The Goods Market
The composition of GDP
● Consumption - goods / services purchased by consumers
● (Fixed) investment - the sum of nonresidential and residential investment
● Government spending - purchases of goods / services by the federal, state,
local governments (excludes government transfers)
● Exports (X) - purchases of US goods / services by foreigners
● Imports (IM) - purchases of foreign goods / services by US consumers, firms
and the government
● Net exports / trade balance (NX) = X - IM
● Inventory investment - the difference between production and sales
○ When a firm sells a good out of inventory, GDP is not changed
The demand for goods
● Z = C + I + G + (X-IM)
○ Closed economy: Z = C + I + G
● Consumption is a function of disposable income (income after government
transfers and taxes)
○ Positive correlation between disposable income and consumption
○ 𝐶 = 𝐶(𝑌𝐷 ) = the consumption function
● 𝐶 = 𝑐0 + 𝑐1 𝑌𝐷 - the Keynesian Consumption function
○ 𝑐1= the marginal propensity to consume. 0<𝑐1<1. Consumption
increases less than 1 for 1 with income
○ 𝑐0 = what people what consume if their disposable income = 0
■ Positive because there are always necessities that need to be
bought
■ Changes in C0 represent changes in consumption for a given
level of income
● 𝑌𝐷 = 𝑌 − 𝑇(disposable income = income - taxes)
● Endogenous variables depend on other variables within the model
● Exogenous variables are taken as given
○ 𝐼- a bar on investment means it is taken as given
○ G and T (fiscal policy) are exogenous
Determination of equilibrium output
● Equilibrium occurs when Y = Z
1
● 𝑌 = 𝑍 = 𝑐𝑜 + 𝑐1 (𝑌 − 𝑇) + 𝐼 + 𝐺 = 1−𝑐 (𝑐0 + 𝐼 + 𝐺 − 𝑐1 𝑇)
1
1
○ = the multiplier (>1)
1−𝑐1
The composition of GDP
● Consumption - goods / services purchased by consumers
● (Fixed) investment - the sum of nonresidential and residential investment
● Government spending - purchases of goods / services by the federal, state,
local governments (excludes government transfers)
● Exports (X) - purchases of US goods / services by foreigners
● Imports (IM) - purchases of foreign goods / services by US consumers, firms
and the government
● Net exports / trade balance (NX) = X - IM
● Inventory investment - the difference between production and sales
○ When a firm sells a good out of inventory, GDP is not changed
The demand for goods
● Z = C + I + G + (X-IM)
○ Closed economy: Z = C + I + G
● Consumption is a function of disposable income (income after government
transfers and taxes)
○ Positive correlation between disposable income and consumption
○ 𝐶 = 𝐶(𝑌𝐷 ) = the consumption function
● 𝐶 = 𝑐0 + 𝑐1 𝑌𝐷 - the Keynesian Consumption function
○ 𝑐1= the marginal propensity to consume. 0<𝑐1<1. Consumption
increases less than 1 for 1 with income
○ 𝑐0 = what people what consume if their disposable income = 0
■ Positive because there are always necessities that need to be
bought
■ Changes in C0 represent changes in consumption for a given
level of income
● 𝑌𝐷 = 𝑌 − 𝑇(disposable income = income - taxes)
● Endogenous variables depend on other variables within the model
● Exogenous variables are taken as given
○ 𝐼- a bar on investment means it is taken as given
○ G and T (fiscal policy) are exogenous
Determination of equilibrium output
● Equilibrium occurs when Y = Z
1
● 𝑌 = 𝑍 = 𝑐𝑜 + 𝑐1 (𝑌 − 𝑇) + 𝐼 + 𝐺 = 1−𝑐 (𝑐0 + 𝐼 + 𝐺 − 𝑐1 𝑇)
1
1
○ = the multiplier (>1)
1−𝑐1
