interactions between production, income and demand

- changes in the demand for goods --> changes in production

- changes in production --> changes in income

- changes in income --> changes in the demand for goods

 

** compostition of GDP

GDP (Y) = Consumption (C) + Investment (I) + Government spending (G) + Net export (X - IM) + inventory investment

1. Consumption

goods and services purchased by consumers, rangin from food to airline tickes, to vacations, to new cars, and so on.

It is the largest component of GDP

2. Investment

the sume of nonresidential investment and residential investment

3. Government spending

the purchase of goods and services by governments

But G doesn't include government transfers nor interest payment on the government debt.

4. Net exports

trade deficit vs. trade surplus

5. Inventory investment

the difference between goods produced and goods sold in a given year ==> Production = Sales + Inventory

positive inventory investment: production exceeds sales

 

** Demand for Goods

total demand for goods (Z) = C+I+G+X-IM

Noted that inventory investment is not part of demand

* Determinants of Z -- Consumption

Assumptions: X = IM = 0

Consumption decisions depend on disposable income (Yd) -- the income that remains after consumers have received transfers from the government and paid their taxes

Yd is positively related to C

- consumption function: C(Yd) = c0 + c1*Yd

- parameters: c1 - propensity to consume/ marginal propensity to consume; c0 - dissave

Both c1 and c0 are positive