The Demand for Goods

Assume there is only one good, and use the decomposition of GDP to think about demand for that good. Assume the economy is closed, so that net exports are zero, and ignore inventory investment, which is typically a small part of GDP. Then, demand (Z) can be written as

Z=C+I+G. (3.1)

Write consumption as a linear function of disposable income (Y_D), which is income minus taxes (T):

C=c₀+c₁(Y_D)=c₀+c₁(Y-T). (3.2)

Note that “taxes” (T) refers to taxes minus government transfers. Government spending (G) does not include transfers.

The parameter c₀ , which represents how much consumption would occur even if disposable income were zero, is called autonomous consumption or consumer confidence. The parameter c₁ , which represents the increase in consumption for every extra unit of disposable income, is called the (marginal) propensity to consume. Assume that households do not consume every dollar of additional income, but save some, so that 0< c₁<1.

Assume that investment is exogenous, and call it . Assume that government spending and taxes are exogenous, and under the control of the fiscal authorities. Substitute for consumption and investment, and rewrite demand:

Z= c₀+c₁(Y-T)+ +G. (3.3)

Date: 2015-01-12; view: 981