1. Product Markets and National Output
Chapter 12

2. Discussion Topics Circular flow of payments
Composition and measurement of gross domestic product
Consumption, saving and investment
Equilibrium national income and output

3. Partial vs General Equilibrium
Discussion of market outcomes in the preceding chapters was conducted within a partial equilibrium framework
Partial Equilibrium – focus on a single market, assuming everything else remains constant
General Equilibrium – focus on all markets in the economy; all markets are interdependent
Objectives of Chapter
Illustrate how businesses and households are linked through resource and product markets
Discuss the composition and measurement of national output

4. Circular Flow Diagram for the General Economy

5. Page 224 We can measure macro- economic activity in either
resource markets or
product markets.
Page 224

6. Four major sectors
in the U.S. economy…
Page 224

7. Page 224 Businesses are net borrowers in financial markets while
households are net savers…
Page 224

8. Page 224 Government receives net inflows of
taxes from businesses and households
and is a net borrower in financial
markets…
Page 224

9. Page 224 Businesses make investment expenditures,
Governments make expenditures, and
Households make consumption expenditures
Page 224

10. Page 224 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…
Page 224

11. Measurement of Gross Domestic Product

12. GDP

14. Gross Domestic Product
B. Measurement
Money – a common denominator ; add up the value of money in terms of the total output of goods and services during a certain time period, normally a year.

21. Everything below
zero represents a
recession
Page 227

22. GDP = C + I + G + (X – M)

23. GDP = C + I + G + (X – M)

24. GDP = C + I + G + (X – M)

25. GDP = C + I + G + (X – M)

26. What’s in GDP? Focus is on new goods and services produced in current year

27. Types of consumer
expenditures…
Page 226

28. Types of investment
expenditures…
Page 226

29. Calculation of net
exports…
Page 226

30. Types of government
Expenditures…
Page 226

31. Items not included
in GDP…
Page 226

32. Understanding the Domestic Determinants of GDP C, I, G

33. 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
Page 228

34. C = AC + MPC(DPI) Planned Consumption Function Page 228
The consumption function
in this graph can be
expressed graphically as
shown below.
C = AC + MPC(DPI)
Page 228

35. C = $1,500 + .70($3,000) = $3,600 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, ($3,000) = $3,600
Page 228

36. C = $1,500 + .70($4,000) = $4,300 Planned Consumption Function
An increase in
disposable income to
$4,000 would raise
expenditures to
$4,300.
Dis-saving would
fall to $300.
C = $1, ($4,000) = $4,300
Page 228

37. C = $1,500 + .70($5,000) = $5,000 Planned Consumption Function
An increase in
disposable income to
$5,000 would raise
expenditures to
$5,000.
Dis-saving would
fall to zero.
C = $1, ($5,000) = $5,000
Page 228

38. 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
Page 228 and 229

39. 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.
Page 228

40. 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.
Page 228

41. 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 nation’s household sector
Expectations of higher income in the near future

42. I = AI – MIS(i) Planned Investment Function Level of autonomous
investment spending
I = AI – MIS(i)
Page 233

43. I = AI – MIS(i) Planned Investment Function
The slope of the investment
function is the marginal
interest sensitivity of investment or:
MIS = I÷i
I = AI – MIS(i)
Page 233

44. I = $475 – 25(9.0) Planned Investment Function Level of investment
expenditures would
be $250 at an interest
rate of 9 percent if
MIS = 25.
I = $475 – 25(9.0)
Page 233

45. I = $475 – 25(7.0) Planned Investment Function
Should interest rates fall to 7%
as a result of events in the
money market, investment
expenditures would increase
from $250 to $300.
I = $475 – 25(7.0)
Page 233

46. Shifts in Investment Function
Profit expectations
Prices of new investment goods
Technological change
Taxes

47. I = $525 – 25(7.0) 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)
Page 234

48. Understanding Product Market Equilibrium

49. Aggregate Expenditures= C+I+G
Consumption expenditures function:
C = $1, (DPI)
Page 235

50. Aggregate Expenditures
Consumption expenditures function:
C = $1, (DPI)
Investment expenditures function:
I = $475 –25(i)
Page 235

51. Aggregate Expenditures
Consumption expenditures function:
C = $1, (DPI)
Investment expenditures function:
I = $475 –25(i)
Government expenditures function:
G = $880
Page 235

52. Aggregate Expenditures (AE)
Consumption expenditures function:
C = $1, (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, (DPI) + $475 – 25(7) +$880
= $2, (DPI)
Page 235

53. Aggregate Expenditures
Aggregate expenditures equation:
AE = $2, (NI-Tax)
Page 235

54. Aggregate Expenditures
Aggregate expenditures equation:
AE = $2, (NI-Tax)
where national output equals national income (NI) and
Tax is based upon last year’s income (Tax = $400).
Page 235

55. Aggregate Expenditures
Aggregate expenditures equation:
AE = $2, (NI-Tax)
where national output equals national income (NI) and
Tax is based upon last year’s income (Tax = $400).
If national income is $6,000, then
AE = $2, ($6,000 - $400)
= $6,600
which represents the first line in Table 12.4
Page 235

56. Aggregate Expenditures
Aggregate expenditures equation:
AE = $2, (NI-Tax)
where national output equals national income (NI) and
Tax is based upon last year’s income (Tax = $400).
If national income is $6,000, then
AE = $2, ($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 236

57. Aggregate Expenditures Curve
Total autonomous
domestic spending…
Page 236

58. Aggregate Expenditures Curve
Point where spending
equals output Y=C+I+G. This
equilibrium assumes a given
market interest rate and general
price level.
Note: below this equilibrium,
AE>Y which should draw down
unsold inventories and increase
pressures to expand Y.
Page 236

59. Deriving the Aggregate Demand Curve
Demand equals supply
Corresponding price level
Page 237

60. of the aggregate supply curve
Aggregate Supply Curve: represents the nation’s output
supplied to consumers, businesses, governments, foreign
countries
Three distinct ranges
of the aggregate supply
curve
Page 238

61. 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
Page 238

62. Product Market Equilibrium
YFE represents full employment output: economy’s max non-inflationary
or natural rate of employment
YE represents current or actual output (planned spending)
YPOT represents potential or maximum output
Page 238

63. YE > YFE YFE > YE Page 238
Product Market Equilibrium : theoretical goal is to
eliminate inflationary or recessionary gaps
YE > YFE
YFE > YE
Planned spending exceeds
full employment output,
causing higher inflationary
pressures in economy.
Planned spending less than
full employment output,
causing underutilization of
economy’s resources.
Page 238

64. 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