national income savings and investment

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  • NationalIncome

    SavingsandInvestment

    1AndrewRose,GlobalMacroeconomics2

  • CircularFlowofIncome

    InaVERYsimpleeconomy Laborisafactorinput usedtoproducegoods Laborreceivesincome ofwages

    Wagesthenexchangedforgoods

    Producers

    Wages/Goods

    FactorInputs/

    Consumers

    Labor/Payments

    2AndrewRose,GlobalMacroeconomics2

    Supply

    Demand

  • MeasuresofEconomicActivity

    1. Laborservicessoldforwages("supplyside)2. Goodssoldforrevenue("demandside)

    NotethatTotalIncome (receivedbytheworkers)must equalTotalSpending

    3AndrewRose,GlobalMacroeconomics2

  • Generality

    Basiclogicofcircularflowdoesnotchangewithadditionof: FinancialMarkets(thefuture),assets,money,bonds,

    Governmenttaxing/spending, InternationalExchange(trade)ofgoods,services,capital

    4AndrewRose,GlobalMacroeconomics2

  • GrossDomesticProduct GDP("output")isdefinedasthevalue ofallfinal goods

    andservicesproducedwithinthecountryatcurrentprices GDPaflowmeasure(usuallyannual) Outputisvaluedatmarketprices(somethingpricedatzeroisnotincluded)

    Onlyfinal goodsandservicescount,sothatvalueadded ismeasured

    InflationmakesnominalGDPuninterestingoverlongperiodsoftime

    RealGDP isrealvalueofallgoodsandservices,accountingforinflation

    5AndrewRose,GlobalMacroeconomics2

  • Many IssueswithNationalAccounts

    Leisure isignoredbutvaluable Incomedistributionrelevant NonMarketServices(thosenotpriced)areignoredbutimportant

    Environmental Degradation UndergroundEconomygeneratesvalue Statistical Problems

    mismeasurementisrife(e.g.,CPIqualitybias) 2importantexamples:a)risingquality;b)newgoods

    6AndrewRose,GlobalMacroeconomics2

  • ModelingIncome:SupplySide

    Standardmicroeconomics Outputproducedfrominputfactorslabor andcapital,givenatpointintime

    Factorscombinedwithproductionfunctionwhichmapsinputstooutputvia(shortrun)fixedtechnology Y=F(K,L) GDP(Y)producedfromcapital(K)andlabor(L)usingexistingtechnologyF(.)

    7AndrewRose,GlobalMacroeconomics2

  • AnImportantAssumption

    ConstantReturnstoScale(CRS) Doublinginputsdoublesoutput Replication

    UsuallyassumecompetitiveinputmarketsandprofitmaximizationWithCRS,economicprofitsarezero

    8AndrewRose,GlobalMacroeconomics2

  • AnImportantFact

    TheCobbDouglasProductionFunctionworks(surprisingly)wellempirically:

    Y=AKL1 where .25/.33empirically iscapitalsshareofincome(rK/Y) (1)islaborsshareofincome(wL/Y) Arepresentstechnology

    Empirical(ratherthantheoretical)finding Can betreatedasconstant?

    9AndrewRose,GlobalMacroeconomics2

  • Demand(Expenditure)Side

    TheNationalIncomeAccountingIdentity

    Y C+I+G+(XM)

    10AndrewRose,GlobalMacroeconomics2

  • Consumption(C)

    Consumption isundertakenbyhouseholds Approximately60%ofaggregatespendingonaverage

    1. MostlyServices(inRichCountries)2. Goods

    Durables NonDurables ImportantinDevelopingCountries

    11AndrewRose,GlobalMacroeconomics2

  • Investment(I)

    Physical InvestmentinCapitalisundertakenbyfirms Slightlymorethan20%ofaggregatespendingonaverage

    1. Depreciation2. Structures

    Residential Nonresidential

    3. MachineryandEquipment4. ResearchandDevelopment(new)5. ChangeinInventories

    12AndrewRose,GlobalMacroeconomics2

  • DirectGovernmentSpending(G)

    Governmentdirectlypurchasesgoodsandservices(forpublicconsumption)

    Slightlylessthan20%aggregatespendingonaverage Differentlevelsofgovernment Majorcomponents:

    1. Healthcare2. Education3. Military4. Infrastructure,

    13AndrewRose,GlobalMacroeconomics2

  • IndirectGovernmentSpending

    WhoReceivesTransfers?1. Old2. Unemployed3. Poor4. Agriculture5. Bondholders(HoldersofNationalDebt),

    Note:indirectspendingoftenlargerthandirectgovernmentspending

    14AndrewRose,GlobalMacroeconomics2

  • NetExports(NX)

    NetExports =exports(X)minusimports(M)

    Thatis,oursalestoforeigners,lessour

    purchasesfromforeigners

    15AndrewRose,GlobalMacroeconomics2

  • ModelingAggregateSpending

    Assume: Consumption afunctionof(disposable)incomewithslope,cMarginalPropensitytoConsume(MPC)sothatC=cY Note:noeffectofinterestratesonconsumption,andhencenointeresteffectonsavings Theoreticallyambiguous,empiricallyweak

    Investment afunctionofthe(real)interestrate,PresentValue

    Direct GovernmentPurchasesand NetExports arebothexogenous,latterzero

    16AndrewRose,GlobalMacroeconomics2

  • Equilibrium:FormalStuff

    CombineDemandandSupplyModels Supplyside:Y=F(K,L) Demandside:Y=C+I+G+(XM)

    ButC=c(Y);I=I(r);Gfixed;(XM)=0 Factorsuppliesandoutputfixedintheshortrun:Y=c(Y)+I(r)+G Alternatively,Y=C+I+G

    =>Y C G=I=>(Y C G)=I=>NationalSavings=Investment

    17AndrewRose,GlobalMacroeconomics2

  • Equilibrium

    S=Y C G=I(r)

    18AndrewRose,GlobalMacroeconomics2

    r

    S, I

    I(r)

    S = Y C(Y) - G

    A=equilibrium

  • WhatHappenswhenGRises?

    IncreaseinDirectGovernmentSpending (e.g.,warfinancedbydeficit) Savings(S)andhenceInvestment(I)contract Interestrate(r)rises,endogenously

    19AndrewRose,GlobalMacroeconomics2

    r

    S, I

    A

    B

    I(r)

    S = Y C(Y) - G

  • TechnologicalInnovation

    IncreaseinInvestmentSchedule(shiftsup) Interestrate(r)increasesendogenously NochangeinSavingsorInvestment

    20AndrewRose,GlobalMacroeconomics2

    r

    S, I

    A

    B

    I(r)

    S = Y C(Y) - G

    I(r)

  • KeyTakeaways

    CircularFlowofIncome ProductionFunction

    Y=F(K,L) NationalIncomeAccountingIdentity

    Y=C+I+G+(XM) Inaclosed economy,investmentandsavingsinteracttodeterminetheinterestrate

    AndrewRose,GlobalMacroeconomics2 21

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