Week 3: National Income There are three key variables in macroeconomics: 1) Output = Income (e. g. real GDP) 2) General Price (e. g. GDP deflator) 3) Employment (e. g. unemployment rate) The level of output is the quantity of goods & services that are produced in our economy. In equilibrium, the quantity and price are determined by the supply and demand curves. [1] P D S P* Y* Y Last Week: Level of output was studied from a supply side: capital, labour, and technology. A particular attention was paid to the labour force.

This Week: Level of output will be examined from a demand side. 1 Demand for Aggregate Output 1. 1 National Income Accounts Identity Products are demanded by four sectors. (1) Households (2) Firms (3) Government (4) Overseas sector Demand for our products is decomposed: Y ( C + I + G + EX, C: Consumption I: Investment G: Government Purchases EX: Net Exports. [2] This is the “National Income Accounts Identity”. 2. Consumption Demand (non-durable goods, durable goods, and services) The higher your disposable income, the more you consume:

C = C (Y – T), where T denotes tax payments. 3. Investment Demand (business fixed investment, residential investment, and inventory investment. ) – Firms and

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households borrow money to finance their investments. – A higher interest rate discourages you to borrow money, thereby reducing investments: I = I ( r ) where r denotes the real interest rate. 1. 4 Demand of Government – To finance its expenditures, government collects tax from households and firms. – Government’s expenditures and tax (G and T) are determined outside of the economy. G and T are assumed constant. 1. 5 Demand of Foreign Countries When the local currency depreciates, net export will increase. Net export depends on the exchange rate: NX = NX (e), where e denotes the exchange rate. 1. 6 Implication of National Income Accounts Identity National Income Accounts Identity becomes: Y – T = C + I + G – T+ NX. ( Y – T – C ) + (T – G ) – I = NX Now, we have S – I = NX. – When national saving exceeds investment, the country lends to foreign countries, which corresponds to trade surplus. When national saving is insufficient to finance investment, the country must borrow from overseas, which corresponds trade deficit. ( There is one-to-one relationship between trade balance and excess of saving over investment. In Japan, – national savings have consistently exceeded national investments, and – trade balance has bee consistently surplus. [pic] [pic] [pic] [pic] [pic] [pic] [pic] ———————– [1] Aggregate demand and supply curves will be the focuses of the lectures in Week 8 to 11. [2] Net export is defined as exports less imports.