Intro to Macroeconomics Lecture 3 1 The economy as a circular flow aggregate output spending The gross domestic product GDP What determined GDP 1 Supply factors What resources are available to produce GDP Labor with various types of skills Capital goods buildings structures machinery equipment tools Land and other natural resources water air Knowledge science technology experience What determines GDP 2 Demand factors How much of those resources are actually in use because someone offers to buy the product Depends on level of demand sending That is aggregate demand Who spends 1 Households Consumption Spending 2 Firms investment spending 3 Government Government spending 4 Foreign residents HHs firms governments Exports Omits churches other non profits Omits crime organizations except as they operate throughout Aggregate expenditure total demand C I G X M By subtracting ALL imports we automatically subtract the imports from EACH category CONSUMPTION Means BUYING by household does NOT mean eating or using up INVESTMENT Investment has more than one meaning Macroeconomists usually mean Spending money on increasing physical productive capacity and sometimes also increasing skills and knowledge of workers THE ECONOMY AS A CIRCULAR FLOW Income Y Investment Savings BUSINESSES HOUSEHOLDS Spending Definition STABLE EQUILIBRIUM What determines GDP Simplest model actors are Households Consumption spending C Firms Is the economy in equilibrium Value Y is produced incomes Y arepaid The level of Y implies a level of C Value AE C I is then spent We ask is Y equal to C I If yes y is in equilibrium If no in the next time period Y will rise or fall For one value of Y For what Y are we in equilibrium What determines C It depends on size of income after taxtes are paid and government transfers received transfers social security unemployment benefits ect This is Disposable Personal Income DPI For what Y are in equilibrium Plotting C against DPI gives a straight line C a b DPI a is a positive b is between 0 and 1 a is the vertical intercept b is the slope In our simple model No government no taxes no tranfers So DPI Y EXAMPLE C 1 0 8Y I 1