Lecture 1 - 3-2 The Demand for Goods Flashcards
What is the total demand for goods Z and how is it represented in the equation form?
The total demand for goods, denoted as Z, is represented by the equation Z=C+I+G+X−IM. This equation is an identity and defines Z as the sum of consumption (C), investment (I), government spending (G), exports (X), minus imports (IM).
What assumptions are made to simplify the discussion of the determinants of Z?
Three simplifying assumptions are made: 1) All firms produce the same good, 2) Firms are willing to supply any amount of the good at a given price level P, and 3) The economy is closed, meaning no trade with the rest of the world (X=IM=0). These assumptions allow focus on the market for “the” good and the role demand plays in the determination of output.
How is consumption (C) related to disposable income (YD)?
Consumption (C) is a function of disposable income (YD), represented by the consumption function C(YD). A common assumption is that this relationship is linear, represented as C=c0 + c1 YD, where c1 is the propensity to consume, and c0 represents consumption if disposable income is zero.
What is the role and definition of disposable income (YD)?
Disposable income (YD) is defined as income (Y) minus taxes (T), where T represents taxes paid minus government transfers received. It’s used to calculate consumption, as higher YD typically leads to increased consumption.
How are investment (I) and government spending (G) treated in the model?
Both investment (I) and government spending (G) are treated as exogenous variables in the model. This means they are taken as given and not explained within the model. For investment, this assumption keeps the model simple, although it may not realistically describe how firms respond to changes in production. For government spending and taxes, this is because government behavior is less predictable and often a subject of macroeconomic analysis.
