Goods market equilibrium

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Goods market equilibrium [alternatively: output market equilibrium ] (equilibrium in the goods market) is a macroeconomic term. There is an equilibrium in the macroeconomic goods market when planned supply and planned demand or planned saving and planned investments coincide in a period.

Classification of the model

The goods market equilibrium is, in addition to the money market equilibrium and the labor market equilibrium , a macroeconomic market equilibrium on which supply and demand or savings and investments correspond ex post . The balance between the macroeconomic supply of goods and the macroeconomic demand for goods forms the focus of the real economic sector. The links between supply and demand are of particular importance. In macroeconomic theory, there are two rival approaches, the classical and the Keynesian approach. These are explained in more detail in the following sections.

Classic approach

The classical approach is based on Jean-Baptiste Say's theorem , according to which every supply creates its demand. The idea is based on experiences from the barter economy , which in the 18th and 19th centuries revived to a limited extent due to the great mass poverty on the one hand and the low production of goods at a time when industrialization was just beginning. In a total exchange economy, everyone exchanges his surplus production for other goods. As a result, there can be no overproduction as there is always sufficient demand for all products. According to the classics, employment determines production. This in turn creates the supply that forms the level of the national income . National income is the prerequisite for any demand.

However, this approach includes the following premises:

  • Debt and financial assets do not appear in the model; The premise that the planned saving of money always corresponds to the desired borrowing results in a circular conclusion about the balance.
  • Saving and investing must correspond to each other within a period, because a higher saving compared to the investments would mean a loss for consumption .
  • The economy as a whole is considered because the model only works across all goods groups and cannot be transferred to the microeconomic level of a company .
  • All prices on both the factor and the goods markets are adjusted, which guarantees the price mechanism .
  • It is a long-term view, as supply and demand can also diverge here in the short term .

Keynesian approach

The reason for the theory after John Maynard Keynes was the world economic crisis that began in 1929 . Companies had to close because they could no longer sell their products. This development contradicted Say's theorem and required a new explanation. Keynes recognized that real household saving is determined by net investment (I = S). If private households want to increase their savings, the savings paradox does not lead to higher savings, but to falling incomes. Conversely, attempts by households to reduce their savings do not lead to lower savings but to higher incomes. From the savings rate, the multiplier can be calculated which gives the corresponding income for the household savings made possible by the net investment, the national deficit and the balance of foreign trade. Higher investments or an additional government deficit or an export surplus (foreign debt) make it possible to increase household incomes in line with the savings rate.

However, this theory is also limited in its application by premises:

  • With higher incomes, more is saved. Therefore, income is limited by the savings that are possible macroeconomically and mechanically . The production function does not apply.
  • The saving paradox applies: households as a whole have no influence on the amount of their savings. A change in the propensity to save leads to a corresponding increase or decrease in income.
  • Falling demand leads to unemployment and recession .
  • Only the short term is considered.

The model of the goods market equilibrium

The basic assumption of this model is the following equilibrium condition:

Macroeconomic supply of goods = Macroeconomic demand for goods. In short: Y = Z

Please note the following assumption: Supply = Production = Income = Y.

Demand for goods

The demand for goods Z is described in the model under consideration by the following definition:

According to this definition, the demand for goods Z is the sum of the consumer demand C, the investment demand I, the state demand G and the export demand X minus the import demand IM.

Consumer demand as an endogenous variable essentially depends on disposable income and can therefore be understood as a function of it. is defined as the difference between Y, income, and T, taxes, less transfer payments received . C also depends on the marginal consumption rate . It is assumed that consumption increases with an increase in disposable income ( ). Furthermore, autonomous consumption must be taken into account, which reflects the level of consumption with an disposable income equal to zero. These statements can be divided into the following function summarized . Since the model is only to be explained in its basic features at this point, both I and G as well as T are regarded as exogenous factors . For the same reason, only the closed economy is considered here, which means that there are neither imports nor exports (IM = 0; X = 0).

Hence we get the equation for our consideration:

Supply of goods

Since the supply of goods is determined by the production of goods and consequently also represents the national income, the same variable, Y, can be used for all three terms. The model also assumes that companies cannot build up or reduce stocks , as otherwise goods production and demand will not necessarily match.

Model investigation based on the multiplier analysis

Fig. 1: The equilibrium in the goods market
Fig. 2: The multiplier effect

Algebraic Analysis

... exogenously given parameters

The equation describes the equilibrium production Y *, i.e. the level at which supply (= production) and demand correspond. are independent of the level of production and are defined as autonomous expenditures, since the macroeconomic demand function for goods shifts completely when these expenditures increase / decrease (cf. graphic analysis). The multiplier states how much the equilibrium income changes with an increase / decrease in autonomous expenditure. The higher the marginal consumption rate , the greater the multiplier and the greater the change in production.

Graphic analysis

Consideration of the graphic "The equilibrium in the goods market":

Since production (= supply) and income are always the same, the production function (= supply function) was plotted on the 45 ° line. Furthermore, the demand function was removed, whereby the autonomous expenditure and the slope of the demand function define.

Consideration of the graphic "The multiplier effect":

If overall economic demand increases, the ZZ function shifts upwards. The multiplier effect, which is shown in the right figure by the arrows, sets in. The increase in demand causes an increase in production, which in turn leads to an increase in income. This is spent according to the level of the marginal consumption rate. There is a renewed increase in demand, which triggers the process just described anew. The result is the shift in equilibrium production from point A to point A 'and the increase in income by a multiple of the increase in demand. The amount of this multiple is determined by the multiplier.

Consider an example

Consider the following example: An increase in consumer spending of one million euros is recorded. The marginal consumption rate is 60% ( ).

Since consumer demand has increased by one million euros, the consumer goods industry produces one million euros more. The consumer goods industry generates an additional income of one million euros. 60% of this additional income is spent again (marginal consumption rate). New consumer goods are produced for 600,000 euros, which generated an additional income of 600,000 euros. This in turn is spent at 60%. ... The further increase in demand leads to a further increase in production, which leads to a further increase in income. This infinite cycle is known as the multiplier process. The resulting infinite series converges to a final value that can be calculated using the multiplier:

As a result, the increase in consumer spending by one million euros has resulted in an income increase of 2.5 million euros.

Balance of investing and saving

This alternative approach deals with the balance between investing and saving. This is an equivalent to the above-mentioned approach of the balance between supply and demand. Here, too, the reader finds himself in a closed economy.

Mathematical proof

The savings volume S is defined as the difference between disposable income and consumption .

, there

Equilibrium condition on the goods market: Y = Z

If you subtract tax T left and right and then bring consumption C to the left side of the equation, the following formula results:

The left side of the formula then corresponds to the formula for S, since saving is defined as income Y minus taxes T and consumption C:

That means: The amount of investments is equal to the sum of private saving S and state saving (tax revenue T - government expenditure G). With a balanced national budget (T = G), the following applies: Investments are equal to private saving.

Economic justification

In a “Robinson Crusoe” economy, it is essential to forego consumption for any investment good. Savings arise from foregone consumption. Once these have reached a corresponding level, they can be invested in the desired good. The theory was named after Robinson Crusoe , who initially had to forego fishing in order to be able to create a net for it. The very time he saved fishing was invested in making the net. In a modern economy, companies decide about investments, the state usually about its deficit and households about their savings or consumption. On balance, investment, government deficit and private savings must always be zero.

With the appropriate choice of government spending G or taxes T, the government could achieve any desired level of production. Because the income of the economy increases with the possible savings and the savings result from the sum of investment and state deficit, the government can increase the income of the economy through deficit spending : S = I + (G - T)

Aiming at a certain level of production can, however, have undesirable side effects: the increase in the deficit increases the national debt, rising demand could increase inflation or flow into imports from abroad, the necessary changes to the law take time and consumer expectations play a role in tax cuts a major role.

The goods market equilibrium in the open economy

In the open economy, the goods market equilibrium is dependent on the development of the exchange rate , as this has a high influence on imports and exports and therefore on overall economic demand.

For example, if the foreign currency appreciates against the domestic currency, foreign goods become more expensive than domestic ones. Domestic demand increases and the aggregate demand function shifts upwards. Due to the multiplier process, equilibrium production increases. A fall in the domestic price level or an increase in the foreign price level at a constant exchange rate have the same effect.

In summary, it can be stated that a fall (rise) in the real exchange rate - regardless of the causes - with otherwise unchanged conditions, leads to a shift in the aggregate demand function upwards (downwards) and an expansion (a decrease) in production.

The equilibrium condition in an open economy is: supply = demand

W is the real exchange rate. If, for all components, the demand for domestic goods is combined with the supply, the result is a simple equation in which the supply is compared with a demand composed as follows:

Supply = consumption (income - taxes) + investment (depending on production and interest) + government expenditure - WImports (depending on income and W) + exports (depending on foreign income and W)

Importance of the goods market equilibrium

The goods market equilibrium is the reference point for the direction of the multiplier process. If there is excess demand (seller's market), there is an increase in production and thus an increase in supply; If there is a surplus of supply (buyer's markets), production is cut back and supply drops. After the process is complete, supply and demand will be in equilibrium.

See also

Individual evidence

  1. Cf. Mussel, Gerhard: Introduction to Macroeconomics, 6th, revised and updated edition, Verlag Franz Vahlen GmbH, Munich, 2000, page 47f.
  2. Cf. Mussel, Gerhard: Introduction to Macroeconomics, 6th, revised and updated edition, Verlag Franz Vahlen GmbH, Munich, 2000, page 63
  3. Cf. Mussel, Gerhard: Introduction to Macroeconomics, 6th, revised and updated edition, Verlag Franz Vahlen GmbH, Munich, 2000, page 64
  4. Cf. Blanchard, Olivier; Illing, Gerhard: Macroeconomics, 5th, updated edition, Pearson Education Deutschland GmbH, Munich, 2009, page 93
  5. Cf. Blanchard, Olivier; Illing, Gerhard: Macroeconomics, 3rd, updated edition, Pearson Education Deutschland GmbH, Munich, 2003, page 89
  6. Cf. Blanchard, Olivier; Illing, Gerhard: Macroeconomics, 3rd, updated edition, Pearson Education Deutschland GmbH, Munich, 2003, page 90
  7. Cf. Blanchard, Olivier; Illing, Gerhard: Macroeconomics, 5th, updated edition, Pearson Education Deutschland GmbH, Munich, 2009, page 103
  8. Cf. Blanchard, Olivier; Illing, Gerhard: Macroeconomics, 5th, updated edition, Pearson Education Deutschland GmbH, Munich, 2009, page 105
  9. a b See Krugman, Paul R .; Obstfeld, Maurice: International Economy, Theory and Politics of Foreign Trade, 7th, updated edition, Pearson Education Deutschland GmbH, Munich, 2006, page 533
  10. Source: Blanchard, O. and Illing, G .: Macroeconomics. 3rd, updated edition. Pearson studies, Munich, 2003


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