THE GOODS MARKET

LEARNING OBJECTIVES

To understand the composition of GDP and the different

sources of the demand for goods.

To understand multiplier effect and its relation to

marginal propensity to consume.

To understand how equilibrium output is determined by

the condition that the production of goods must be equal
to the demand for goods.

NEWS HEADLINES

Ezz Steel bets on growth of local demand on reinforcing

bars to increase sales

Laptop sales increase as customers' demands grow

Haier India eyes 30% increase in sales this year on good

demand

Ford delivers best first-half U.S. Sales in a decade; Strong

demand for F-series, Ford brand SUVs drive gains

THE COMPOSITION OF GDP

Consumption (C) refers to the goods and services purchased by

consumers.

Investment (I), sometimes called fixed investment, is the

purchase of capital goods. It is the sum of nonresidential
investment and residential investment.

Government Spending (G) refers to the purchases of goods and

services by the Centre, state, and local governments. It does not
include government transfers, nor interest payments on the
government debt.
Imports (IM) are the purchases of foreign goods and services by
consumers, business firms, and the government.

Exports (X) are the purchases of goods and services by

foreigners.

THE DEMAND FOR GOODS

The total demand for goods is written as:

Z C I G X IM

CONSUMPTION

Consumption

Positive, stable relationship with income both

for households and for the economy as a whole.

Disposable income

CONSUMPTION FUNCTION

Consumption, C

Depends on disposable income

Function of income

C dependent variable

DI independent variable

Positive slope

MARGINAL PROPENSITIES TO
CONSUME AND SAVE

Marginal propensity to consume, MPC

Change in consumption / change in income

Marginal propensity to save, MPS

Fraction of additional income that is spent

Fraction of additional income that is saved

Change in saving / change in income

MPC + MPS = 1

MPC, MPS, AND THE SLOPE OF

CONSUMPTION AND SAVING

MPC

The slope of the Consumption

function C

MPC

DI

MPS

The slope of the Saving function

S
MPS
DI

MARGINAL PROPENSITY TO CONSUME

Consumption function

consumption

MPC=C/DI=0.4/0.5=4/5

b
C=0.4

a
DI=0.5
0

disposable income

The slope of the C function equals the marginal propensity to consume.

For the straight-line C function in (a), the slope is the same at all levels of income and
is given by the change in consumption divided by the change in disposable income
that causes it: MPC=4/5.

INVESTMENT
Gross private domestic investment
New physical capital
New housing
Net increases to inventories

GOVERNMENT PURCHASES
Government purchases of goods and services, G
Government purchase function, G
Government purchases unrelated to DI
Autonomous

NET EXPORTS
Net exports = Exports Imports
Income increases: imports increase
If M > X: Net exports < 0
If X > M: Net exports > 0
Lets assume Net export is autonomous of income

THE DETERMINATION OF EQUILIBRIUM

OUTPUT
Assuming that exports and imports are both zero, the demand
for goods is the sum of consumption, investment, and
government spending:

Z C I G
Then:

Z c0 c1 Y - T I G

THE DETERMINATION OF EQUILIBRIUM OUTPUT

Equilibrium in the goods market requires that production,
Y, be equal to the demand for goods, Z:

Y Z
The equilibrium condition is that, production, Y, be equal to
demand. Demand, Z, in turn depends on income, Y, which
itself is equal to production.

Then:

Y c0 c1 (Y T ) I G

THE DETERMINATION OF EQUILIBRIUM

OUTPUT
Rewrite the equilibrium equation:

Y c0 c1Y c1T I G
Move

c1Y to the left side and reorganize the right side:

1 c Y
1

Divide both sides by

c0 I G c1T

(1 c1 ) :

1
c0 I G c1T
Y
1 c1

THE DETERMINATION OF EQUILIBRIUM

OUTPUT
The equilibrium equation can be manipulated to derive some
important terms:
Autonomous spending and the multiplier:
The term [c I G c T ]
is that part of the demand for
goods that does not depend on output, it is called
autonomous spending.
0

Because the propensity to consume (c1) is between zero

1
one, 1 c 1

and
is a number greater than one. For this
reason, this number is called the multiplier.

1
1 c1

[c 0 I G c1T ]

THE DETERMINATION OF EQUILIBRIUM

OUTPUT

Z (c0 I G c1T ) c1Y

Equilibrium in the Goods
Market
Equilibrium output is determined
by the condition that production
be equal to demand.

THE DETERMINATION OF EQUILIBRIUM

OUTPUT

THE DETERMINATION OF EQUILIBRIUM

OUTPUT

INVESTMENT MULTIPLIER

The multiplier is the amount by which equilibrium output

changes when investment changes.

Investment multiplier is the ratio of the final change in

equilibrium national income to the initial change in investment
that caused it.

It is reciprocal of the MPS.

Y
1

I
(1 C1)

Round

100

50

50

50

25

25

25

12.5

12.5

12.5

6.25

6.25

6.25

3.125

3.125

200

100

100

INCOME DETERMINATION WITH

GOVERNMENT SPENDING AND
AUTONOMOUS TAX
Y=C+I+G
or, Y = C + C (Y T) + I + G

or, Y = C + C Y C T + I + G

or,Y ( 1- C ) = C C T + I + G

Y = C C T + I + G/ 1- C

INCOME DETERMINATION WITH

TRANSFER PAYMENTS

A transfer payments is a non quid pro quo payment made

by government to different sections of the society for a
social welfare purposes like old-age pensions,
retirement benefits ,unemployment compensations
,social security payments, social welfare payments etc.

It enhances spending capacity of the households and

hence have a positive effect on the equilibrium income.

Assumption:
- Transfer payments is autonomous in nature.

INCOME DETERMINATION WITH

TRANSFER PAYMENTS
C = C + C ( Y-T + Gt)
Y=C+I+G
Y = C + C ( Y T + Gt) + I + G
Y = C - C T + C Gt + I + G 1- C

GOVERNMENT EXPENDITURE
MULTIPLIER

The government expenditure multiplier is the amount by

which equilibrium level of income changes when
government expenditure changes.
Y / G = 1/1- C

TRANSFER PAYMENTS
MULTIPLIER

If instead of increase in government expenditure on

goods and services ,government increases transfer
payments ,the transfer payments multiplier will be
Y/ Gt = C /1- C

The difference between government expenditure

multiplier and transfer payments multiplier is 1

LUMP SUM TAX AND TAX

MULTIPLIER

A rise in tax( Ta)has a negative effect on the equilibrium

level of the national income.
Y / Ta = - C /1- C

INCOME DETERMINATION WITH

TAX AS A FUNCTION OF INCOME

Let total tax is combination of autonomous constant

lump-sum tax and a proportional income tax rate.

T = Ta + tY
Y=C+I+G
Y = C + C ( Y Ta tY ) + I + G
Y = C - C Ta + I + G 1- C (1-t)

INCOME DETERMINATION WITH TAX

FUNCTION, GOVERNMENT EXPENDITURE AND
TRANSFER PAYMENTS

G
(1-t)

Y=C+I+G
Y = C + C ( Y Ta tY + Gt ) + I +
Y = C - C Ta + C Gt + I + G 1- C

THE BALANCED BUDGET

MULTIPLIER

When a government adopts a balanced budget policy it

spends only as much as it collects through taxation.

The effect of balanced budget policy on national income

is measured through balanced budget multiplier.

The balanced budget multiplier is always equal to 1

BBm = Gm + Tm
= 1/1- C

- C /1- C = 1

CLASS -TASK-17

Find out the value of multiplier given the following:

a)

MPC = 0.8

b)

MPC= 0.75

c)

MPS = 0.30

CLASS -TASK-17

a)
b)
c)

Find out the value of multiplier given the following:

MPC = 0.8 =5
MPC= 0.75 = 4
MPS = 0.30 = 3.33

CLASS TASK-18
Suppose the level of autonomous investment in an
economy is Rs 200 crores and consumption function of
the economy is
C = 80 + 0.75Y
a)
What will be the equilibrium level of income?
b)
What will be the increase in national income if
investment increases by Rs 25 crores.

CLASS TASK-18
Suppose the level of autonomous investment in an
economy is Rs 200 crores and consumption function of
the economy is
C = 80 + 0.75Y
a) What will be the equilibrium level of income?
Rs 1120 crores

b) What will be the increase in national income if investment

increases by Rs 25 crores.
Rs 100 crores

CLASS TASK-19

The following data characterizes the macroeconomic

conditions of a hypothetical economy.
C = 100 + 0.75 Yd
I = 200
G = T = 100

Calculate equilibrium income of the economy .

CLASS TASK-19

The following data characterizes the macroeconomic

conditions of a hypothetical economy.
C = 100 + 0.75 Yd
I = 200
G = T = 100

Calculate equilibrium income of the economy .

Ans : 1300

CLASS TASK- 20

Suppose structural model of an economy is given as

follows.
C = 100 + 0.80 Yd
Yd = Y-T
I = 100
G = 100
T =100
Find expenditure multiplier and changed income if
changed G = 50

CLASS TASK- 20

Suppose structural model of an economy is given as

follows.
C = 100 + 0.80 Yd
Yd = Y-T
I = 100
G = 100
Ta =100
Find expenditure multiplier and changed income if
changed G = 50

Ans: 250

CLASS TASK-21
In a two sector model economy ,
C = 50 + 0.75 Y , I = Rs 50
a) Find equilibrium NI
b) Add government sector in the economy and find the
changes in equilibrium income if government taxes Rs
20 and does not spend.
c) Government spends Rs 20 without taxing people.
d) Government taxes Rs 20 and spends total revenue.

CLASS TASK-21

In a two sector model economy ,

C = 50 + 0.75 Y , I = Rs 50

a) Find equilibrium NI = 400

b) Add government sector in the economy and find the
changes in equilibrium income if government taxes Rs
20 and does not spend.
Ans :340
c) Government spends Rs 20 without taxing people.
Ans: 480
d) Government taxes Rs 20 and spends total revenue.
Ans : 420

CLASS TASK-22

The following data characterizes the macroeconomic

conditions of a hypothetical economy.
C = 100 + 0.75 Yd
I = 200
G = T = 100

a)

Calculate equilibrium income of the economy .

Calculate equilibrium income of the economy with
transfer payment ,TP = 50
Find transfer payment multiplier

b)

c)

CLASS TASK-22

The following data characterizes the macroeconomic

conditions of a hypothetical economy.
C = 100 + 0.75 Yd
I = 200
G = T = 100
TP= 50

Calculate equilibrium income of the economy .

Ans: a) 1300
b) 1450
c) 3

CLASS TASK-23

The following data characterizes the macroeconomic

conditions of a hypothetical economy.
C = 100 + 0.75 Yd
I = 200
T= 100

a)

Calculate equilibrium income of the economy .

Calculate equilibrium income of the economy with
transfer payment ,TP = 50
Calculate equilibrium income of the economy with
G =50(TP=0)

b)

c)

CLASS TASK-23
The following data characterizes the macroeconomic
conditions of a hypothetical economy.
C = 100 + 0.75 Yd
I = 200
T= 100
a) Calculate equilibrium income of the economy .

Ans :900
b) Calculate equilibrium income of the economy with
transfer payment ,TP = 50
Ans : 1050
c) Calculate equilibrium income of the economy with
G =50
Ans: 1100

CLASS TASK- 24

Suppose structural model of an economy is given as

follows.
C = 50 + 0.80 Yd
Yd = Y-T
I = 70
G = 200
Gt =100
t= 0.2
1) Find equilibrium level of income.
2) Tax multiplier when t =0.2

CLASS TASK- 24

Suppose structural model of an economy is given as

follows.
C = 50 + 0.80 Yd
Yd = Y-T
I = 70
G = 200
Gt =100
t= 0.2
1) Find equilibrium level of income- 1111
2) Tax multiplier =2.77

CLASS TASK- 25

Suppose structural equations are given as follows:

C= 100 +0.80(Y-T) I = 200 T =25 +0.1Y G=100

1.Find equilibrium income
2.Tax multiplier

CLASS TASK- 25

Suppose structural equations are given as follows:

C= 100 +0.80(Y-T) I = 200 T =25 +0.1Y G=100

1.Find equilibrium income = 1356.60
2.Tax multiplier=3.5714

CLASS TASK-26

Suppose structural model of an economy is given as

follows.
C = 100 + 0.80Y
I = 100

a)

Find the equilibrium output.

b)

Find the equilibrium output when G =100 and T =100

c)

Find the balanced budget multiplier.

CLASS TASK-26

Suppose structural model of an economy is given as

follows.
C = 100 + 0.80Y
I = 100

a) Find the equilibrium output.

Ans : 1000
b) Find the equilibrium output when G =100 and T =100
Ans : 1100
c) Find the balanced budget multiplier.
Ans : 1

CLASS TASK-27

It is given that full employment occurs at a level of

income Rs 600 cr. Equilibrium income is currently Rs 500
cr and MPC is 0.80.If the government wishes to bring the
economy to a position of full employment ,what are the
necessary changes required in

a)

Government expenditure

b)

Tax revenue

c)

Tax revenues or government expenditure when the

government is committed to a balanced budget

CLASS TASK-27

It is given that full employment occurs at a level of

income Rs 600 cr. Equilibrium income is currently Rs 500
cr and MPC is 0.80.If the government wishes to bring the
economy to a position of full employment ,what are the
necessary changes required in

a) Government expenditure
Ans: Rs 20cr
b) Tax revenue
Ans: -Rs 25cr
c) Tax revenues or government expenditure when the
government is committed to a balanced budget
Ans:Rs 100 cr

AN OPEN ECONOMY
In

by:

an open economy, the demand for domestic goods is given

Z C + I + G IM + X

The

first three termsconsumption, C, investment, I, and

government spending, Gconstitute the domestic demand for
goods.

Until now, we have only looked at C + I + G. But now

we have to make two adjustments:

First, we must subtract imports.

Second, we must add exports.

FOUR - SECTOR MODEL

With the introduction of the foreign sector (i.e.

households C, firms I, government expenditure G)
aggregate expenditure Z consists of one more
component, net exports X- M.
Z = C + I + G + (X - M)
Still, the equilibrium condition is
Y= Z

EXPORT FUNCTION

It is usually assumed to be an exogenous function

Gross exports is an autonomous variable ,the value of

which for any time period is wholly determined by forces
outside the domestic economy.

EXPORTS AND AGGREGATE

DEMAND
AD = C + I + G + X
C = C + C (Y-T)
Y = C + C ( Y- T) + I + G + X
Y = C - C T + I + G + X / 1- C

Export Multiplier = 1/1- C

IMPORT FUNCTION
Imports is usually assumed to be a function of national
income Y.
Imports are purchase of goods and services from outside
the economy. Payments for imports are a leakage from the
income stream because payments made for imports make
a domestic incomes flow out of the economy.
Two major variable in the short run import function are
The level of income
Autonomous import, independent of the level of the
income.
M = Ma + mY
Marginal Propensity to Import MPM = m
It is defined as the change in imports per unit change in
income Y, i.e., m = M / Y

IMPORTS AND AGGREGATE

DEMAND

The aggregate demand equation for an open economy is

expressed as:
Y = C + I + G +( X-M)

If M > X, the AD decreases and if M< X, the AD increases.

NATIONAL INCOME EQUILIBRIUM IN A

FOUR-SECTOR MODEL
Y=C+I+G+(XM)
C = C + C ( Y T )
M = Ma + mY
Y = C + C ( Y-T) + I + G + ( X Ma mY)
Y = C C T + I + G + X Ma / 1- C +m

FOREIGN TRADE MULTIPLIER

Y / X = 1/ 1- C +m

A COMPLETE FOUR-SECTOR
MODEL
Y=C+I+G+(XM)
Where, C = C + C ( Y T + Gt)
T = Ta + tY
M = Ma + mY
Thus, Y = C C Ta + C Gt + I + G + X Ma
1- C (1-t)+ m

AN OPEN ECONOMY
The Demand for
Domestic Goods and
Net Exports
The domestic demand for
goods is an increasing
function of income (output).
(Panel a)
The demand for domestic
goods is obtained by
subtracting the value of
imports from domestic
demand, and then adding
exports. (Panel b)

AN OPEN ECONOMY
The Demand for
Domestic Goods and
Net Exports
The demand for domestic
goods is obtained by
subtracting the value of
imports from domestic
demand, and then adding
exports. (Panel c)
The trade balance is a
decreasing function of output.
(Panel d)

EQUILIBRIUM OUTPUT AND THE

TRADE BALANCE
The

goods market is in equilibrium when domestic

output equals the demand both domestic and
foreign for domestic goods:

Y Z

Collecting

the relations we derived for the

components of the demand for domestic goods, Z,
we get:
Y = C(Y T) + I + G IM + X

EQUILIBRIUM OUTPUT AND THE

TRADE BALANCE
Equilibrium Output
and Net Exports
The goods market is in
equilibrium when domestic
output is equal to the demand
for domestic goods. At the
equilibrium level of output, the
trade balance may show a
deficit or a surplus.

CLASS TASK 28

An economy is characterized by the following equation:

C = 60 + 0.9 Yd
I = 10,G =10 ,X = 20
M = 10 + 0.05 Y

a)

What is equilibrium income?

b)

Calculate trade balance

c)

What is the value of foreign trade multiplier?

CLASS TASK 28

An economy is characterized by the following equation:

C = 60 + 0.9 Yd
I = 10,G =10 ,X = 20
M = 10 + 0.05 Y

a)

What is equilibrium income?( 600)

b)

Calculate trade balance( -20 )

c)

What is the value of foreign trade multiplier?( 6.66)

CLASS TASK 29

An economy is characterized by the following equation:

C = 100 + 0.8Y
I = 50
G = 50, X = 10
M = 5 + 0.1Y

t = 0.25 , T = 50
a ) Find the equilibrium national income.
b) Find the foreign trade multiplier.
c) Find the equilibrium value of imports.

CLASS TASK 29

An economy is characterized by the following equation:

C = 100 + 0.8 ( Y -50 0.25Y)
I = 50
G = 50, X = 10
M = 5 + 0.1Y
t = 0.25 , T = 50

a ) Find the equilibrium national income.(330)

b) Find the foreign trade multiplier.(2)
c) Find the equilibrium value of imports.(38)

CLASS TASK 30

Suppose the following functions have been estimated for an

economy
C = 10 + 0.8Yd
T =50
I=135
G=60
X=35
M=0.05Y

Find
a)

The equilibrium level of income

b)

Net Export

c)

The increase in income if both the govt spending and tax

were to increase by 10 each.

d)

Net exports if exports were to increase by 6.25

CLASS TASK 30

Suppose the following functions have been estimated for an

economy
C = 10 + 0.8Yd
T =50
I=135
G=60
X=35
M=0.05Y

Find
a)

The equilibrium level of income = 800

b)

Net Export= -5

c)

The increase in income if both the govt spending and tax

were to increase by 10 each. = 8

d)

Net exports if exports were to increase by 6.25 = 825, 0