Demand Side Determinants & the Market For Loanable Funds...

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AGENDADemand side determinants Consumption functionInvestmentGovernment PurchasesEquilibrium Supply & Demand ModelThe Market for Loanable FundsDetermination of the real interest rateDetermination of the quantity of investmentRelationship between Goods and Loans MarketsFiscal Policy Applications
Demand for goods & servicesComponents of aggregate demand:C= consumer demand for g & sI= demand for investment goodsG= government demand for g & sNX= 0 for now since we ASSUME a closed economy
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Consumption, def: Disposable incomeis total income minus total taxes: YConsumption function: C= C(YShows that (YT) def: Marginal propensity to consume (MPC) is the change in Cwhen disposable income increases by one dollar.
C
T.
T)
C
The consumption functionCY – TC(Y T 1MPCThe slope of the consumption function is the MPC
)
.
Investment, IThe investment function is I= I(r), where rdenotes the real interest rate,the nominal interest rate corrected for inflation. The real interest rate isthe cost of borrowing the opportunity cost of using one’s own funds to finance investment spendinginversely related to the present value of a future cash flowSo, rI
The investment functionrII(r)Spending on investment goods depends negatively on the real interest rate.
Government spending, GG= govt spending on goods and services. Gexcludes transfer payments (e.g., social security benefits, unemployment insurance benefits).Assume government spending and total taxes are exogenous:and GGTT
The market for goods & servicesAggregate demand:Aggregate supply:Equilibrium:The real interest rate adjusts to equate demand with supply.()( )C YTIrG(,)YF K L= ()( )YC YTIr
G
The loanable funds market

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