Goods & Services Market¶

Last Updated: 3 months ago2024-12-26 ; Contributors: AhmedThahir, web-flow

Aggregate Demand¶

Sign	Component	Symbol	Meaning
+	Consumption	$C$	G&S purchased by consumers
+	Investment	$I$	Sum of residential and non-residential investment
+	Government spending	$G$	Purchases of G&S by federal, state, and local govts (excluding Govt transfers)
+	Exports	$E$	Goods & services produced by country purchased by foreign countries
-	Imports		Foreign goods & services purchased by country
+	Inventory Investment		Difference between production and sales

Behavioral Assumptions - Investment is exogenous of fiscal policy - Consumption is endogenous to disposable income

Consumption¶

Assuming Consumption $\propto$ Income

C = c_0 + c_1 (I-T)

$C =$ total consumption
$c_0 =$ base/autonomous consumption
- $c \ne 0$
$c_1 =$ MPC (Marginal Propensity to Consume)
$I =$ Income
$T=$ Taxes
$(I-T)=$ disposable income

IDk¶

	Short-Run	Medium-Run	Long-Run
Equilibrium Output Factors	- Aggregate Demand - Production - Income
Equilibrium Condition	$\text{Aggregate Demand} = \text{Aggregate Income}$ $\text{Aggregate Investment} = \text{Aggregate Savings}$
Equilibrium Output	$\dfrac{1}{1-c_1} (c_0 - T + I + G)$

Increase in autonomous consumption $c_0$

Output Multiplier¶

$m = \dfrac{1}{1-c_1}$

Implication - If $m>1$: even small consumer spending will lead to increased output - If $m \le 1$: lots of consumer spending required for growth

Short-Run¶

Paradox of Saving¶

\[ \begin{aligned} \text{Investment} &= \bar S^G + S(Y) \\ S(Y) &= \dfrac{1}{1-c_1} Y & (\text{Output $Y$ = Income}) \end{aligned} \]

If savings $S(Y)$ increase due to decrease in $c_1$ - then savings > investment, ie consumption decreases - then $Y$ reduces to restore equilibrium - this reduces income - this reduces consumption - this reduces output - vicious cycle

where $Y =$ Real output

This is why drastic contractionary fiscal policy is detrimental - introducing high GST/VAT - decrease in govt expenditure