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Chapter 4A

Chapter 4A. GOODS MARKET EQUILIBRIUM. 7. GOODS MARKET EQUILIBRIUM. How do we know that the amount of goods and services customers and investors want to buy is equal to the amount that the producers are willing to provide?

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Chapter 4A

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  1. Chapter 4A GOODS MARKET EQUILIBRIUM

  2. 7. GOODS MARKET EQUILIBRIUM • How do we know that the amount of goods and services customers and investors want to buy is equal to the amount that the producers are willing to provide? • What economic forces bring goods market into equilibrium, with quantity demanded equals to quantity supplied?

  3. 7. GOODS MARKET EQUILIBRIUM • Demand for consumption goods by household and demand for investment goods by firms. • The real interest rate adjusts to bring the goods market into equilibrium • Goods market is in equilibrium when aggregate quantity of goods supplied = aggregate quantity of goods demanded.

  4. 7. GOODS MARKET EQUILIBRIUM (cont.) • Algebraically, Y = Cd + Id + G goods market equilibrium condition. Y = Quantity of goods supplied by firms determine by; Y = AF (K,N) Cd + Id + G = aggregate demand for goods • Differs from income-expenditure identity (Y = C + I + G + NX) – assuming that there is no foreign sector  is a relationship between actual income (output) and actual spending, which by definition is always satisfied.

  5. 7. GOODS MARKET EQUILIBRIUM (cont.) • Algebraically, Y = Cd + Id + G goods market equilibrium condition. Y = Quantity of goods supplied by firms determine by; Y = AF (K,N) Cd + Id + G = aggregate demand for goods • Differs from income-expenditure identity (Y = C + I + G + NX) – assuming that there is no foreign sector  is a relationship between actual income (output) and actual spending, which by definition is always satisfied.

  6. 7. GOODS MARKET EQUILIBRIUM (cont.) • The real interest rate adjusts to bring the goods market into equilibrium • Y = Cd + Id + G (4.7) goods market equilibrium condition • Differs from income-expenditure identity, as goods market equilibrium condition need not hold; undesired goods may be produced, so goods market won’t be in equilibrium • It is different from the income-expenditure identity relationship for a closed economy – i.e. Y = C + I + G; with NX = 0; where relationship between actual income and actual spending is always satisfied.

  7. 7. GOODS MARKET EQUILIBRIUM (cont.) • Alternative representation: since • Y – Cd – G = Id • Where; Sd = Y – Cd – G, • Therefore, Sd = Id (4.8) • It means that goods market is in equilibrium when desired-savings = desired investment.

  8. 7. GOODS MARKET EQUILIBRIUM (cont.) • The saving-investment diagram • Plot Sd vs. Id (Key Diagram 3; text Fig. 4.7)

  9. Figure 4.7 Goods market equilibrium Adjustment of real interest rates allows goods market equilibrium. Graph: Real interest rates on the vertical axis, savings and investments on the horizontal axis. Goods market equilibrium when desired national savings equal to desired investment. Equilibrium occurs at interest rate of 6%. Market can be out of equilibrium, but competition among borrowers for funds would then cause i/rate to rise and back to equilibrium.

  10. Table 4.3 Components of Aggregate Demand for Goods (An Example)

  11. 7. GOODS MARKET EQUILIBRIUM (cont.) • Shifts of the saving curve • Saving curve shifts right due to a rise in current output, a fall in expected future output, a fall in wealth, a fall in government purchases, a rise in taxes (unless Ricardian equivalence holds, in which case tax changes have no effect) • Example: Temporary increase in government purchases shifts S left • Result of lower savings: higher r, causing crowding out of I - ↑ government purchases meaning that government is using more real resources , some of which otherwise have gone into investment. (Fig. 4.8)

  12. Figure 4.8 A decline in desired saving When current government purchases ↑; ↓ Sd and S1 move left to S2. New goods equilibrium market is now at F with real interest rate of 7%. Reflecting demand for fund exceeds supply of savings. ↑G, national savings and investments ↓. Savings ↓- partially offsets by increase in i/rates; investment ↓higher i/rate, ↑ uc of K that firms have to face. a

  13. 7. GOODS MARKET EQUILIBRIUM (cont.) • Shifts of the investment curve • Investment curve shifts right due to a fall in the effective tax rate or a rise in expected future marginal productivity of capital • Result of increased investment: higher r, higher S and I (Fig. 4.9)

  14. Figure 4.9 An increase in desired investment Change in economy that increase the desired investment will move the curve to the right and vice versa. ↑ in desired investment is due to invention that ↑expected MPK. I1 move to I2 moving goods market equilibrium point from E to G, real i/rates ↑ from 6% to 8% - increase demand for investment. Savings and investment both ↑from 1000 to 1100, also reflecting savers are willing to save more when real interest rates rise.

  15. 8. SHIFTS OF THE SAVING AND INVESTMENT CURVE - Summary • Any change that raises Sdshift S  right • Any change that reduces Sd shift S  left

  16. 8.1 Determinants of desired national saving - Summary

  17. 8.2 Determinants of desired investment

  18. Key Diagram 3 The saving–investment diagram In an economy with no foreign trade, goods mkt. In equilibrium. When Desired national savings equal to Desired national Investment

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