National Income: Where It Comes From and Where It Goes

National Income: Where It Comes From and Where It Goes

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Goods Market Equilibrium

Factor markets are already explained above, while goods markets will be explained below:
Recall components of Gross Domestic Product : Consumption + Investment + Government purchases or GDP: C+I+G
1. Consumption (C)
– Consumption depends on disposable income or C = C(Y-T)
– Marginal Propensity to Consume (MPC) is the increase in C caused by a one-unit increase in disposable income

Consumption Function


2. Investment
– Investment depends on real interest rate
– Nominal interest rate vs. real interest rate (I = I(r))


3. Government purchases
Government purchases include all of spending by government, such as weapons, services, park benches, roads, etc.

Government purchases exclude welfare or social security, since these are categorized as transfer payments and not directly using economy’s output
So, the T in disposable income (Y-T) includes the net of taxes minus transfers.
We’ll assume G, T fixed (exogenous)

Equilibrium in market of goods and services
Y = C + I + G
Y = C(Y-T) + I(r) + G
real interest rate must adjust to equilibriate demand and supply
Equilibrium in financial markets
Y – C – G = I or (Y-T-C) + (T-G) = I
Private saving is income minus tax minus consumption (Y-T-C)
Public saving is tax revenue minus government purchases (T-G)
Equilibrium in this “loanable funds” market explains that private saving + public saving = national saving = investment

References: Macroeconomics by N. Gregory Mankiw



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