Lecture 3_KeynesianCross

Lecture Overview

• Lecture 3: The Goods (and Services) Market

• Reading: Blanchard, Chapter 3

• Key Point: GDP includes both goods and services.

Major Macroeconomic Variables (from previous lecture)

• GDP: Gross Domestic Product

• Unemployment Rate: Measures the percentage of the labor force that is unemployed.

• Inflation Rate: Rate at which the general level of prices for goods and services is rising.

• Understand the relationships and approaches:

  • Nominal vs. Real GDP

  • Unemployment (U) related to the labor force (i)

  • GDP growth rate (p) and price level (GDP deflator & CPI)

Composition of GDP

• Expressed as: Y = C + I + G + NX

  • C: Consumption

  • I: Investment

  • G: Government Spending

  • NX: Net Exports (Exports - Imports)

Key Components

1. Consumption (C): Expenditures by domestic consumers

2. Investment (I): Includes:

   • Fixed Investment (by firms, new buildings, machinery)

   • Residential Investment (new houses)

3. Government Spending (G): Expenditures on military, office equipment, services by government employees (e.g., salaries of police, teachers).

4. Net Exports (NX): Represents trade balance.

   • Positive when exports > imports (surplus)

   • Negative when exports < imports (deficit)

Components Breakdown

• Inventory Investment: Goods produced but not yet sold

• If consumption is based on previous years' goods, this affects inventory levels but does not change current GDP.

Detailed US GDP Composition (2018)

• Total GDP: $20,500 Billion (100%)

  • Consumption (C): $13,951 Billion (68%)

  • Investment (I): $3,595 Billion (17.5%)

  • Government Spending (G): $3,522 Billion (17.2%)

  • Net Exports (NX): -$625 Billion (-3%)

  • Inventory Investment: $56 Billion (0.2%)

Implications

• Inventory investment is generally small; for simplicity, assume Y = C + I + G + NX with NX = 0 in the context of US GDP.

Consumption Function

• Factors influencing consumption (C):

  • Income (Y), Interest rates, Expectations of future income, Taxes, Consumer confidence, etc.

• Formulation: C = c0 + c1(Y - T)

  • c0: Autonomous consumption (household needs)

  • c1: Marginal Propensity to Consume (MPC).

Changes in Consumption

• Movement along the curve with changes in disposable income.

• Shifts in the curve occur with changes to other factors affecting consumption.

Keynesian Cross

• Demand (Z) wants to purchase a certain amount of goods based on income (Y).

• Supply (Y) is determined by production capabilities.

Investment-Saving Interpretation

• Investment (I) must equal total savings.

• Private savings: S = YD - C

• Public savings: S = T - G

• Equilibrium condition requires that total investment matches total savings.

Fiscal Policy Considerations

• Different types of government spending: Entitlement (mandatory) vs. Discretionary spending.

• Importance of automatic stabilizers like unemployment insurance and progressive tax.

Future Outlook

• Next lecture: Focus on financial markets and interest rate determination. Explore chapter 4 of Blanchard.