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Week 3: National Income
There are three key variables in macroeconomics:
1) Output = Income (e.g. real GDP)
2) General Price (e.g. GDP deflator)
3) Employment (e.g. unemploymentrate)
The level of output is the quantity of goods & services that are produced in our economy.

In equilibrium, the quantity and price are determined by the supply and demand curves.[1]

Y* Y
Last Week: Level of output was studied from a supply side: capital, labour, and technology. A particular attention was paid to the labour force.

This Week: Level of outputwill be examined from a demand side.

1 Demand for Aggregate Output

1.1 National Income Accounts Identity
Products are demanded by four sectors.
(1) Households (2) Firms
(3)Government (4) Overseas sector

Demand for our products is decomposed:
Y ( C + I + G + EX,
C: Consumption I: Investment
G: Government Purchases EX: Net Exports.[2]

This is the“National Income Accounts Identity”.

2. Consumption Demand (non-durable goods, durable goods, and services)
The higher your disposable income, the more you consume:
C = C (Y – T),where T denotes tax payments.
3. Investment Demand (business fixed investment, residential investment, and inventory investment.)
- Firms and households borrow money to finance their investments.- A higher interest rate discourages you to borrow money, thereby reducing investments:
I = I ( r )
where r denotes the real interest rate.

1.4 Demand of Government
- To finance itsexpenditures, government collects tax from households and firms.
- Government’s expenditures and tax (G and T) are determined outside of the economy.
( G and T are assumed constant.

1.5 Demand ofForeign Countries
When the local currency depreciates, net export will increase.
Net export depends on the exchange rate:
NX = NX (e),
where e denotes the exchange rate.
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