Product Markets and National Output Chapter 12 Discussion

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

Circular Flow Diagram for General Economy

We can measure macro economic activity in either resource markets or product markets. Result is the same… Page 277

Four major sectors In this economy… Page 277

Businesses are net borrowers in financial markets while households are net savers… Page 277

Government receives net inflows of taxes from businesses and households and is a net borrower in financial markets… Page 277

Businesses make investment expenditures, Governments makes expenditures, and Households make consumption expenditures Page 277

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 277

Measurement of Gross Domestic Product

Everything below zero represents a recession Page 279

What’s in GDP?

Types of consumer expenditures… Page 279

Types of investment expenditures… Page 279

Calculation of net exports… Page 279

Types of government Expenditures… Page 279

Items not included in GDP… Page 279

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 281

Planned Consumption Function The consumption function in this graph can be expressed graphically as shown below. C = AC + MPC(DPI) Page 281

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 281

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 281

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 281

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 282 and 284

When the savings rate rises significantly, a recession is often near.

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 281

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 281

Real Wealth Effect Suppose stock market prices rose, increasing real wealth of consumers by $700. Page 283

Real Wealth Effect This would increase the intercept by $700, Page 283

Real Wealth Effect This shifts the curve upward for given income level, boosts consumer spending to $5, 000. This raises dis-saving to $1, 000, raises debt relative to income, and can be inflationary…. . C = $2, 200 +. 70($4, 000) = $5, 000 Page 283

Planned Investment Function Level of autonomous investment spending I = AI – MEI(i) Page 287

Planned Investment Function The slope of the investment function is the marginal efficiency of investment, or: MEI = I÷ i I = AI – MEI(i) Page 287

Planned Investment Function Level of investment expenditures would be $250 at an interest rate of 9 percent if MEI = 25. I = $475 – 25(9. 0) Page 287

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 287

Effects of Profit Expectations An increase in profit expectations would cause businesses to expand their planned investment expenditures by $50 at the same interest rate I = $525 – 25(7. 0) Page 288

Understanding Product Market Equilibrium

Aggregate Expenditures Consumption expenditures function: C = $1, 500+0. 70(DPI) Page 289

Aggregate Expenditures Consumption expenditures function: C = $1, 500+0. 70(DPI) Investment expenditures function: I = $475 – 25(i) Page 289

Aggregate Expenditures Consumption expenditures function: C = $1, 500+0. 70(DPI) Investment expenditures function: I = $475 – 25(i) Government expenditures function: G = $880 Page 289

Aggregate Expenditures 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 289

Aggregate Expenditures Aggregate expenditures equation: AE = $2, 680+0. 70(NI-Tax) Page 289

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 289

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 289

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 290 Page 289

Aggregate Expenditures Curve Total autonomous domestic spending… Page 290

Aggregate Expenditures Curve Point where spending equals output… Page 290

Deriving Aggregate Demand Curve Aggregate demand curve Demand equals supply Corresponding price level Page 291

Aggregate Supply Curve Three distinct ranges of aggregate supply curve Page 292

Aggregate Supply Curve Maximum potential output in the short run… End of depression or Keynesian range Page 292

Product Market Equilibrium YFE represents full employment output YE represents current or actual output YPOT represents potential or maximum output Page 293

Product Market Equilibrium 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 293

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 when economy not at full employment output

Chapter 13 focuses on the application of monetary and fiscal policy….