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. Circular Flow Diagram for General Economy

4. Page 277 We can measure macro economic activity in either resource markets or product markets. Result is the same… We can measure macro economic activity in either resource markets or product markets. Result is the same…

5. Page 277 Four major sectors In this economy… Four major sectors In this economy…

6. Page 277 Businesses are net borrowers in financial markets while households are net savers… Businesses are net borrowers in financial markets while households are net savers…

7. Page 277 Government receives net inflows of taxes from businesses and households and is a net borrower in financial markets… Government receives net inflows of taxes from businesses and households and is a net borrower in financial markets…

8. Page 277 Businesses make investment expenditures, Governments makes expenditures, and Households make consumption expenditures Businesses make investment expenditures, Governments makes expenditures, and Households make consumption expenditures

9. Page 277 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… 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…

10. Measurement of Gross Domestic Product

11. Page 279 Everything below zero represents a recession Everything below zero represents a recession

12. GDP = C + I + G + (X – M)

16. What’s in GDP?

17. Page 279 Types of consumer expenditures… Types of consumer expenditures…

18. Page 279 Types of investment expenditures… Types of investment expenditures…

19. Page 279 Calculation of net exports… Calculation of net exports…

20. Page 279 Types of government Expenditures… Types of government Expenditures…

21. Page 279 Items not included in GDP… Items not included in GDP…

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

23. Page 281 Autonomous or fixed consumption Autonomous or fixed consumption Planned Consumption Function The slope of the consumption function is the marginal propensity to consume (MPC), or  C÷  Y D where Y D represents disposable income. The slope of the consumption function is the marginal propensity to consume (MPC), or  C÷  Y D where Y D represents disposable income.

24. Page 281 Planned Consumption Function The consumption function in this graph can be expressed graphically as shown below. The consumption function in this graph can be expressed graphically as shown below. C = A C + MPC(DPI)

25. Page 281 Consumer expenditures would be $3,600 if disposable income was equal to $3,000. Consumers would be dis-saving by $600. Consumer expenditures would be $3,600 if disposable income was equal to $3,000. Consumers would be dis-saving by $600. Planned Consumption Function C = $1,500 +.70($3,000) = $3,600

26. Page 281 An increase in dis- posable income to $4,000 would raise expenditures to $4,300. Dis-saving would fall to $300. An increase in dis- posable income to $4,000 would raise expenditures to $4,300. Dis-saving would fall to $300. Planned Consumption Function C = $1,500 +.70($4,000) = $4,300

27. Page 281 An increase in dis- posable income to $5,000 would raise expenditures to $5,000. Dis-saving would fall to zero. An increase in dis- posable income to $5,000 would raise expenditures to $5,000. Dis-saving would fall to zero. Planned Consumption Function C = $1,500 +.70($5,000) = $5,000

28. 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 282 and 284

29. When the savings rate rises significantly, a recession is often near.

30. Page 281 A role for fiscal policy here: A cut in the tax rate increases consump- tion. An increase in the tax rate decreases consumption. A role for fiscal policy here: A cut in the tax rate increases consump- tion. An increase in the tax rate decreases consumption. Planned Consumption Function

31. Page 281 A role for fiscal policy here: A cut in the tax rate increases consump- tion. An increase in the tax rate decreases consumption. A role for fiscal policy here: A cut in the tax rate increases consump- tion. An increase in the tax rate decreases consumption. Planned Consumption Function

32. Page 283 Real Wealth Effect Suppose stock market prices rose, increasing real wealth of consumers by $700. Suppose stock market prices rose, increasing real wealth of consumers by $700.

33. Page 283 Real Wealth Effect This would increase the intercept by $700, This would increase the intercept by $700,

34. Page 283 Real Wealth Effect C = $2,200 +.70($4,000) = $5,000 This shifts the curve upward for given income level, boosts consumer spending to $5,000. This raises dis-saving to $1,000, raises debt relative to income, and can be inflationary….. This shifts the curve upward for given income level, boosts consumer spending to $5,000. This raises dis-saving to $1,000, raises debt relative to income, and can be inflationary…..

35. Page 287 Planned Investment Function Level of autonomous investment spending Level of autonomous investment spending I = A I – MEI(i)

36. Page 287 Planned Investment Function The slope of the investment function is the marginal efficiency of investment, or: MEI =  I÷  i The slope of the investment function is the marginal efficiency of investment, or: MEI =  I÷  i I = A I – MEI(i)

37. Page 287 Planned Investment Function Level of investment expenditures would be $250 at an interest rate of 9 percent if MEI = 25. Level of investment expenditures would be $250 at an interest rate of 9 percent if MEI = 25. I = $475 – 25(9.0)

38. Page 287 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. 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)

39. Page 288 Effects of Profit Expectations I = $525 – 25(7.0) An increase in profit expectations would cause businesses to expand their planned investment expenditures by $50 at the same interest rate An increase in profit expectations would cause businesses to expand their planned investment expenditures by $50 at the same interest rate

40. Understanding Product Market Equilibrium

41. Aggregate Expenditures Consumption expenditures function: C = $1,500+0.70(DPI) Page 289

42. Aggregate Expenditures Consumption expenditures function: C = $1,500+0.70(DPI) Investment expenditures function: I = $475 –25(i) Page 289

43. Aggregate Expenditures Consumption expenditures function: C = $1,500+0.70(DPI) Investment expenditures function: I = $475 –25(i) Government expenditures function: G = $880 Page 289

44. Aggregate Expenditures Consumption expenditures function: C = $1,500+0.70(DPI) Investment expenditures function: I = $475 –25(i) Government expenditures function: G = $880 If the interest rate (i) is equal to 7%, then AE = $1,500 + 0.70(DPI) + $475 – 25(7) +$880 = $2,680 + 0.70(DPI) Page 289

45. Aggregate Expenditures Aggregate expenditures equation: AE = $2,680+0.70(NI-Tax) Page 289

46. Aggregate Expenditures Aggregate expenditures equation: AE = $2,680+0.70(NI-Tax) where national output equals national income (NI) and Tax is based upon last year’s income (Tax = $400). Page 289

47. Aggregate Expenditures Aggregate expenditures equation: AE = $2,680+0.70(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 = $2,680+0.70($6,000 - $400) = $6,600 which represents the first line in Table 12.4 Page 289

48. Aggregate Expenditures Aggregate expenditures equation: AE = $2,680+0.70(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 = $2,680+0.70($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 290 Page 289

49. Page 290 Total autonomous domestic spending… Total autonomous domestic spending… Aggregate Expenditures Curve

50. Page 290 Point where spending equals output… Point where spending equals output… Aggregate Expenditures Curve

51. Page 291 Deriving Aggregate Demand Curve Demand equals supply Corresponding price level Aggregate demand curve Aggregate demand curve

52. Page 292 Aggregate Supply Curve Three distinct ranges of aggregate supply curve Three distinct ranges of aggregate supply curve

53. Page 292 Aggregate Supply Curve Maximum potential output in the short run… Maximum potential output in the short run… End of depression or Keynesian range End of depression or Keynesian range

54. Page 293 Y FE represents full employment output Y E represents current or actual output Y POT represents potential or maximum output Y FE represents full employment output Y E represents current or actual output Y POT represents potential or maximum output Product Market Equilibrium

55. Page 293 Product Market Equilibrium Planned spending exceeds full employment output, causing higher inflationary pressures in economy. 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. Planned spending less than full employment output, causing underutilization of economy’s resources. Y E > Y FE Y FE > Y E

56. 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 when economy not at full employment output

57. Chapter 13 focuses on the application of monetary and fiscal policy….