Tools and Concepts

Chapter 3. The Goods Market

I. Motivating Question

How Is Output Determined in the Short Run?

Output is determined by equilibrium in the goods market, i.e., by the condition that supply (production of goods) equals demand. This condition always determines output, but in the short run, we assume that production adjusts automatically to output without changes in price. Thus, in the short run, output is effectively determined by demand. Moreover, in this chapter, investment is characterized as independent of the interest rate, so there is no need to consider simultaneous equilibrium of goods and financial markets.

II. Why the Answer Matters

The determination of output is the basic issue confronting macroeconomics. This chapter introduces the topic through the Keynesian cross model, which considers the goods market in isolation. The Keynesian cross provides basic intuition about model building and solving, output determination, and the role of fiscal policy. The short-run, qualitative results generally survive in more complicated models. Chapter 4 examines the financial markets in isolation, and Chapter 5 combines the goods and financial markets to construct the demand side of the economy.

III. Key Tools, Concepts, and Assumptions

Tools and Concepts

i. The chapter introduces functional notation. Appendix 2 discusses functions in more detail.

ii. The chapter introduces modeling terminology: exogenous and endogenous variables, behavioral equations, identities, and equilibrium conditions.

iii. The chapter describes the Keynesian cross model (although it does not use this expression), and associated terms, such as the (marginal) propensity to consume, disposable income, and autonomous spending.

iv. The chapter introduces fiscal policy.

Date: 2015-01-12; view: 886