Goods market equilibrium

Macroeconomic Theory I

ECON222

Fall 2017

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 1/8
Goods market equilibrium in a closed economy
The real interest rate adjusts to bring the aggregate quantities of
goods/services produced and desired into balance

The goods market equilibrium condition is:

Y = Cd + Id + G
which implies
I d = Sd

The income-expenditure identity for a closed economy

(Y C + I + G ) is always satised
,! the equilibrium condition holds only if r adjusts appropriately
,! the dierence is due to unplanned changes in inventories:
I Id = Cd C

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 2/8
The savings-investment diagram

The saving curve, S (r ), is upward sloping

,! a higher r raises desired national savings

The investment curve, I (r ), is downward sloping

,! a higher r increases uc and, thus, reduces investment

Adjustments of r , in response to excess supply or demand for saving,

bring the goods market into equilibrium.

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 3/8
 r S(r)

r1

I(r)

S1d = I1d Sd, I d

Figure: Goods Market Equilibrium

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 4/8
Shifts of the saving curve

Saving curve shifters are all factors, excluding r , which aect S d

Example: The crowding out of investment by government purchases

,! increase in G causes the savings curve to shift left
,! the equilibrium r goes up
,! I d falls because of higher uc.

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 5/8
 r
S
(r)
S(r)

r2
r1

I(r)

d
Sd2= I 2 S1d = I1d d
S, I
d

Figure: Impact of Increase in Current Government Spending, G

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 6/8
Shifts of the investment curve

Investment curve shifters are all factors, excluding r , which aect I d

Example: an innovation or economic reform raises MPK f

,! increase in K causes investment curve to shifts right
,! r rises to a new equilibrium level
,! S d increases (movement along the savings curve)

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 7/8
Why are real interest rates currently so low in Canada?

The theory above suggests that something has occured to cause

,! the saving curve to shift out
,! or the investment curve to shift in
,! or both

But we cant address this question without thinking internationally

,! Canada is an open economy
,! r is determined in global nancial markets

Macroeconomic Theory I (ECON222) Consumption, Savings & Investment Fall 2017 8/8