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Literature summary Macroeconomics
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Summary of the entire prescribed literature for the elective Macroeconomics
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Literatuur MacroeconomicsWeek 2
Hoofdstuk 3
Interactions among demand, production, and income:
Changes in the demand lead to changes in production
Changes in production lead to changes in income
Changes in income lead to changes in the demand for goods
Gross domestic product (GDP): Z ≡C + I + G+ X−I
Consumption (C): goods and services purchased by consumers
Investment (I): sum of non-residential and residential investment
o Non-residential: purchase by firms of new plants or new machines
o Residential: purchase by people of new houses or apartments
Government spending (G): purchases of goods and services by the federal, state, and
local governments, does not include government transfers
Export (X): purchases of goods and services by foreigners
Imports (IM): purchases of foreign goods and services by consumers, firms, and
government
Trade balance/net exports = difference between export – import, > 0 is a trade surplus, < 0 is
a trade deficit
Inventory investment = difference between production and sales
Consumption (C)
Consumption function depends on the disposable income and the propensity to consume
C=c 0 +c 1 Y D
o c 0: consumption if disposable income would be zero
o c 1: propensity to consume, effect an additional dollar of disposable income has on
consumption, between 0 and 1
o Y D: disposable income, income – taxes (Y – T)
o This is a behavioural equation with a linear relation
Investment (I) and Government spending (G)
Exogenous variables so for now taken as given
Write investment as I
Together with T, G describes the fiscal policy
Equilibrium in the goods market
Equilibrium requires that production Y is equal to demand for goods Z
This gives: Y =c 0+ c 1( Y −T )+ I +G, with the trade balance = 0
1
We can rewrite this to: Y = [c + I +G−c 1 T ]
1−c1 0
1
o : money multiplier, multiplies the increase/decrease in variable to a bigger
1−c 1
effect, higher demand leads to higher production leads to higher income leads to
higher demand etc.
o [ c 0 + I +G−c 1 T ] : autonomous spending, part that doesn’t depend on output
, Graphical description of equilibrium:
Standard equilibrium Change in one variable and multiplier effect
Saving
Private saving: saving by consumers
o S ≡Y D−C
o S ≡Y −T −C
o S ≡−c 0 +(1−c 1)(Y −T )
o (1−c1 ): propensity to save
Public saving
o T–G
o Budget surplus or budget deficit
Investment equals saving: equilibrium for goods-market
Rewriting the equilibrium can give you investment = saving
I = S + (T – G)
Also called the IS-relation
Hoofdstuk 4
Variables in the financial market:
Two different monetary assets:
o Money: can be used for transactions, pays no interest
o Bonds: pay a positive interest rate i, cannot be used for transactions
Proportions of these monetary assets depend on:
o Level of transactions: need to have enough money to do
transactions
o Interest rate: higher interest rate gives a higher return on
bonds
Demand for money
Demand for money: sum of all the individual demands by
people and firms
M d =$ Y L ( i )
(-)
o Demand for money is equal to nominal income $Y times a
decreasing function of the interest rate
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