Literature summary Macroeconomics

Literatuur Macroeconomics
Week 2
Hoofdstuk 3
Interactions among demand, production, and income:
 Changes in the demand lead to changes in production
 Changes in production lead to changes in income
 Changes in income lead to changes in the demand for goods

Gross domestic product (GDP): Z ≡C + I + G+ X−I
 Consumption (C): goods and services purchased by consumers
 Investment (I): sum of non-residential and residential investment
o Non-residential: purchase by firms of new plants or new machines
o Residential: purchase by people of new houses or apartments
 Government spending (G): purchases of goods and services by the federal, state, and
local governments, does not include government transfers
 Export (X): purchases of goods and services by foreigners
 Imports (IM): purchases of foreign goods and services by consumers, firms, and
government

Trade balance/net exports = difference between export – import, > 0 is a trade surplus, < 0 is
a trade deficit
Inventory investment = difference between production and sales

Consumption (C)
 Consumption function depends on the disposable income and the propensity to consume
 C=c 0 +c 1 Y D
o c 0: consumption if disposable income would be zero
o c 1: propensity to consume, effect an additional dollar of disposable income has on
consumption, between 0 and 1
o Y D: disposable income, income – taxes (Y – T)
o This is a behavioural equation with a linear relation

Investment (I) and Government spending (G)
 Exogenous variables so for now taken as given
 Write investment as I
 Together with T, G describes the fiscal policy

Equilibrium in the goods market
 Equilibrium requires that production Y is equal to demand for goods Z
 This gives: Y =c 0+ c 1( Y −T )+ I +G, with the trade balance = 0
1
 We can rewrite this to: Y = [c + I +G−c 1 T ]
1−c1 0
1
o : money multiplier, multiplies the increase/decrease in variable to a bigger
1−c 1
effect, higher demand leads to higher production leads to higher income leads to
higher demand etc.
o [ c 0 + I +G−c 1 T ] : autonomous spending, part that doesn’t depend on output

, Graphical description of equilibrium:




Standard equilibrium Change in one variable and multiplier effect

Saving
 Private saving: saving by consumers
o S ≡Y D−C
o S ≡Y −T −C
o S ≡−c 0 +(1−c 1)(Y −T )
o (1−c1 ): propensity to save
 Public saving
o T–G
o Budget surplus or budget deficit

Investment equals saving: equilibrium for goods-market
 Rewriting the equilibrium can give you investment = saving
 I = S + (T – G)
 Also called the IS-relation

Hoofdstuk 4
Variables in the financial market:
 Two different monetary assets:
o Money: can be used for transactions, pays no interest
o Bonds: pay a positive interest rate i, cannot be used for transactions
 Proportions of these monetary assets depend on:
o Level of transactions: need to have enough money to do
transactions
o Interest rate: higher interest rate gives a higher return on
bonds

Demand for money
 Demand for money: sum of all the individual demands by
people and firms
 M d =$ Y L ( i )
(-)
o Demand for money is equal to nominal income $Y times a
decreasing function of the interest rate