Basic Macroeconomics - Part 2: Goods Market Equilibrium

You may not realize it, but every day you are participating in the Financial Market and Goods Market. So what are these markets and how do they affect the economy? We will explore these two main markets in parts 2 and 3 of Viet Hustler's Basic Macroeconomics series.

Viet Hustler officially launches channel Youtube Viet Hustler, with content posted being important market articles and news snippets, which were previously conveyed through articles, now adapted into videos.

First video: China - Serious consequences of credit downgrade

What is the Goods Market (The Goods Market)?

All activities of individuals or businesses from income, consumption purchases, tax payments, savings and investment… constitute the Goods Market.

In general, the Goods Market is where demand for goods is met, and supply of goods is produced according to demand. From there, businesses and people have income to spend to meet the above demands.

Main components in the Goods Market

The main components of the Goods Market (which are also the components that make up GDP) include:

• Consumption (C - Consumption): includes expenditures for personal consumption by households on goods and services.

• Investment (I - Investment): total domestic investment by the private sector; includes business expenditures on equipment, factories or construction, households' purchase of new houses.

• Government Spending (G - Government Purchases): includes government expenditures such as on defense, law, education, health,...

• Net Exports (X - IM: Export - Import): difference between Export value (X) and Import value (IM).

Aggregate Demand formula for open economy0

• Assume the economy is a closed economy, self-sufficient and does not import or export goods and services from abroad.

  Then the Aggregate Demand formula for closed economy will eliminate the import-export factor:

Equilibrium in the Goods Market

1. Consumption (Consumption)

Consumption (C) is the process by which households or businesses use goods for different purposes in life.

The consumption factor of the entire economy depends on the Income of the components in that economy (households, businesses, government).

Disposable Income (Disposable Income - Y_D) is the income actually received after deducting Tax (Tax): Y_D = Y - T

• Relationship between Consumption (C) and Disposable Income (Y_DWhen income increases, spending will also increase.Consumption and Saving are two components in the disposable income of economic agents. Therefore, economists will be interested if Disposable Income (Y_DWhen income increases, spending will also increase. increases, how much more will economic agents Consume (C).

Consumption function formula:

Where:

• 1_{=> Consequently, businesses adjust equilibrium output (Y) to increase: A => A’ (and nominal income also higher)} : minimum expenditure (even when disposable income =0, people still have to consume at least c_{=> Consequently, businesses adjust equilibrium output (Y) to increase: A => A’ (and nominal income also higher)}).

• 1_{Z = Y}: is the “marginal propensity to consume” (MPC - Marginal Propensity to Consume),

  • indicating when disposable income (Y_D) We can simply understand:

Even when income of households/businesses = 0, they still need to spend a certain amount to buy necessities, food, pay rent,… (

• c1_{=> Consequently, businesses adjust equilibrium output (Y) to increase: A => A’ (and nominal income also higher)}When income increases, spending will also increase.

• However, people will not spend all the money earned. They will divide Income into 2 parts: Consumption and Savings.

• Therefore

  • c 1_{Z = Y} 2. Investment (I), Government Spending (G) and Taxes (T)

To simplify the model, assume all 3 factors

Investment, Government Spending and Autonomous spending (Autonomous spending) are all exogenous factors: Investment (I) depends on variables not in the model.

• However, in most models, investment is always an endogenous factor:

  • Investment also depends on income Y of people/businesses and interest rate (i - interest rate).

    • In most simple models:

    • Investment (I) = Savings (S) (to be mentioned below) Government Spending (G) and Taxes (T) are also determined by the Government and depend heavily on the country's fiscal policy depending on the period.

• 3. Determining equilibrium output

Equilibrium in the Goods Market for the closed economy (excluding imports and exports) occurs when

Equilibrium in the commodity market for a closed economy (not accounting for imports and exports) occurs when Goods supply (Y) = Goods demand (Z)":","Y = Z = c0

+ c_{=> Consequently, businesses adjust equilibrium output (Y) to increase: A => A’ (and nominal income also higher)} * (Y - T) + I + G_{Z = Y} Effect of increasing Autonomous spending on Output:It can be seen that the above formula consists of 2 main parts: Multiplier (Multiplier - pink)

and Autonomous spending (Autonomous spending - blue): Autonomous spending (Autonomous spending) does not depend on income because the variables c

• 0 , I, G, T are all exogenous variables._{=> Consequently, businesses adjust equilibrium output (Y) to increase: A => A’ (and nominal income also higher)}0

  • , I, G are all positive so unless tax T is very high, Autonomous spending will be positive._{=> Consequently, businesses adjust equilibrium output (Y) to increase: A => A’ (and nominal income also higher)}will be greater than 1 (because c

1 always lies in the range from 0 to 1). When c_{Z = Y} is larger_{Z = Y} then Output (Y) will be larger. However, if considering the equilibrium between Demand (Z) and Income (Y): equilibrium output (demand) is given in the graph below: Z = c

0

• + c_{=> Consequently, businesses adjust equilibrium output (Y) to increase: A => A’ (and nominal income also higher)} * (Y - T) + I + G_{Z = Y} Effect of increasing Autonomous spending on Output:

• Any increase in any component of Autonomous spending (c

0

, I, G) or a decrease in tax (T) will cause Demand (Z) to increase even higher._{=> Consequently, businesses adjust equilibrium output (Y) to increase: A => A’ (and nominal income also higher)}Output increases → Income increases → Demand increases → Output increases → …

IS Relation - Relationship between Saving and Investment

Private saving (Private saving - S

private

) is the disposable income of households/businesses after deducting all consumption expenditures.^privateprivate

Government saving (Public saving - S^public) is the surplus in government spending that remains unused, usually calculated as the difference between Budget Revenue (Taxes - T) and Government Spending (G).

• If T > G (Revenue more than Spending), the government is running a budget surplus.

• If T < G (Spending more than Revenue), the government is running a budget deficit.

Total saving = Income - total spending (of government and private sector)

To simplify the model, we will assume a closed economy, meaning no import-export factors:

→ In a closed economy, equilibrium in the Goods Market requires Investment (I) must equal total Saving (S).

Conclusion

In part 2, we have learned that the Goods Market is not merely a place for transactions but also plays a pivotal role in balancing production, income, and spending in the economy.

Next week, we will continue to learn about the Money Market, where money and financial instruments play an important role in determining the value and flow of financial assets; factors influencing from monetary policy to global economic factors.