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. unemployment rate)
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. P D S P*
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 output will 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.
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 its expenditures, 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 of Foreign 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.