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Unformatted text preview: slide 0 CHAPTER 3 National Income Outline of model A closed economy, marketclearing model Supply side factor markets (supply, demand, price) determination of output/income Demand side determinants of C , I , and G Equilibrium goods market loanable funds market DONE DONE Next slide 1 The economic “story” of our model so far … GDP (denoted by Y) is produced with factors of production K and L. People receive payments as factor income. Total factor income is MPL*L+MPK*K. Since the production function has the property of constant returns to scale, MPL*L+MPK*K = Y. So, total income is Y. CHAPTER 3 National Income slide 2 The economic “story” of our model so far … People will now pay taxes T. def: Disposable income is total income minus total taxes: Y – T. Now people will have to make decisions about how to spend their income. We need to talk about the components of aggregate demand. CHAPTER 3 National Income slide 3 CHAPTER 3 National Income Demand for goods & services Components of aggregate demand: C = consumer demand for g & s I = demand for investment goods G = government demand for g & s (closed economy: no NX ) slide 4 CHAPTER 3 National Income Consumption, C Consumption function: C = C ( Y – T ) Shows that ↑ ( Y – T ) ⇒ ↑ C def: Marginal propensity to consume (MPC) is the increase in C caused by a oneunit increase in disposable income. slide 5 CHAPTER 3 National Income The consumption function C Y – T C ( Y – T ) 1 MPC The slope of the consumption function is the MPC . slide 6 Consumption and saving The part of disposable income that is not consumed becomes a person’s saving. Saving is equivalent to future consumption . Note that when disposable income increases, both consumption and saving rise, because the MPC is less than 1. Example: if income increases by $1000, and if MPC=0.75, then consumption increases by $750, and saving increases by $250. CHAPTER 3 National Income slide 7 Now you try … If consumers expect their future income to increase, what happens to their current consumption? Current saving? If the interest rate rises, what happens to consumers’ total consumption and saving? CHAPTER 3 National Income slide 8 CHAPTER 3 National Income Investment, I The investment function is I = I ( r ), where r denotes the real interest rate , the nominal interest rate corrected for inflation. The real interest rate is the cost of borrowing the opportunity cost of using one’s own funds to finance investment spending. So, ↑ r ⇒ ↓ I slide 9 CHAPTER 3 National Income The investment function r I I ( r ) Spending on investment goods depends negatively on the real interest rate. slide 10 Investment and capital Which is a stock variable, and which is a flow?...
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This note was uploaded on 05/08/2011 for the course ECON 362 taught by Professor Birz during the Fall '08 term at Binghamton.
 Fall '08
 BIRZ

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