil)
↑ debt relative to income
Real Wealth Effect on Consumption GDP = C + I + G
+ (X – M)
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Aggregate Investment Function
I = AI – MEI x IR
Investment function slope is the marginal efficiency of investment (MEI)
MEI = I ÷ IRI = f(IR)
GDP = C + I + G + (X – M)
31
Level of autonomousinvestment spending(i.e., independent of IR)IR = interest rate
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Aggregate Investment Function
I = $475 – 25(9.0)
Level of investmentexpenditures wouldbe $250 at an interestrate of 9% if MEI = 25
32
GDP = C + I + G + (X – M)
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Aggregate Investment Function
If IR ↓ to 7% investmentexpenditures would ↑from $250 to $300.
I = $475 – 25 x 7.0 = $300
33
GDP = C + I + G + (X – M)
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Effects of Profit Expectationson Aggregate Investments
I = $525 – 25(7.0)
An ↑ in profit expectations → AI ↑ and planned
investment expend. at the same IR
At 7% IR investment ↑by $50
GDP = C + I + G + (X – M)
34
Understanding the Product Market
Equilibrium
35
Aggregate ExpendituresConsumption expenditures function (Bil $):
C = $1,500 + 0.70 x DPIInvestment expenditures function (Bil $):
I = $475 – 25 x IRGovernment expenditures function (Bil $):
G = $880Aggregate Expenditures (AE) = C + I + G
If the interest rate (IR) = 7% AE = ($1,500 + 0.70 x DPI) + ($475 – 25 x 7) + $880
= $2,680 + (0.70 x DPI)
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GDP = C + I + G + (X – M) = AE + (X – M)
C I G
36
Aggregate Expenditures Aggregate expenditures equation: AE = $2,680 + 0.70 x (NI – Taxes Paid)
where NI (National Income) = Wages + Rents + Interest + Profits
Lets assume that the amount of taxes = $400 If national income is $6,000, then
AE = $2,680+ 0.70 x ($6,000 - $400) = $6,600
which represents the 1st line in Table 12.4 Repeating this for other levels of national
income generates the following graph Page 235
DPI
GDP = AE + (X – M)
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Aggregate Expenditures Curve
Total autonomousdomestic spending…
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Aggregate Expenditures Curve
National Income
Point where C + I + G = NI
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Deriving The Aggregate Demand Curve
Demand equals supply Corresponding price level
Aggregatedemand curve
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Aggregate Supply Curve
Three distinct rangesof aggregate supplycurve
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Aggregate Supply Curve
End of depressionor Keynesian range
Maximum potentialoutput in the shortrun…
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YFE represents full employment outputYE represents current or actual outputYPOT represents potential or maximum output
Product Market Equilibrium
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Product Market Equilibrium
Planned spending exceedsfull employment output,causing higher inflationarypressures in economy.
Planned spending less thanfull employment output,causing underutilization ofeconomy’s resources.
YE > YFE
YFE > YE
SummaryGDP consists of C, I, G and (X-M) Consumption influenced by disposable
income and wealthInvestment influenced by interest rates
and profit expectationsProduct market equilibrium occurs where
aggregate demand equals aggregate supply
Inflationary and recessionary gaps occur when economy not at full employment output