2003-6-29 1
Chapter 3:The Goods Market
3-1:The Composition of GDP
3-2:The Demand for Goods
3-3:The Determination of Equilibrium Output
3-4:Investment Equals Saving:An Alternative
Way of Thinking About Goods-Market
Equilibrium
3-5:Is the Government Omnipotent?A
warning
2003-6-29 2
Figure 1:Production,Income,
and the Demand for Goods
Production Income
Demand
2003-6-29 3
3-1:The Composition of GDP
● The first component of GDP is consumption,(C)
● Investment (I) is sometimes called fixed investment
to distinguish it form inventory investment.
?Nonresidential investment
? Residential investment
● Government spending,(G)
? Not include government transfers
● Net exports(X-Q) is the difference between exports(X)
and imports(Q).
● Inventory investment(IS) is the difference between
goods produced and goods sold in a given year.
2003-6-29 4
The Composition of
U.S.GDP,1998
Billions of
Dollars
Percent of GDP
GDP(Y)
1 Consumption(C)
2 Investment(I)
Nonresidential
Residential
3 Government Spending(G)
4 Net Exports
Exports(X)
Imports(Q)
5 Inventory Investment(IS )
8509
5806
1308
939
369
1488
-154
958
-1112
61
100
68
15
11
4
18
-2
11
-13
1
2003-6-29 5
3-2:The Demand for Goods
Consumption (C)
Investment (I)
Government (G)
2003-6-29 6
The Demand for Goods
Z≡C+I+G+X-Q
If The Economy is closed,then
Z≡C+I+G
2003-6-29 7
Consumption(C)
C=C(YD)
(+)
? YD is disposable income
C= c0+c1YD (3.1)
? c1 is called the marginal propensity to
consume
? c0 is autonomous consume
YD ≡ Y-T
C=c0+c1(Y-T) (3.2)
Figure,Consumption and
Disposable Income
C
C = c
0
+c
1
Y
D
c
0
S l o p e = c
1
Y
D
Investment (I)
I = I ( 3, 3 )
· w e t ak e i nv estm en t a s gi v en her e,Pu tt in g a
ba r on in ve stm en t is a sim pl e t y po gr ap hi cal
w ay to r em in d us th at w e ta ke in ve st m en t as
gi ve n,
2003-6-29 10
Government (G)
G describes fiscal policy— the choice of taxes
and spending by the government.
? Government do not behave with the same regularity
as consumers or firms,So there is no reliable rule
we could write for G or T corresponding to the rule
we write for consumption.
? One of the tasks of macroeconomists is to advise
governments on spending and tax decisions,That
means we do not want to look at a model in which
we have already assumed something about their
behavior.
2003-6-29 11
3-3:The Determination of
Equilibrium Output
Using Algebra
Using a Graph
Using Words
How Long Does It Take for Output to
Adjust?
2003-6-29 12
3-3:The Determination of
Equilibrium Output
Solving a model means not only solving it
algebraically but also understanding why the
results are what they are,In the book,solving
a model will also mean characterizing the
results using graphs—sometimes skipping the
algebra—and describing the results and the
mechanisms in words.macroeconomists
always use three tools:
? 1.Algebra to make sure that the logic is right
? 2.Graphs to build the intuition
? 3.Words to explain the results
The Determination of
Equilibrium Output
Z ≡ C+I+G
Z =c
0
+c
1
(Y - T)+ I +G (3.4)
∵ Y=Z ( 3, 5 )
∴ Y= c
0
+c
1
(Y - T)+ I +G (3.6)
Using Algebra
Rew rite the equi libri um equat ion(3, 6),
Y=c
0
+c
1
Y - c
1
T+ I +G
Mov e c
1
Y to the lef t side and reor g anize the rig ht and the lef t sides,
(1 - c
1
)Y=c
0
+
I
+G - c
1
T
Div ide both sides by (1 - c
1
),
Y=
1
1
1
c?
[c
0
+
I
+G - c
1
T] (3.7)
· The second term,[c
0
+
I
+G - c
1
T],is call ed autono m ous spend ing,
· The f irst term,
1
1
1
c?
is call ed the m ultip lier,
Using a Graph 1
Z or Y 45
0
li ne
P r o d u c t i o n s l o p e = 1
Z Z
D e m a n d
Y A slo pe= c
1
E q u i l i b r i u m p o i n t, Y = Z
Au to no m ou s
s p e n d i n g
Y
Z = ( c
0
+
I
+ G - c
1
T ) + c
1
Y
Using a Graph 2
Z orY
Z Z
1
Y
1
A
1
B Z Z
Y ＄ 1billion A
4 5
0
Y Y
1
1+c 1 +c 1
2
+ … +c 1
n
2003-6-29 17
How Long does It Takes for
Output to Adjust
In our example,all adjustment is instantaneous,But
in the real word,this instantaneous adjustment does
not seem very plausible,And indeed it is not,A firm
that faces an increase in demand may decide to
wait for before adjusting its production,drawing
down its inventories to satisfy demand,A consumer
who gets a raise at work may not adjust her
consumption right away,And these delays imply
that the adjust of output will take time.
2003-6-29 18
3-4:Investment Equals Saving:An
Alternative Way of Thinking About Goods-
Market Equilibrium
S≡YD –C≡Y-T-C
Y=C+I+G S=I+G-T
Y-T-C=I+G-T
Rearranging,we get
I=S+(T-G) (3.8)
The term on the left is investment,The first term on
the right is private saving,The second term is public
saving—taxes minus government spending.
2003-6-29 19
Change way to look
equilibrium
Equation (3.8) gives us another way of looking at
equilibrium in the goods market,Equilibrium in
the goods market requires that investment equals
saving– the sum of private and public
saving.This way of looking at equilibrium explain
why the equilibrium condition for the goods
market is called the IS relation,for ―Investment
equals to Saving.‖What firm want to invest must
be equal to what people and the government
want to save.
2003-6-29 20
An Alternative Way of Thinking About the
Determination of Equilibrium Output
S = Y-T-C
= Y-T-co-c1(Y-T)
Rearranging,we get
S = -co +(1 -c1)(Y-T)
Replacing private saving in equation (3.8),
I = -co +(1 -c1)(Y-T)+(T-G)
Solving for output,
Y = 1/(1 -c1)[co +I+G- c1T]
2003-6-29 21
3-5:Is the Government
Omnipotent?A warning
Changing government spending or taxes may be far
from easy.
The effects of spending and taxes on demand are
much less mechanical than equation(3.7)makes them
appear.
Maintaining a desired level of output may come with
unpleasant side effects.
Cutting taxes or increasing government spending
may lead to large budget deficits,and an
accumulation of public debt.
Chapter 3:The Goods Market
3-1:The Composition of GDP
3-2:The Demand for Goods
3-3:The Determination of Equilibrium Output
3-4:Investment Equals Saving:An Alternative
Way of Thinking About Goods-Market
Equilibrium
3-5:Is the Government Omnipotent?A
warning
2003-6-29 2
Figure 1:Production,Income,
and the Demand for Goods
Production Income
Demand
2003-6-29 3
3-1:The Composition of GDP
● The first component of GDP is consumption,(C)
● Investment (I) is sometimes called fixed investment
to distinguish it form inventory investment.
?Nonresidential investment
? Residential investment
● Government spending,(G)
? Not include government transfers
● Net exports(X-Q) is the difference between exports(X)
and imports(Q).
● Inventory investment(IS) is the difference between
goods produced and goods sold in a given year.
2003-6-29 4
The Composition of
U.S.GDP,1998
Billions of
Dollars
Percent of GDP
GDP(Y)
1 Consumption(C)
2 Investment(I)
Nonresidential
Residential
3 Government Spending(G)
4 Net Exports
Exports(X)
Imports(Q)
5 Inventory Investment(IS )
8509
5806
1308
939
369
1488
-154
958
-1112
61
100
68
15
11
4
18
-2
11
-13
1
2003-6-29 5
3-2:The Demand for Goods
Consumption (C)
Investment (I)
Government (G)
2003-6-29 6
The Demand for Goods
Z≡C+I+G+X-Q
If The Economy is closed,then
Z≡C+I+G
2003-6-29 7
Consumption(C)
C=C(YD)
(+)
? YD is disposable income
C= c0+c1YD (3.1)
? c1 is called the marginal propensity to
consume
? c0 is autonomous consume
YD ≡ Y-T
C=c0+c1(Y-T) (3.2)
Figure,Consumption and
Disposable Income
C
C = c
0
+c
1
Y
D
c
0
S l o p e = c
1
Y
D
Investment (I)
I = I ( 3, 3 )
· w e t ak e i nv estm en t a s gi v en her e,Pu tt in g a
ba r on in ve stm en t is a sim pl e t y po gr ap hi cal
w ay to r em in d us th at w e ta ke in ve st m en t as
gi ve n,
2003-6-29 10
Government (G)
G describes fiscal policy— the choice of taxes
and spending by the government.
? Government do not behave with the same regularity
as consumers or firms,So there is no reliable rule
we could write for G or T corresponding to the rule
we write for consumption.
? One of the tasks of macroeconomists is to advise
governments on spending and tax decisions,That
means we do not want to look at a model in which
we have already assumed something about their
behavior.
2003-6-29 11
3-3:The Determination of
Equilibrium Output
Using Algebra
Using a Graph
Using Words
How Long Does It Take for Output to
Adjust?
2003-6-29 12
3-3:The Determination of
Equilibrium Output
Solving a model means not only solving it
algebraically but also understanding why the
results are what they are,In the book,solving
a model will also mean characterizing the
results using graphs—sometimes skipping the
algebra—and describing the results and the
mechanisms in words.macroeconomists
always use three tools:
? 1.Algebra to make sure that the logic is right
? 2.Graphs to build the intuition
? 3.Words to explain the results
The Determination of
Equilibrium Output
Z ≡ C+I+G
Z =c
0
+c
1
(Y - T)+ I +G (3.4)
∵ Y=Z ( 3, 5 )
∴ Y= c
0
+c
1
(Y - T)+ I +G (3.6)
Using Algebra
Rew rite the equi libri um equat ion(3, 6),
Y=c
0
+c
1
Y - c
1
T+ I +G
Mov e c
1
Y to the lef t side and reor g anize the rig ht and the lef t sides,
(1 - c
1
)Y=c
0
+
I
+G - c
1
T
Div ide both sides by (1 - c
1
),
Y=
1
1
1
c?
[c
0
+
I
+G - c
1
T] (3.7)
· The second term,[c
0
+
I
+G - c
1
T],is call ed autono m ous spend ing,
· The f irst term,
1
1
1
c?
is call ed the m ultip lier,
Using a Graph 1
Z or Y 45
0
li ne
P r o d u c t i o n s l o p e = 1
Z Z
D e m a n d
Y A slo pe= c
1
E q u i l i b r i u m p o i n t, Y = Z
Au to no m ou s
s p e n d i n g
Y
Z = ( c
0
+
I
+ G - c
1
T ) + c
1
Y
Using a Graph 2
Z orY
Z Z
1
Y
1
A
1
B Z Z
Y ＄ 1billion A
4 5
0
Y Y
1
1+c 1 +c 1
2
+ … +c 1
n
2003-6-29 17
How Long does It Takes for
Output to Adjust
In our example,all adjustment is instantaneous,But
in the real word,this instantaneous adjustment does
not seem very plausible,And indeed it is not,A firm
that faces an increase in demand may decide to
wait for before adjusting its production,drawing
down its inventories to satisfy demand,A consumer
who gets a raise at work may not adjust her
consumption right away,And these delays imply
that the adjust of output will take time.
2003-6-29 18
3-4:Investment Equals Saving:An
Alternative Way of Thinking About Goods-
Market Equilibrium
S≡YD –C≡Y-T-C
Y=C+I+G S=I+G-T
Y-T-C=I+G-T
Rearranging,we get
I=S+(T-G) (3.8)
The term on the left is investment,The first term on
the right is private saving,The second term is public
saving—taxes minus government spending.
2003-6-29 19
Change way to look
equilibrium
Equation (3.8) gives us another way of looking at
equilibrium in the goods market,Equilibrium in
the goods market requires that investment equals
saving– the sum of private and public
saving.This way of looking at equilibrium explain
why the equilibrium condition for the goods
market is called the IS relation,for ―Investment
equals to Saving.‖What firm want to invest must
be equal to what people and the government
want to save.
2003-6-29 20
An Alternative Way of Thinking About the
Determination of Equilibrium Output
S = Y-T-C
= Y-T-co-c1(Y-T)
Rearranging,we get
S = -co +(1 -c1)(Y-T)
Replacing private saving in equation (3.8),
I = -co +(1 -c1)(Y-T)+(T-G)
Solving for output,
Y = 1/(1 -c1)[co +I+G- c1T]
2003-6-29 21
3-5:Is the Government
Omnipotent?A warning
Changing government spending or taxes may be far
from easy.
The effects of spending and taxes on demand are
much less mechanical than equation(3.7)makes them
appear.
Maintaining a desired level of output may come with
unpleasant side effects.
Cutting taxes or increasing government spending
may lead to large budget deficits,and an
accumulation of public debt.
