Product Markets and National Output Chapter 12 Discussion
- Slides: 64
Product Markets and National Output Chapter 12
Discussion Topics üCircular flow of payments üComposition and measurement of gross domestic product üConsumption, saving and investment üEquilibrium national income and output
Partial vs General Equilibrium ü Discussion of market outcomes in the preceding chapters was conducted within a partial equilibrium framework ü Partial Equilibrium – focus on a single market, assuming everything else remains constant ü General Equilibrium – focus on all markets in the economy; all markets are interdependent ü Objectives of Chapter ü Illustrate how businesses and households are linked through resource and product markets ü Discuss the composition and measurement of national output
Circular Flow Diagram for the General Economy
We can measure macroeconomic activity in either resource markets or product markets. Page 224
Four major sectors in the U. S. economy… Page 224
Businesses are net borrowers in financial markets while households are net savers… Page 224
Government receives net inflows of taxes from businesses and households and is a net borrower in financial markets… Page 224
Businesses make investment expenditures, Governments make expenditures, and Households make consumption expenditures Page 224
Businesses receive funds from total expenditures in product markets while households, who own businesses, receive wages, rents, interest and business in resource markets profits where they provide labor and capital services… Page 224
Measurement of Gross Domestic Product
GDP
Gross Domestic Product B. Measurement Money – a common denominator ; add up the value of money in terms of the total output of goods and services during a certain time period, normally a year.
Everything below zero represents a recession Page 227
What’s in GDP? Focus is on new goods and services produced in current year
Types of consumer expenditures… Page 226
Types of investment expenditures… Page 226
Calculation of net exports… Page 226
Types of government Expenditures… Page 226
Items not included in GDP… Page 226
Understanding the Domestic Determinants of GDP C, I, G
Planned Consumption Function The slope of the consumption function is the marginal propensity to consume (MPC), or C÷ YD where YD represents disposable income. Autonomous or fixed consumption Page 228
Planned Consumption Function The consumption function in this graph can be expressed graphically as shown below. C = AC + MPC(DPI) Page 228
Planned Consumption Function Consumer expenditures would be $3, 600 if disposable income was equal to $3, 000. Consumers would be dis-saving by $600. C = $1, 500 +. 70($3, 000) = $3, 600 Page 228
Planned Consumption Function An increase in disposable income to $4, 000 would raise expenditures to $4, 300. Dis-saving would fall to $300. C = $1, 500 +. 70($4, 000) = $4, 300 Page 228
Planned Consumption Function An increase in disposable income to $5, 000 would raise expenditures to $5, 000. Dis-saving would fall to zero. C = $1, 500 +. 70($5, 000) = $5, 000 Page 228
Savings vs. Consumption We said that the slope of the consumption function was the marginal propensity to consume, or: MPC = C ÷ DPI Savings is defined as S = DPI – C And, therefore, the marginal propensity to save is MPS = 1. 0 – MPC Page 228 and 229
Planned Consumption Function A role for fiscal policy here: A cut in the tax rate increases consumption. An increase in the tax rate decreases consumption. Page 228
Planned Consumption Function A role for fiscal policy here: A cut in the tax rate increases consumption. An increase in the tax rate decreases consumption. Page 228
Shifts in Consumption Function • Changes in the level of income correspond to movements along the consumption function • Factors that can shift the consumption function: – Increase/decrease in wealth of nation’s household sector – Expectations of higher income in the near future
Planned Investment Function Level of autonomous investment spending I = AI – MIS(i) Page 233
Planned Investment Function The slope of the investment function is the marginal interest sensitivity of investment or: MIS = I÷ i I = AI – MIS(i) Page 233
Planned Investment Function Level of investment expenditures would be $250 at an interest rate of 9 percent if MIS = 25. I = $475 – 25(9. 0) Page 233
Planned Investment Function Should interest rates fall to 7% as a result of events in the money market, investment expenditures would increase from $250 to $300. I = $475 – 25(7. 0) Page 233
Shifts in Investment Function • Profit expectations • Prices of new investment goods • Technological change • Taxes
Effects of Profit Expectations An increase in profit expectations would shift the investment function to the right (e. g. , would cause businesses to expand their planned investment expenditures by $50 at the same interest rate). I = $525 – 25(7. 0) Page 234
Understanding Product Market Equilibrium
Aggregate Expenditures= C+I+G Consumption expenditures function: C = $1, 500+0. 70(DPI) Page 235
Aggregate Expenditures Consumption expenditures function: C = $1, 500+0. 70(DPI) Investment expenditures function: I = $475 – 25(i) Page 235
Aggregate Expenditures Consumption expenditures function: C = $1, 500+0. 70(DPI) Investment expenditures function: I = $475 – 25(i) Government expenditures function: G = $880 Page 235
Aggregate Expenditures (AE) Consumption expenditures function: C = $1, 500+0. 70(DPI) Investment expenditures function: I = $475 – 25(i) Government expenditures function: G = $880 If the interest rate (i) is equal to 7%, then AE = $1, 500 + 0. 70(DPI) + $475 – 25(7) +$880 = $2, 680 + 0. 70(DPI) Page 235
Aggregate Expenditures Aggregate expenditures equation: AE = $2, 680+0. 70(NI-Tax) Page 235
Aggregate Expenditures Aggregate expenditures equation: AE = $2, 680+0. 70(NI-Tax) where national output equals national income (NI) and Tax is based upon last year’s income (Tax = $400). Page 235
Aggregate Expenditures Aggregate expenditures equation: AE = $2, 680+0. 70(NI-Tax) where national output equals national income (NI) and Tax is based upon last year’s income (Tax = $400). If national income is $6, 000, then AE = $2, 680+0. 70($6, 000 - $400) = $6, 600 which represents the first line in Table 12. 4 Page 235
Aggregate Expenditures Aggregate expenditures equation: AE = $2, 680+0. 70(NI-Tax) where national output equals national income (NI) and Tax is based upon last year’s income (Tax = $400). If national income is $6, 000, then AE = $2, 680+0. 70($6, 000 - $400) = $6, 600 which represents the first line in Table 12. 4 Repeating this for other levels of income gives us the graph on page 236
Aggregate Expenditures Curve Total autonomous domestic spending… Page 236
Aggregate Expenditures Curve Point where spending equals output Y=C+I+G. This equilibrium assumes a given market interest rate and general price level. Note: below this equilibrium, AE>Y which should draw down unsold inventories and increase pressures to expand Y. Page 236
Deriving the Aggregate Demand Curve Aggregate demand curve Demand equals supply Corresponding price level Page 237
Aggregate Supply Curve: represents the nation’s output supplied to consumers, businesses, governments, foreign countries Three distinct ranges of the aggregate supply curve Page 238
Aggregate Supply Curve Maximum potential output in the short run: economy reaches capacity to supply goods and services in current period End of depression or Keynesian range: increases in demand supply unaccompanied by rising prices Page 238
Product Market Equilibrium YFE represents full employment output: economy’s max non-inflationary or natural rate of employment YE represents current or actual output (planned spending) YPOT represents potential or maximum output Page 238
Product Market Equilibrium : theoretical goal is to eliminate inflationary or recessionary gaps YE > YFE > YE Planned spending exceeds full employment output, causing higher inflationary pressures in economy. Planned spending less than full employment output, causing underutilization of economy’s resources. Page 238
Summary ü GDP consists of C, I, G and (X-M) ü Focus is on new goods produced and services performed in the current year ü Consumption influenced by disposable income and wealth ü Investment influenced by interest rates and profit expectations ü Product market equilibrium occurs where aggregate demand equals aggregate supply ü Inflationary and recessionary gaps occur
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