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NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)

<< NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
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Macroeconomics ECO 403
VU
LESSON 09
NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES
(Continued...)
Government spending, G
·
G includes government spending on goods and services.
·
G excludes transfer payments
·
Assume government spending and total taxes are exogenous:
The market for goods & services
Summarizing the Discussion so far:
Y=C+I+G
C = C(Y - T)
I = I(r)
G=G
T=T
Market for goods & services
Agg. Demand:
C(Y - T) + I(r) + G
Agg. Supply:
Y = F(K, L)
Equilibrium:
Y = C(Y - T) + I (r) + G
The real interest rate adjusts
to equate demand with supply.
The loanable funds market
A simple supply-demand model of the financial system.
One asset:
"loanable funds"
demand for funds:  investment
supply of funds:  saving
"price" of funds:
real interest rate
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Macroeconomics ECO 403
VU
Demand for funds: Investment
The demand for loanable funds:
·
Comes from investment:
Firms borrow to finance spending on plant & equipment, new office buildings, etc.
Consumers borrow to buy new houses.
· Depends negatively on r , the "price" of loanable funds (the cost of borrowing).
Loanable funds demand curve
r
The investment curve is also the
demand curve for loanable funds.
I (r)
I
Supply of funds: Saving
The supply of loanable funds comes from saving:
·
Households use their saving to make bank deposits, purchase bonds and other assets.
These funds become available to firms to borrow to finance investment spending.
·
The government may also contribute to saving if it does not spend all of the tax
revenue it receives.
Types of saving
·
Private saving = (Y ­T) ­ C
·
Public saving =
T­G
·
National saving, S
= private saving + public saving
= (Y ­T) ­ C +  T ­ G
=
Y ­C ­G
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Macroeconomics ECO 403
VU
Digression:
Budget surpluses and deficits
·
When T > G, budget surplus = (T ­ G) = public saving
·
When T < G, budget deficit = (G ­T) and public saving is negative.
·
When T = G, budget is balanced and public saving = 0.
Budget Deficit of Pakistan
(as % of GDP)
10
9
8
7
6
5
4
3
2
1
0
1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02
%
Loanable funds supply curve
r
S = Y ­ C(Y - T) - G
National saving does
not depend on r,
so the supply curve is
vertical.
S, I
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Macroeconomics ECO 403
VU
Loanable funds market equilibrium
r
S = Y ­ C(Y - T) - G
Equilibrium real
interest rate
I (r )
S, I
Equilibrium level of
investment
The special role of r
r adjusts to equilibrate the goods market and the loanable funds market simultaneously:
If L.F. market in equilibrium, then
S=I
(Y ­ C ­ G) = I
Rewriting as:
Y = C + I + G (goods market equilibrium)
Thus,
Equilibrium in Loanable funds Market
Equilibrium in goods Market
Digression: mastering models
To learn a model well, be sure to know:
1. Which of its variables are endogenous and which are exogenous.
2. For each curve in the diagram, know
­
definition
­
intuition for slope
­
all the things that can shift the curve
3. Use the model to analyze the effects of each item in 2c.
30
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Macroeconomics ECO 403
VU
Mastering the loanable funds model
1. Things that shift the saving curve
·  Public saving
·  Fiscal policy: changes in G or T
·  Private saving
·  Preferences
·  Tax laws that affect saving
Now you try...
·
Draw the diagram for the loanable funds model.
·
Suppose the tax laws are altered to provide more incentives for private saving.
·
What happens to the interest rate and investment?
·
(Assume that T doesn't change)
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Table of Contents:
  1. INTRODUCTION:COURSE DESCRIPTION, TEN PRINCIPLES OF ECONOMICS
  2. PRINCIPLE OF MACROECONOMICS:People Face Tradeoffs
  3. IMPORTANCE OF MACROECONOMICS:Interest rates and rental payments
  4. THE DATA OF MACROECONOMICS:Rules for computing GDP
  5. THE DATA OF MACROECONOMICS (Continued…):Components of Expenditures
  6. THE DATA OF MACROECONOMICS (Continued…):How to construct the CPI
  7. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES
  8. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  9. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  10. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  11. MONEY AND INFLATION:The Quantity Equation, Inflation and interest rates
  12. MONEY AND INFLATION (Continued…):Money demand and the nominal interest rate
  13. MONEY AND INFLATION (Continued…):Costs of expected inflation:
  14. MONEY AND INFLATION (Continued…):The Classical Dichotomy
  15. OPEN ECONOMY:Three experiments, The nominal exchange rate
  16. OPEN ECONOMY (Continued…):The Determinants of the Nominal Exchange Rate
  17. OPEN ECONOMY (Continued…):A first model of the natural rate
  18. ISSUES IN UNEMPLOYMENT:Public Policy and Job Search
  19. ECONOMIC GROWTH:THE SOLOW MODEL, Saving and investment
  20. ECONOMIC GROWTH (Continued…):The Steady State
  21. ECONOMIC GROWTH (Continued…):The Golden Rule Capital Stock
  22. ECONOMIC GROWTH (Continued…):The Golden Rule, Policies to promote growth
  23. ECONOMIC GROWTH (Continued…):Possible problems with industrial policy
  24. AGGREGATE DEMAND AND AGGREGATE SUPPLY:When prices are sticky
  25. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  26. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  27. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  28. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  29. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  30. AGGREGATE DEMAND IN THE OPEN ECONOMY:Lessons about fiscal policy
  31. AGGREGATE DEMAND IN THE OPEN ECONOMY(Continued…):Fixed exchange rates
  32. AGGREGATE DEMAND IN THE OPEN ECONOMY (Continued…):Why income might not rise
  33. AGGREGATE SUPPLY:The sticky-price model
  34. AGGREGATE SUPPLY (Continued…):Deriving the Phillips Curve from SRAS
  35. GOVERNMENT DEBT:Permanent Debt, Floating Debt, Unfunded Debts
  36. GOVERNMENT DEBT (Continued…):Starting with too little capital,
  37. CONSUMPTION:Secular Stagnation and Simon Kuznets
  38. CONSUMPTION (Continued…):Consumer Preferences, Constraints on Borrowings
  39. CONSUMPTION (Continued…):The Life-cycle Consumption Function
  40. INVESTMENT:The Rental Price of Capital, The Cost of Capital
  41. INVESTMENT (Continued…):The Determinants of Investment
  42. INVESTMENT (Continued…):Financing Constraints, Residential Investment
  43. INVESTMENT (Continued…):Inventories and the Real Interest Rate
  44. MONEY:Money Supply, Fractional Reserve Banking,
  45. MONEY (Continued…):Three Instruments of Money Supply, Money Demand