Koofers

Chapter 3: Goods Market in Short Run - Flashcards

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Class:ECON 3340 - Macro Economics
Subject:Economics
University:Lamar University
Term:Spring 2013
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      Mode:   CARDS LIST       ? pages   PRINT EXIT
Composition of GDP
(The Percentages are for USA in 2010)
  1. (C) Consumption 70.5%
  2. (I) Investment 12%
  3. (G) Government Spending 20.4%
  4. (X - IM) Trade Balance/Net Exports 3.5%
  5. Inventory Investment? (Book is unclear on how it fits in)
Consumption (C) Goods and services purchased by consumers.

C = c0 + c1 Yd
Consumption = theoretical consumption at 0 income + (propensity to consume x Disposable Income)

c0 is y intercept
c1 is slope
Yd is Disposable income (Income - Taxes or Y - T)
Investment (I) The sum of residential and nonresidential investment.
I = nonresidential + residential investment

I = S + ( T - G )

I = -c0 + ( 1 - c1 ) ( Y - T ) + ( T - G )

S: private saving
T: taxes
G: government spending
Government Spending (G) Purchases of goods and services by federal, state, and local governments.

Does NOT include government transfers like medicare, interest on debt, or social security.
Generated by Koofers.com
Trade Balance or Net Exports The difference between exports (X) and imports (IM).

If exports exceeds imports, country has a trade surplus
If imports exceeds exports, country has a trade deficit

Trade Balance = Exports - Imports
NE = X - IM
Inventory Investment What is produced in a certain country is naturally also sold eventually, but some of the goods produced in a given year may be sold in a later year rather than in the year they were produced.

Inventory Investment = Production - Sales
Total Demand for Goods (Z) (Equation) Z = C + I + G + X - IM

Expanded: Z = c0 + c1(Y - T) + I + G

Z: Demand
C: Consumption
I: Investment
G: Government Spending
X: Exports
IM: Imports
Disposable Income (Yd) Income that remains once consumers have received transfers from government and paid taxes. 

When disposable income goes up people buy more goods, when it goes down they buy less.

Yd = Y - T
Y: Income
T: Taxes
This is an identity equation
Generated by Koofers.com
Consumption Function (Equation) WIKIPEDIA: The consumption function is a single mathematical function used to express consumer spending. 

C = c0 + c1 Yd

considered a "Behavioral Equation"

C = C(Yd) defined as this in book but not really important to know.
Propensity to Consume (c1) Gives the effect an additional dollar of disposable income has on consumption.

Is c1 in the consumption equation: C = c0 + c1 Yd

Usually positive and less than 1 b/c people are likely to consume some but not all of additional income received.
Endogenous Variables that depend on other variables in the model.
Exogenous Variables not explained within the model but are instead taken as given.

Example: (Until Ch 5)Investment, Government Spending, and Taxes.
Generated by Koofers.com
Fiscal Policy
The choice of taxes and spending by the government

WIKIPEDIA: Fiscal policy is the use of government revenue collection and expenditure (spending) to influence the economy.
Equilibrium in the Goods Market (assuming inventory investment is always equal to zero)
In equilibrium: Production is equal to demand. Demand depends on income, which is equal to production.

Requires that Production (Y) be equal to the demand for goods (Z).

Y = Z, which is an equilibrium condition.
and since "Z = c0 + c1 (Y - T) + I + G" is true
the following must also be true: Y = c0 + c1 (Y - T) + I + G
Production, Income, and Demand (Two Equations) Y = c0 + c1Y - c1T + I + G

Rewritten after moving c1Y to left, reorganizing the right, and dividing both sides by (1 - c1):

                               Y =       1       [ c0 + I + G - c1T ]
                                        1 - c1 
The part in brackets is autonomous spending, the part outside is called the multiplier.
Autonomous Spending The part of demand for goods that does NOT depend on output.

Autonomous Spending = [ c0 + I + G - c1T ]

If T = G (Balanced Budget), and the propensity to consume (c1) is less than 1, then (G - c1T) is positive and so is Autonomous Spending. Only by a very large budget surplus ( T > G) could autonomous spending be negative.
Generated by Koofers.com
Balanced Budget A country runs a balanced budget when Taxes equals Government Spending.

T = G

If T = G, and the propensity to consume (c1) is less than 1, then (G - c1T) is positive and so is Autonomous Spending.
Multiplier Multiplies autonomous spending. Is greater than 1

 Multiplier =             1        
                             (1 - c1)  

Example: if c0 increases by 1billion, output increases by more than 1billion. If c1=0.6 then multiplier=1 / (1 - 0.6) = 2.5 therefore output increases by 2.5 x 1billion which = 2.5billion
Demand & Production as Functions of Income Demand as a function of income:
Z = ( c0 + I + G - c1T) + c1Y

EQ output = Y = Z, b/c only at that point Production=Demand
Y Intercept = Autonomous Spending
Slope = c1 = propensity to consume
ZZ = relation between demand and income

Production line is 45 degrees b/c production and income are equal
Changes in Demand An Increase in demand leads to an increase in production and a corresponding increase in income, increased income leads to further increase in demand, which leads to further increase in production ETC.
Generated by Koofers.com
Econometrics The set of statistical methods used in economics.
Dynamics Formally describing adjustments (of something like output) over time.
Private Saving (S) Savings by consumers.

Is equal to their disposable income minus consumption:
                                       S = Yd - C
therefore S is equal to Income minus taxes minus consumption:
                                       S = Y - T - C
                                           = Y - T - c0 - c1 ( Y - T )

Public Saving Public saving is equal to Taxes (T) minus government spending (G)

Public Saving = T - G 

If T < G, budget deficit
If T > G, budget surplus
Generated by Koofers.com
IS relation
Stands for "Investment equals Saving"

Equilibrium in the goods market requires that investment (I) equals saving (sum of public and private saving)

I = S + ( T - G)

S: Private saving
(T - G): public saving
The Two Equivalent Ways of Stating EQ in the Goods market Production = Demand

Investment = Saving 

b/c once consumers choose how much to consume, they have automatically decided how much to save (and vice versa)
Propensity to Save How much of an additional unit of income people save.

Since S = Y - T - C, 
S must also equal = Y - T - c0 - c1(Y - T)
rearranged: S = -c0 + (1 - c1) (Y - T)

Propensity to Save = ( 1 - c1 )
Generated by Koofers.com

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 Composition of GDP
(The Percentages are for USA in 2010)
  1. (C) Consumption 70.5%
  2. (I) Investment 12%
  3. (G) Government Spending 20.4%
  4. (X - IM) Trade Balance/Net Exports 3.5%
  5. Inventory Investment? (Book is unclear on how it fits in)
 Consumption (C)Goods and services purchased by consumers.

C = c0 + c1 Yd
Consumption = theoretical consumption at 0 income + (propensity to consume x Disposable Income)

c0 is y intercept
c1 is slope
Yd is Disposable income (Income - Taxes or Y - T)
 Investment (I)The sum of residential and nonresidential investment.
I = nonresidential + residential investment

I = S + ( T - G )

I = -c0 + ( 1 - c1 ) ( Y - T ) + ( T - G )

S: private saving
T: taxes
G: government spending
 Government Spending (G)Purchases of goods and services by federal, state, and local governments.

Does NOT include government transfers like medicare, interest on debt, or social security.
 Trade Balance or Net ExportsThe difference between exports (X) and imports (IM).

If exports exceeds imports, country has a trade surplus
If imports exceeds exports, country has a trade deficit

Trade Balance = Exports - Imports
NE = X - IM
 Inventory InvestmentWhat is produced in a certain country is naturally also sold eventually, but some of the goods produced in a given year may be sold in a later year rather than in the year they were produced.

Inventory Investment = Production - Sales
 Total Demand for Goods (Z) (Equation)Z = C + I + G + X - IM

Expanded: Z = c0 + c1(Y - T) + I + G

Z: Demand
C: Consumption
I: Investment
G: Government Spending
X: Exports
IM: Imports
 Disposable Income (Yd)Income that remains once consumers have received transfers from government and paid taxes. 

When disposable income goes up people buy more goods, when it goes down they buy less.

Yd = Y - T
Y: Income
T: Taxes
This is an identity equation
 Consumption Function (Equation)WIKIPEDIA: The consumption function is a single mathematical function used to express consumer spending. 

C = c0 + c1 Yd

considered a "Behavioral Equation"

C = C(Yd) defined as this in book but not really important to know.
 Propensity to Consume (c1)Gives the effect an additional dollar of disposable income has on consumption.

Is c1 in the consumption equation: C = c0 + c1 Yd

Usually positive and less than 1 b/c people are likely to consume some but not all of additional income received.
 EndogenousVariables that depend on other variables in the model.
 ExogenousVariables not explained within the model but are instead taken as given.

Example: (Until Ch 5)Investment, Government Spending, and Taxes.
 Fiscal Policy
The choice of taxes and spending by the government

WIKIPEDIA: Fiscal policy is the use of government revenue collection and expenditure (spending) to influence the economy.
 Equilibrium in the Goods Market(assuming inventory investment is always equal to zero)
In equilibrium: Production is equal to demand. Demand depends on income, which is equal to production.

Requires that Production (Y) be equal to the demand for goods (Z).

Y = Z, which is an equilibrium condition.
and since "Z = c0 + c1 (Y - T) + I + G" is true
the following must also be true: Y = c0 + c1 (Y - T) + I + G
 Production, Income, and Demand (Two Equations)Y = c0 + c1Y - c1T + I + G

Rewritten after moving c1Y to left, reorganizing the right, and dividing both sides by (1 - c1):

                               Y =       1       [ c0 + I + G - c1T ]
                                        1 - c1 
The part in brackets is autonomous spending, the part outside is called the multiplier.
 Autonomous SpendingThe part of demand for goods that does NOT depend on output.

Autonomous Spending = [ c0 + I + G - c1T ]

If T = G (Balanced Budget), and the propensity to consume (c1) is less than 1, then (G - c1T) is positive and so is Autonomous Spending. Only by a very large budget surplus ( T > G) could autonomous spending be negative.
 Balanced BudgetA country runs a balanced budget when Taxes equals Government Spending.

T = G

If T = G, and the propensity to consume (c1) is less than 1, then (G - c1T) is positive and so is Autonomous Spending.
 MultiplierMultiplies autonomous spending. Is greater than 1

 Multiplier =             1        
                             (1 - c1)  

Example: if c0 increases by 1billion, output increases by more than 1billion. If c1=0.6 then multiplier=1 / (1 - 0.6) = 2.5 therefore output increases by 2.5 x 1billion which = 2.5billion
 Demand & Production as Functions of IncomeDemand as a function of income:
Z = ( c0 + I + G - c1T) + c1Y

EQ output = Y = Z, b/c only at that point Production=Demand
Y Intercept = Autonomous Spending
Slope = c1 = propensity to consume
ZZ = relation between demand and income

Production line is 45 degrees b/c production and income are equal
 Changes in DemandAn Increase in demand leads to an increase in production and a corresponding increase in income, increased income leads to further increase in demand, which leads to further increase in production ETC.
 EconometricsThe set of statistical methods used in economics.
 DynamicsFormally describing adjustments (of something like output) over time.
 Private Saving (S)Savings by consumers.

Is equal to their disposable income minus consumption:
                                       S = Yd - C
therefore S is equal to Income minus taxes minus consumption:
                                       S = Y - T - C
                                           = Y - T - c0 - c1 ( Y - T )

 Public SavingPublic saving is equal to Taxes (T) minus government spending (G)

Public Saving = T - G 

If T < G, budget deficit
If T > G, budget surplus
 IS relation
Stands for "Investment equals Saving"

Equilibrium in the goods market requires that investment (I) equals saving (sum of public and private saving)

I = S + ( T - G)

S: Private saving
(T - G): public saving
 The Two Equivalent Ways of Stating EQ in the Goods marketProduction = Demand

Investment = Saving 

b/c once consumers choose how much to consume, they have automatically decided how much to save (and vice versa)
 Propensity to SaveHow much of an additional unit of income people save.

Since S = Y - T - C, 
S must also equal = Y - T - c0 - c1(Y - T)
rearranged: S = -c0 + (1 - c1) (Y - T)

Propensity to Save = ( 1 - c1 )
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