Product Markets and National Output

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Product Markets and National Output

• Chapter 12

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Discussion Topics

• Circular flow of payments
• Composition and measurement of gross domestic
  product
• Consumption, saving and investment
• Equilibrium national income and output

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Partial vs General Equilibrium

• Discussion of market outcomes in the preceding
  chapters was conducted within partial equilibrium
• Partial Equilibrium focuses on a single market,
  assuming everything else remains constant
• General Equilibrium focuses on all markets in
  the economy and regards all markets as being
  interdependent
• Objective of Chapter
• Illustrate how businesses and households are
  linked through resource and product markets
• Establish the conditions that must be satisfied
  for an equilibrium between producers and
  consumers for a given rate of interest
• Discuss the composition and measurement of
  national output

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Circular Flow DiagramforGeneral Economy
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We can measure macro economic activity in
either resource markets or product markets.
Result is the same
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Four major sectors In this economy
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Businesses are net borrowers in financial markets
while households are net savers
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Government receives net inflows of taxes from
businesses and households and is a net borrower
in financial markets
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Businesses make investment expenditures, Governmen
ts makes expenditures, and Households make
consumption expenditures
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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
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Measurement ofGross Domestic Product
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GDP
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Everything below zero represents a recession
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GDP C I G (X M)
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GDP C I G (X M)
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GDP C I G (X M)
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GDP C I G (X M)
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Whats in GDP?Focus is on new goods and
services produced in current year
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Types of consumer expenditures
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Types of investment expenditures
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Calculation of net exports
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Types of government Expenditures
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Items not included in GDP
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Understanding the Domestic Determinants of GDPC,
I, G
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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
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Planned Consumption Function
The consumption function in this graph can
be expressed graphically as shown below.
C AC MPC(DPI)
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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
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Planned Consumption Function
An increase in dis- posable income to 4,000
would raise expenditures to 4,300. Dis-saving
would fall to 300.
C 1,500 .70(4,000) 4,300
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Planned Consumption Function
An increase in dis- posable income to 5,000
would raise expenditures to 5,000. Dis-saving
would fall to zero.
C 1,500 .70(5,000) 5,000
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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
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When the savings rate rises significantly, a
recession is often near.
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Planned Consumption Function
A role for fiscal policy here A cut in the tax
rate increases consump- tion. An increase in
the tax rate decreases consumption.
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Planned Consumption Function
A role for fiscal policy here A cut in the tax
rate increases consump- tion. An increase in
the tax rate decreases consumption.
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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 nations household
  sector
• Expectations of higher income in the near future

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Real Wealth Effect
Suppose stock market prices rose, increasing real
wealth of consumers by 700.
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Real Wealth Effect
This would increase the intercept by 700,
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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
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Planned Investment Function
Level of autonomous investment spending
I AI MEI(i)
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Planned Investment Function
The slope of the investment function is the
marginal efficiency of investment, or MEI ?I?i
I AI MEI(i)
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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)
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Planned Investment Function
Should interest rates fall to 7 as a result of
events in the money market, investment expenditure
s would increase from 250 to 300.
I 475 25(7.0)
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Shifts in Investment Function

• Profit expectations
• Prices of new investment goods
• Technological change
• Taxes

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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)
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Understanding Product MarketEquilibrium
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Aggregate Expenditures CIG
Consumption expenditures function C
1,5000.70(DPI)
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Aggregate Expenditures
Consumption expenditures function C
1,5000.70(DPI) Investment expenditures
function I 475 25(i)
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Aggregate Expenditures
Consumption expenditures function C
1,5000.70(DPI) Investment expenditures
function I 475 25(i) Government
expenditures function G 880
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Aggregate Expenditures (AE)
Consumption expenditures function C
1,5000.70(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)
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Aggregate Expenditures
Aggregate expenditures equation AE
2,6800.70(NI-Tax)
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Aggregate Expenditures
Aggregate expenditures equation AE
2,6800.70(NI-Tax) where national output equals
national income (NI) and Tax is based upon last
years income (Tax 400).
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Aggregate Expenditures
Aggregate expenditures equation AE
2,6800.70(NI-Tax) where national output equals
national income (NI) and Tax is based upon last
years income (Tax 400). If national income
is 6,000, then AE 2,6800.70(6,000 - 400)
6,600 which represents the first line in
Table 12.4
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Aggregate Expenditures
Aggregate expenditures equation AE
2,6800.70(NI-Tax) where national output equals
national income (NI) and Tax is based upon last
years income (Tax 400). If national income
is 6,000, then AE 2,6800.70(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
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Aggregate Expenditures Curve
Total autonomous domestic spending
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Aggregate Expenditures Curve
Point where spending equals output YCIG. This
Equilibrium assumes a given market interest
rate and general price level. Note below this
equilibrium, AEgtY which should draw down unsold
inventories and increase pressures to expand Y.
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Deriving Aggregate Demand Curve each price
level will correspond to a different AE and Y
demanded
Aggregate demand curve
Corresponding price level
Demand equals supply
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Aggregate Supply Curve represents the nations
output supplied to consumers, businesses,
governments, foreign countries
Three distinct ranges of aggregate supply curve
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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 and supply unaccompanied by rising
prices
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Product Market Equilibrium
YFE represents full employment output economys
max non-inflationary or natural rate of
employment YE represents current or actual output
(planned spending) YPOT represents potential or
maximum output
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Product Market Equilibrium theoretical goal is
to eliminate inflationary or recessionary gaps
YE gt YFE
YFE gt YE
Planned spending less than full employment
output, causing underutilization of economys
resources.
Planned spending exceeds full employment
output, causing higher inflationary pressures in
economy.
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Summary

• GDP consists of C, I, G and (X-M)
• Focus is on new goods produced and services
  performed in the current year
• Consumption influenced by disposable income and
  wealth
• Investment influenced by interest rates and
  profit expectations
• Product market equilibrium occurs where aggregate
  demand equals aggregate supply
• Inflationary and recessionary gaps occur when
  economy not at full employment output

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