Agri 2312 chapter 12 product markets and national output

Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward

© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights

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Product Markets and

National Output

Chapter 12



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Discussion Topics

Circular flow of paymentsComposition and measurement of gross

domestic productConsumption, saving and investmentEquilibrium national income and output



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Circular Flow Diagramfor

General Economy



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We can measure macroeconomic activity in eitherresource markets orproduct markets. Resultis the same…

We can measure macroeconomic activity in eitherresource markets orproduct markets. Resultis the same…



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Four major sectorsIn this economy…

Four major sectorsIn this economy…



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Businesses are net borrowersin financial markets while households are net savers…

Businesses are net borrowersin financial markets while households are net savers…



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Government receives net inflows oftaxes from businesses and householdsand is a net borrower in financial markets…

Government receives net inflows oftaxes from businesses and householdsand is a net borrower in financial markets…



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Businesses make investment expenditures,Governments makes expenditures, andHouseholds make consumption expenditures

Businesses make investment expenditures,Governments makes expenditures, andHouseholds make consumption expenditures



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Businesses receive funds from totalexpenditures in product markets while households, who own businesses, receive wages, rents, interest and business in resource markets profits where theyprovide labor and capital services…

Businesses receive funds from totalexpenditures in product markets while households, who own businesses, receive wages, rents, interest and business in resource markets profits where theyprovide labor and capital services…



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Measurement ofGross Domestic Product



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Everything belowzero represents arecession

Everything belowzero represents arecession



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GDP = C + I + G + (X – M) GDP = C + I + G + (X – M) Page 225



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What’s in GDP?



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Types of consumerexpenditures…

Types of consumerexpenditures…



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Types of investmentexpenditures…

Types of investmentexpenditures…



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Calculation of netexports…

Calculation of netexports…



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Page 226Types of governmentExpenditures…

Types of governmentExpenditures…



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Page 226Items not includedin GDP…

Items not includedin GDP…



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Understanding the Domestic

Determinants of GDPC, I and G



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Autonomous orfixed consumption

Autonomous orfixed consumption

Planned Consumption FunctionPlanned Consumption Function

The slope of theconsumption functionis the marginal propensityto consume (MPC), or C÷YD where YD represents disposable income.

The slope of theconsumption functionis the marginal propensityto consume (MPC), or C÷YD where YD represents disposable income.



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The consumption functionin this graph can beexpressed graphically asshown below.

The consumption functionin this graph can beexpressed graphically asshown below.

C = AC + MPC(DPI)C = AC + MPC(DPI)



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Consumer expenditureswould be $3,600 ifdisposable income wasequal to $3,000.

Consumers would bedis-saving by $600.

Consumer expenditureswould be $3,600 ifdisposable income wasequal to $3,000.

Consumers would bedis-saving by $600.


C = $1,500 + .70($3,000) = $3,600C = $1,500 + .70($3,000) = $3,600



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An increase in dis-posable income to$4,000 would raiseexpenditures to$4,300.

Dis-saving wouldfall to $300.

An increase in dis-posable income to$4,000 would raiseexpenditures to$4,300.

Dis-saving wouldfall to $300.


C = $1,500 + .70($4,000) = $4,300C = $1,500 + .70($4,000) = $4,300



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An increase in disposable income to$5,000 would raiseexpenditures to$5,000.

Dis-saving wouldfall to zero.

An increase in disposable income to$5,000 would raiseexpenditures to$5,000.

Dis-saving wouldfall to zero.


C = $1,500 + .70($5,000) = $5,000C = $1,500 + .70($5,000) = $5,000



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Savings vs. ConsumptionWe said that the slope of the consumption functionwas the marginal propensity to consume, or:

MPC = C ÷ DPI

Savings is defined as

S = DPI – C

And, therefore, the marginal propensity to save is

MPS = 1.0 – MPC

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When the savings rate rises significantly, a recession is often near.

When the savings rate rises significantly, a recession is often near.



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A role for fiscalpolicy here:

A cut in the tax rate increases consump-tion.

An increase in thetax rate decreasesconsumption.







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Real Wealth EffectReal Wealth Effect

Suppose stock marketprices rose, increasingreal wealth of consumersby $700.

Suppose stock marketprices rose, increasingreal wealth of consumersby $700.



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This would increasethe intercept by $700,

This would increasethe intercept by $700,



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C = $2,200 + .70($4,000) = $5,000C = $2,200 + .70($4,000) = $5,000

This shifts the curve upward for given income level, boosts consumer spending to $5,000. This raisesdis-saving to $1,000, raises debt relative to income, and can be inflationary…..

This shifts the curve upward for given income level, boosts consumer spending to $5,000. This raisesdis-saving to $1,000, raises debt relative to income, and can be inflationary…..



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Planned Investment FunctionPlanned Investment Function

Level of autonomousinvestment spending

Level of autonomousinvestment spending

I = AI – MEI(i)I = AI – MEI(i)



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The slope of the investmentfunction is the marginalefficiency of investment, or:MEI = I÷i

The slope of the investmentfunction is the marginalefficiency of investment, or:MEI = I÷i

I = AI – MEI(i)I = AI – MEI(i)



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Level of investmentexpenditures wouldbe $250 at an interestrate of 9 percent if MEI = 25.

Level of investmentexpenditures wouldbe $250 at an interestrate of 9 percent if MEI = 25.

I = $475 – 25(9.0)I = $475 – 25(9.0)



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Should interest rates fall to 7%as a result of events in themoney market, investmentexpenditures would increasefrom $250 to $300.

Should interest rates fall to 7%as a result of events in themoney market, investmentexpenditures would increasefrom $250 to $300.

I = $475 – 25(7.0)I = $475 – 25(7.0)



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Effects of Profit ExpectationsEffects of Profit Expectations

I = $525 – 25(7.0)I = $525 – 25(7.0)

An increase in profitexpectations wouldcause businesses toexpand their plannedinvestment expendituresby $50 at the same interest rate

An increase in profitexpectations wouldcause businesses toexpand their plannedinvestment expendituresby $50 at the same interest rate



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Understanding Product Market

Equilibrium



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Aggregate ExpendituresConsumption expenditures function:C = $1,500+0.70(DPI)

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Investment expenditures function:I = $475 –25(i)

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Government expenditures function:G = $880

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Government expenditures function:G = $880

If the interest rate (i) is equal to 7%, thenAE = $1,500 + 0.70(DPI) + $475 – 25(7) +$880 = $2,680 + 0.70(DPI)

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Aggregate ExpendituresAggregate expenditures equation:AE = $2,680+0.70(NI-Tax)

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where national output equals national income (NI) andTax is based upon last year’s income (Tax = $400).

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If national income is $6,000, thenAE = $2,680+0.70($6,000 - $400) = $6,600which represents the first line in Table 12.4

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If national income is $6,000, thenAE = $2,680+0.70($6,000 - $400) = $6,600which represents the first line in Table 12.4

Repeating this for other levels of income gives us the graph on page 235

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Total autonomousdomestic spending…

Total autonomousdomestic spending…

Aggregate Expenditures CurveAggregate Expenditures Curve



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Point where spendingequals output…

Point where spendingequals output…

Aggregate Expenditures CurveAggregate Expenditures Curve



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Deriving Aggregate Demand CurveDeriving Aggregate Demand Curve

Demand equals supplyDemand equals supply Corresponding price levelCorresponding price level

Aggregatedemand curve

Aggregatedemand curve



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Aggregate Supply CurveAggregate Supply Curve

Three distinct rangesof aggregate supplycurve

Three distinct rangesof aggregate supplycurve



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Aggregate Supply CurveAggregate Supply Curve

Maximum potentialoutput in the shortrun…

Maximum potentialoutput in the shortrun…

End of depressionor Keynesian range

End of depressionor Keynesian range



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YFE represents full employment outputYE represents current or actual outputYPOT represents potential or maximum output

YFE represents full employment outputYE represents current or actual outputYPOT represents potential or maximum output

Product Market EquilibriumProduct Market Equilibrium



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Product Market EquilibriumProduct Market Equilibrium

Planned spending exceedsfull employment output,causing higher inflationarypressures in economy.

Planned spending exceedsfull employment output,causing higher inflationarypressures in economy.

Planned spending less thanfull employment output,causing underutilization ofeconomy’s resources.

Planned spending less thanfull employment output,causing underutilization ofeconomy’s resources.

YE > YFEYE > YFE YFE > YE

YFE > YE



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SummaryGDP consists of C, I, G and (X-M) Focus is on new goods produced and services

performed in the current yearConsumption influenced by disposable income

and wealthInvestment influenced by interest rates and

profit expectationsProduct market equilibrium occurs where

aggregate demand equals aggregate supplyInflationary and recessionary gaps occur when

economy not at full employment output



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Chapter 13 focuses on the application of monetary and fiscal policy….