Product
Markets and
National Output
Chapter 12
Discussion Topics
Circular flow of payments
Composition and measurement of gross
domestic product
Consumption, saving and investment
Equilibrium national income and output
Circular Flow Diagram
for
General Economy
We can measure macro
economic activity in either
resource markets or
product markets. Result
is the same…
Page 277
Four major sectors
In this economy…
Page 277
Businesses are net borrowers
in financial markets while
households are net savers…
Page 277
Government receives net inflows of
taxes from businesses and households
and is a net borrower in financial
markets…
Page 277
Businesses make investment expenditures,
Governments makes expenditures, and
Households make consumption expenditures
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…
Page 277
Measurement of
Gross Domestic Product
Everything below
zero represents a
recession
Page 279
GDP = C + I + G + (X – M)
GDP = C + I + G + (X – M)
GDP = C + I + G + (X – M)
GDP = C + I + G + (X – M)
What’s in GDP?
Types of consumer
expenditures…
Page 279
Types of investment
expenditures…
Page 279
Calculation of net
exports…
Page 279
Types of government
Expenditures…
Page 279
Items not included
in GDP…
Page 279
Understanding the
Domestic
Determinants of GDP
C, I, G
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 281
Planned Consumption Function
The consumption function
in this graph can be
expressed graphically as
shown below.
C = AC + MPC(DPI)
Page 281
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 = $1,500 + .70($3,000) = $3,600
Page 281
Planned Consumption Function
An increase in disposable income to
$4,000 would raise
expenditures to
$4,300.
Dis-saving would
fall to $300.
C = $1,500 + .70($4,000) = $4,300
Page 281
Planned Consumption Function
An increase in disposable income to
$5,000 would raise
expenditures to
$5,000.
Dis-saving would
fall to zero.
C = $1,500 + .70($5,000) = $5,000
Page 281
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
When the savings rate rises
significantly, a recession is
often near.
Planned Consumption Function
A role for fiscal
policy here:
A cut in the tax rate
increases consumption.
An increase in the
tax rate decreases
consumption.
Page 281
Planned Consumption Function
A role for fiscal
policy here:
A cut in the tax rate
increases consumption.
An increase in the
tax rate decreases
consumption.
Page 281
Real Wealth Effect
Suppose stock market
prices rose, increasing
real wealth of consumers
by $700.
Page 283
Real Wealth Effect
This would increase
the intercept by $700,
Page 283
Real Wealth Effect
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…..
C = $2,200 + .70($4,000) = $5,000
Page 283
Planned Investment Function
Level of autonomous
investment spending
I = AI – MEI(i)
Page 287
Planned Investment Function
The slope of the investment
function is the marginal
efficiency of investment, or:
MEI = I÷i
I = AI – MEI(i)
Page 287
Planned Investment Function
Level of investment
expenditures would
be $250 at an interest
rate of 9 percent if
MEI = 25.
I = $475 – 25(9.0)
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.
I = $475 – 25(7.0)
Page 287
Effects of Profit Expectations
An increase in profit
expectations would
cause businesses to
expand their planned
investment expenditures
by $50 at the same
interest rate
I = $525 – 25(7.0)
Page 288
Understanding
Product Market
Equilibrium
Aggregate Expenditures
Consumption expenditures function:
C = $1,500+0.70(DPI)
Page 289
Aggregate Expenditures
Consumption expenditures function:
C = $1,500+0.70(DPI)
Investment expenditures function:
I = $475 –25(i)
Page 289
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
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
Aggregate Expenditures
Aggregate expenditures equation:
AE = $2,680+0.70(NI-Tax)
Page 289
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
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
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
Aggregate Expenditures Curve
Total autonomous
domestic spending…
Page 290
Aggregate Expenditures Curve
Point where spending
equals output…
Page 290
Deriving Aggregate Demand Curve
Aggregate
demand curve
Demand equals supply
Corresponding price level
Page 291
Aggregate Supply Curve
Three distinct ranges
of aggregate supply
curve
Page 292
Aggregate Supply Curve
Maximum potential
output in the short
run…
End of depression
or Keynesian range
Page 292
Product Market Equilibrium
YFE represents full employment output
YE represents current or actual output
YPOT represents potential or maximum output
Page 293
Product Market Equilibrium
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 293
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
Chapter 13 focuses on the
application of monetary and
fiscal policy….