HE2002 - The Goods Market

• The 5 composition of GDP are Consumption, Investment, Government spending, Exports and Imports.
• Investment is also known as fixed investment which is the sum of residential investment and nonresidential investment
• Government transfer is excluded from government spending
• Government purchase of services mean services provided by government employees
• Government spending does not include government transfers and interest payments on the government debt
• Inventory investment is the difference between goods produced and goods sold in a given year
• Inventory investment is the difference between production and sales
• When production exceeds sales, inventory investment is said to be positive
• Production = Sales + Inventory Investment
• Inventory investment is typically small and positive in some years while negative in others
• 3 assumptions about the determinants of Z: 1. Assume that all firms produce the same goods. 2. Assume that firms are willing to supply any amount of good at a given price level. 3. Assume that the economy is closed
• Disposable income is income that remains once consumers have received transfers from the government and paid their taxes
• Disposable income = Income - Taxes paid + Government transfers
• The positive sign below Yd reflects the fact that when disposable income increases, so does consumption.

  
• Consumption function is a behavioural equation which indicates that the equation capture some aspect of behaviour - in this case, the behaviour of consumers
• Linear consumption function assumes that consumption function has a linear relation with two parameters, c0 (autonomous consumption) and c1 (propensity to consume).
• 2 natural restrictions on c1 (propensity to consume): 1. It must be positive, an increase in disposable income is likely to lead to an increase in consumption. 2. It must be less than 1, people are likely to consume only part of any increase in disposable income and save the rest.
• c0 (autonomous consumption) represents what people would consume if their disposable income in the current year were equal to zero
• If income is equal to zero, people have to dissave in order to have positive consumption, this can be done by selling some assets or by borrowing.
• Consumption (C) = c0 + c1 (Y - T)
• The two types of variables are endogenous variable and exogenous variable
• Endogenous variable is variable that depends on other variable in the model. For instance, consumption.
• Exogenous variable is variable that are taken as given. For instance, investment.
• The investment has a bar on top because investment is taken as given. Therefore, investment has an exogenous variable.

  
• Investment is assumed to have no respond to changes in production
• Government spending and taxes are exogenous variables.
• According to this equilibrium, we assume that firms do not hold inventories and that inventory investment is always equal to zero

  
• This is an equilibrium output where Y is output and Z is demand.

  
• There are 3 types of equations which are identities (disposable income), behaviour equations (consumption function), equilibrium condition (condition that production equals demand).

  
• If the government is running on a very large budget surplus, then the autonomous consumption is likely to be negative
• Multiplier effect captures the cumulative impact of these successive rounds of spending
• An equilibrium output in the good market is being determined by the condition that production is equal to demand
• Private saving (S) = Disposable income (Yd) - Consumption (C)
• Public saving = Taxes (Net of transfer) - Government spending (G)
• Public saving + Private saving = National saving = Investment
• Propensity to save tells us how much of an additional unit of income people save