Seguridad de las sesiones

Chapter 4 Consumption, Savi ng, and I nvestment 1 33

In Chapter 3, we showed that the quantity of goods and services supplied in an economy depends on the level of productivity as determined, for example, by the technology used and on the quantity of inputs, such as the capital and labor used. In this chapter we have discussed the factors that affect the demand for goods and services, particularly the demand for consumption goods by house­ holds and the demand for investment goods by firms. But how do we know that

the amount of goods and services that consumers and investors want to buy will be the same as the amount that producers are willing to provide? Putting the question another way, What economic forces bring the goods market into equilibrium, with quantities demanded equal to quantities supplied? In this section, we show that the real interest rate is the key economic variable whose adjustments help bring the quantities of goods supplied and demanded into balance; thus a benefit of our analysis is an explanation of what determines interest rates. Another benefit is that, by adding the analysis of goods market equilibrium to the analysis of labor market equilibrium in Chapter 3, we take another large step toward constructing a complete model of the macroeconomy.

The goods market is in equilibrium when the aggregate quantity of goods sup­ plied equals the aggregate quantity of goods demanded. (For brevity, we refer

only to "goods" rather than to "goods and services," but services always are included.) Algebraically, this condition is

Y ==

cd

+

Id

+ G. (4.7)

The left side of Eq. (4.7) is the quantity of goods, Y, supplied by firms, which is determined by the factors discussed in Chapter 3. The right side of Eq. (4.7) is the aggregate demand for goods. If we continue to assume no foreign sector, so that net exports are zero, the uantity of goods demanded is the sum of desired consump-

G.13 Equation (4.7) is called the

goods market equilibrium condition.

The goods market equilibrium condition is different in an important way from the income-expenditure identity for a closed economy, Y == C + I + G (this identity is Eq. 2.3, with NX == 0). The income-expenditure identity is a relation­

ship between actual income (output) and actual spending, which, by definition, is always satisfied. In contrast, the goods market equilibrium condition does not always have to be satisfied. For example, firms may produce output faster than consumers want to buy it so that undesired inventories pile up in firms' ware­ houses. In this situation, the income-expenditure identity is still satisfied

(because the undesired additions to firms' inventories are counted as part of total spending see Chapter 2), but the goods market wouldn't be in equilibrium because production exceeds

desired

spending (which does

not

include the unde­

sired increases in inventories). Although in principle the goods market equilibrium condition need not always hold, strong forces act to bring the goods market into equilibrium fairly quickly.

A different, but equivalent, way to write the goods market equilibrium condi­ tion emphasizes the relationship between desired saving and desired investment.

13We assume that G always equals the level desired by the government and so we don't distinguish between desired and actual G.

1 34 Part 2 Long-Run Economic Performance

4.8

Goods market equilibrium

Goods market equilibri­ um occurs when desired national saving equals

desired investment. In the

figure, equilibri urn occurs when the real interest rate is 6 °/o and both desired

national saving and

desired investment equal 1000. If the real interest

rate were, say, 3°/o, desired investment (1500) would not equal desired national

saving (850), and the

goods market would not be in equilibrium. Com­

petition among borrowers for funds would then

cause the real interest rate to rise until it reaches 6°/o.

To obtain this alternative form of the goods market equilibrium condition, we first subtract

Cd

+ G from both sides of Eq. (4.7):

Y -

cd

- G

==

Id.

The left side of this equation, Y -

Cd

- G, is desired national saving,

Sd

(see Eq. 4.1).

Thus the goods market equilibrium condition becomes

sd

₌₌

Id.

_(4.8)

This alternative way of writing the goods market equilibrium condition says that the goods market is in equilibrium when desired national saving equals desired investment. Because saving and investment are central to many issues we present in this book and because the desired-saving-equals-desired-investment form of the goods market equilibrium condition often is easier to work with, we utilize Eq. (4.8) in most of our analyses. However, we emphasize once again that Eq. (4.8) is equivalent to the condition that the supply of goods equals the demand for goods, Eq. (4.7).

The Savi ng-I nvestment Diagram

For the goods market to be in equilibrium, then, the aggregate supply of goods must equal the aggregate demand for goods, or equivalently, desired national

saving must equal desired investment. We demonstrate in this section that adjust­ ments of the real interest rate allow the goods market to attain equilibrium.14

The determination of goods market equilibrium can be shown graphically with a saving-investment diagram (Fig. 4.8). The real interest rate is measured along the

3o/o 850 1000 Saving curve, S 1500 Investment curve, I

Desired national saving,

S d,

and desired investment,

Id

14Strictly speaking, we should refer to the expected real interest rate rather than simply the real inter­ est rate. The two are the same if expected inflation and actual inflation are equal.

Chapter 4 Consumption, Savi ng, and I nvestment 1 35

vertical axis, and national saving and investment are measured along the horizon­ tal axis. The saving curve,

S,

shows the relationship between desired national saving

and the real interest rate. The upward slope of the saving curve reflects the empiri­ cal finding (Section 4.1) that a higher real interest rate raises desired national saving. The investment curve,

I,

shows the relationship between desired investment and the real interest rate. The investment curve slopes downward because a higher real interest rate increases the user cost of capital and thus reduces desired investment.

Goods market equilibrium is represented by point E, at which desired national saving equals desired investment, as required by Eq. (4.8). The real interest rate cor­ responding to E (6°/o in this example) is the only real interest rate that clears the

goods market. When the real interest rate is 6°/o, both desired national saving and desired investment equal 1000.

How does the goods market come to equilibrium at E, where the real interest rate is 6°/o? Suppose instead that the real interest rate is 3°/o. As Fig. 4.8 shows, when the real interest rate is 3°/o, the amount of investment that firms want to undertake (1500) exceeds desired national saving (850). With investors wanting to borrow more than savers want to lend, the "price" of saving the real interest rate that lenders receive will be bid up. The return to savers will rise until it reaches 6°/o, and desired national saving and desired investment are equal. Similarly, if the real interest rate exceeds 6°/o, the amount that savers want to lend will exceed what investors want to borrow, and the real return paid to savers will be bid down. Thus adjustments of the real interest rate, in response to an excess supply or excess demand for saving, bring the goods market into equilibrium.

Although Fig. 4.8 shows goods market equilibrium in terms of equal saving and investment, keep in mind that an equivalent way to express goods market equilibri­ um is that the supply of goods, Y, equals the demand for goods,

cd

+

Id

+ G (Eq. 4.7).

Table 4.3 illustrates this point with a numerical example consistent with the values shown in Fig. 4.8. Here the assumption is that output, Y, and government purchases,

G, are fixed at values of 4500 and 1500, respectively. Desired consumption,

cd,

and desired investment,

Id,

depend on the real interest rate. Desired consumption depends on the real interest rate because a higher real interest rate raises desired saving, which necessarily reduces desired consumption. Desired investment depends on the real interest rate because an increase in the real interest rate raises the user cost of capital, which lowers desired investment.

In the example in Table 4.3, when the real interest rate is 6°/o, desired consumption

Cd

= 2000. Therefore desired national saving

sd

= Y -

cd

- G = 4500 - 2000

- 1500 = 1000. Also, when the real interest rate is 6°/o, desired investment

Id

= 1000.

As desired national saving equals desired investment when r = 6°/o, the equilibrium

real interest rate is 6°/o, as in Fig. 4.8.

Table 4.3

Components of Aggregate Demand for Goods (An Example)

Real

Interest Desired

Rate, r Output, Y Consumption, cd

3o/o 6% 4500 4500 2 1 50 2000 Desired Investment, /d 1 500 1 000 Government Purchases, G 1 500 1 500 Desired National Aggregate Demand

Saving, for Goods, sd ₌ Y - cd - G cd + 1d + G

850 1 000

5 1 50 4500

1 36 Part 2 Long-Run Economic Performance

Figure 4.9

A decline in desired

•

savtng

A change that reduces

desired national saving, such as a temporary

increase in current gov­

ernment purchases, shifts the saving curve to the

left, from 51 to 52. The

goods market equilibri­ um points moves from E to F. The decline in

desired saving raises the real interest rate, from

6°/o to 7°/o, and lowers saving and investment, from 100 to 850.

Note, moreover, that when the real interest rate is at the equilibrium value of 6%, the aggre

f

ate supply of goods, Y, which is 4500, equals the aggregate demand for goods,

C

+

Id

+ G

==

2000 + 1000 + 1500

==

4500. Thus, both forms of the goods market equilibrium condition, Eqs. (4.7) and (4.8), are satisfied when the real interest rate equals 6°/o.

Table 4.3 also illustrates how adjustments of the real interest rate bring about equilibrium in the goods market. Suppose that the real interest rate initially is 3°/o. Both components of private-sector demand for goods

(Cd

and

Id)

are higher when the real interest rate is 3°/o than when it is 6°/o. The reason is that consumers save less and firms invest more when real interest rates are relatively low. Thus, at a real interest of 3°/o, the

demand for goods (Cd ₊

Id

_{+ G}

==

2150 ₊ 1500 ₊ 1500

==

5150) is greater than the

supply of goods (Y

==

4500). Equivalently, at a real interest rate of 3°/o, Table 4.3 shows that desired investment

(Id

==

1500) exceeds desired saving

(Sd

==

850). As Fig. 4.8

shows, an increase in the real interest rate to 6°/o eliminates the disequilibrium in the goods market by reducing desired investment and increasing desired national saving. An alternative explanation is that the increase in the real interest rate eliminates the excess of the demand for goods over the supply of goods by reducing both con­ sumption demand and investment demand.

Shifts of the Saving Curve. For any real interest rate, a change in the economy

that raises desired national saving shifts the saving curve to the right, and a change that reduces desired national saving shifts the saving curve to the left.

(Summary table 5 on p. 118 lists the factors affecting desired national saving.)

A shift of the saving curve leads to a new goods market equilibrium with a dif­ ferent real interest rate and different amounts of saving and investment. Figure 4.9

Q) � _� Q) Q) � � Q) 70/o • a • t • I • t I I • t t • • t • • • I I • • 4 t • • _{t I •} 4 t t I • • • s z 6 Oj0 .. . .. . .. . ... , .. . .. , .. . . . _. . . , _{, • •} , • _{� .. . . �} • , . .. , ·:· • , . .. . , . • • • • • • • • • • • • ' . • • I I • • • • • _• I I • • • • • • • • • ' . I ' • • • • ' ' • • . � • • ' . • • • • • _• • • • • • • • • 850 1000 S l I

Figure 4.1 0

An increase in desired investment

A change in the economy

that increases desired investment, such as an invention that raises the expected future MPK,

shifts the investment

curve to the right, from 11

to 12. The goods market

equilibrium point moves from E to G. The real

interest rate rises from 6°/o to 8°/o, and saving and

investment also rise, from 1000 to 1100.

Chapter 4 Consumption, Savi ng, and I nvestment 1 37

illustrates the effects of a decrease in desired national saving resulting, for exam­ ple, from a temporary increase in current government purchases. The initial equi­ librium point is at E, where (as in Fig. 4.8) the real interest rate is 6°/o and desired national saving and desired investment both equal 1000. When current government purchases increase, the resulting decrease in desired national saving causes the saving curve to shift to the left, from 51 to 52. At the new goods market equilibrium

point, F, the real interest rate is 7°/o, reflecting the fact that at the initial real interest rate of 6°/o the demand for funds by investors now exceeds the supply of saving.

Figure 4.9 also shows that, in response to the increase in government purchases, national saving and investment both fall, from 1000 to 850. Saving falls because of the

initial decrease in desired saving, which is only partially offset by the increase in the real interest rate. Investment falls because the higher real interest rate raises the user cost of capital that firms face. When increased government purchases cause invest­ ment to decline, economists say that investment has been

crowded out.

The crowding

out of investment by increased government purchases occurs, in effect, because the government is using more real resources, some of which would otherwise have gone into investment.

Shifts of the I nvestment Curve. Like the saving curve, the investment curve can shift. For any real interest rate, a change in the economy that raises desired investment shifts the investment curve to the right, and a change that lowers desired investment shifts the investment curve to the left. (See Summary table 6 on p. 130 for the factors affecting desired investment.)

The effects on goods market equilibrium of an increase in desired investment­ as from an invention that raises the expected future marginal product of capital are shown in Fig. 4.10. The increase in desired investment shifts the investment curve to

6o/o .. • . . .. • . , ' . . , • _{� .. .} • _{� . , • • . , •} . _{. , • ..} . _{, . • .. , • .. . .. , ..} . _{.. , .. .} • • • • • • • • • • • • • • • • • _• • • • • • • • _• • • • • • • • • • • • • • • • • • • • • • • • • • _• • • • • • • • _• • 1000 1100

1 38 Part 2 Long-Run Economic Performance

the right, from 11 to 12, changing the goods market equilibrium point from _E to G.

The real interest rate rises from 6°/o to 8°/o because the increased demand for invest­ ment funds causes the real interest rate to be bid up. Saving and investment also increase, from 1000 to 1100, with the higher saving reflecting the willingness of

savers to save more when the real interest rate rises.

In these last two chapters, we have presented supply-demand analyses of the labor and goods markets and developed tools needed to understand the behavior

of various macroeconomic variables, including employment, the real wage, output, saving, investment, and the real interest rate. These concepts and a few more developed in the study of asset markets in Chapter 7 form the basis for the eco­ nomic analysis presented in the rest of this book. In Chapter 5, we use the concepts

developed so far to examine the determinants of trade flows and international borrowing and lending. In Chapter 6, we use them to tackle the fundamental ques­ tion of why some countries' economies grow more quickly than others.

A P P L I C AT I O N

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