The goods market
Mainstream macroeconomic models make simplifying assumptions to look at the behaviour of the participants in a number of markets, at first imagined and understood discretely. These are the goods market (in fact, the market for goods and services) and the factors market, the money market (representing the workings of the domestic financial sector), the foreign-exchange market, and the labour market. How they work in combination is then investigated systematically. One of the main purposes of this is to try to assess the likely impact of policies in addressing specific economic problems, such as unemployment, or inflation, or destabilising shocks to economic growth.
An important concept in mainstream economic modelling is that of aggregate demand (AD), which is a summation of the spending plans faced by firms, and is itself the outcome of the myriad spending decisions of different groups of "economic actors". When firms are willing to supply all the goods and services that households (C), other domestic companies (I), government institutions (G) and foreigners (X) want to buy, the goods market is said to be in balance. In short-run, demand-side models, this is assumed always to be the case—ie firms will always have spare capacity to raise production, or the freedom to cut it back, when faced with changes in aggregate demand.
However, market balance need not correspond to a level of sales that ensures that everyone who wants to work is employed. In fact, finding a way to close the gap between the two (the so-called deflationary gap) was the motivation for the generation of Keynes's economics as a whole, since mass unemployment was the specific problem that he set out to address in the 1930s. He thought that firms' production plans depended in large part on the demand they expect for their products, itself conditioned by their recent sales experience. In order to influence company behaviour, therefore—and so the level of aggregate supply and employment—it is necessary to understand both how aggregate demand is composed and what the knock-on effects of changes in the components of aggregate demand might be. These components, of consumer demand (goods and services wanted by households), investment demand (goods and services desired by domestic companies), government spending and net exports (foreign demand for domestic goods less domestic demand for foreign ones) are conventionally given the letters of C, I, G and (X – Z).
Mainstream macroeconomic models make simplifying assumptions to look at the behaviour of the participants in a number of markets, at first imagined and understood discretely. These are the goods market (in fact, the market for goods and services) and the factors market, the money market (representing the workings of the domestic financial sector), the foreign-exchange market, and the labour market. How they work in combination is then investigated systematically. One of the main purposes of this is to try to assess the likely impact of policies in addressing specific economic problems, such as unemployment, or inflation, or destabilising shocks to economic growth.
An important concept in mainstream economic modelling is that of aggregate demand (AD), which is a summation of the spending plans faced by firms, and is itself the outcome of the myriad spending decisions of different groups of "economic actors". When firms are willing to supply all the goods and services that households (C), other domestic companies (I), government institutions (G) and foreigners (X) want to buy, the goods market is said to be in balance. In short-run, demand-side models, this is assumed always to be the case—ie firms will always have spare capacity to raise production, or the freedom to cut it back, when faced with changes in aggregate demand.
However, market balance need not correspond to a level of sales that ensures that everyone who wants to work is employed. In fact, finding a way to close the gap between the two (the so-called deflationary gap) was the motivation for the generation of Keynes's economics as a whole, since mass unemployment was the specific problem that he set out to address in the 1930s. He thought that firms' production plans depended in large part on the demand they expect for their products, itself conditioned by their recent sales experience. In order to influence company behaviour, therefore—and so the level of aggregate supply and employment—it is necessary to understand both how aggregate demand is composed and what the knock-on effects of changes in the components of aggregate demand might be. These components, of consumer demand (goods and services wanted by households), investment demand (goods and services desired by domestic companies), government spending and net exports (foreign demand for domestic goods less domestic demand for foreign ones) are conventionally given the letters of C, I, G and (X – Z).
AD = C + I + G + X – Z
For the two most important components—consumer demand (C) and investment demand (I)—I'm going to start at the end result, missing out the stage of building them up from their simpler to their more complicated versions.
Consumer demand, often the largest demand component of any economy, is the only one that is held to be conditioned by changes in the income of the economy overall, whereas the factors affecting the other three lie outside the model of income determination. Not all of the income received by households (in the form of wages for labour, interest for capital and rent for land) is available for spending, since some portion of it will usually be saved. This portion tends to decline with rising individual household incomes. For economies as a whole, the share of an increase in income that goes on consumption spending (the marginal propensity to consume) is historically and culturally conditioned, slow to change, and can vary between groups, generations and regions. Since the share of income that households have available to spend—their disposable income—has the most bearing on buying decisions, this is what interests economists most. It is affected by the level of net taxes (taxes minus benefits), which is the link through which governments can influence the level of private consumption demand.
However, some part of consumer spending is taken to be independent of changes in income. This component, sometimes called autonomous consumption, takes account of the impact to changes in consumer preferences or taste, for example. Importantly, it is also taken as a proxy for consumer expectations and confidence, which can be lifted or depressed by perceptions of the economic outlook, or by more specific factors, such as the prospect of a tax increase or of rising unemployment.
One final factor that can help to explain changes in observed patterns of private consumption demand is changes in the value of household property or financial holdings—ie their wealth. The proportionate change in consumer spending linked to a change in wealth—the so called wealth effect—is usually much smaller than for the corresponding relation to income, perhaps because changes in wealth can vary. This is something to look at when property booms or busts are prominent features of the economic scene, or when economically significant numbers of households own stocks or shares.
C = a + bY +dW
No comments:
Post a Comment