lecture5 - Chapter 16: overview Today: The goods market and...

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Chapter 16: overview Today: The goods market and aggregate demand Goods market equilibrium: DD curve Asset market equilibrium: AA curve Overall equilibrium Next time: Policy analysis with the model
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Aggregate demand Aggregate demand (D) = amount of country’s goods and services that people at home and abroad together are willing and able to purchase. Several components to aggregate demand: D = C + I + G + CA Demand is sum of consumption, investment, government expenditure and foreign demand. Let’s for the moment treat I and G as given, and explore the determinants of C and CA .
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What determines consumption? Main determinant: disposable income (Yd) – Define: disposable income = national income minus taxes, or Y d = Y – T – Write the consumption function C = C(Y d ) = C(Y – T) An increasing function. Slope>0. Slope<? Slope is less than 1: marginal propensity to consume (MPC). Some saving on the margin.
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What determines the current account? Recall : CA = EX – IM Disposable income, Yd : Increased Y d makes consumers want more goods, foreign & domestic. Imports rise, CA falls . Real exchange rate, RER = E P*/P – Relative price of representative basket. – If EP*/P rises, foreign products are more expensive relative to domestic. Increase in RER will increase exports and decrease imports. CA rises . CA = CA(EP*/P, Y–T) – Increasing in EP*/P, and decreasing in Y–T
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Summary Aggregate demand equation: D = C(Y–T) + I + G + CA(EP*/P, Y–T) Or, reducing it further: D = D(EP*/P, Y–T, I, G) A real depreciation (rise in EP*/P): shifts domestic and foreign spending from foreign goods to domestic goods, so D increases. A rise in income (rise in Y)
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lecture5 - Chapter 16: overview Today: The goods market and...

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