 The structure of the class, what we are going to be looking for, to be able to understand how economies work at the aggregate level. We understand that as a way of understanding what changes happen in the economy over time. In the short run, we typically are going to focus on demand. It's the demand side that determines the way the economy behaves in the short run, whereas in the long run, we have to bring in supply side factors, production, technology, institutions. So in this segment, we're going to focus on the demand side, and this is the beginning of trying to determine the conditions for equilibrium in the entire economy. The best way to think about equilibrium in the entire economy is by, first of all, looking at equilibrium in different markets. We have the good market, the good market, the money market, or financial market, and then the labor market. In the short run, we're going to focus on the good market, the good market, and the financial market. In terms of the financial markets, we know that there are different financial instruments. There is money, there is non-monetary, financial assets, bonds, and so on. We will see how we can actually determine equilibrium in the financial market by only looking at the money market. But for now, let's look at the goods market. Here what we are interested in is to look at how output, which is goods and services produced, serves to meet the needs of the economic agents. These are households, firms, and the government. So for households, the needs are mainly consumption needs. For firms, it's investment needs. For the government, it's financing public expenditures. So the demand side is going to be composed of consumption by households, investment by firms, and expenditures by the government. This is within the context of a closed economy, when we are not looking at trade. When we open to look at trade, then we look at exports by the U.S., and imports by the U.S. from other countries. So to summarize, demand at the national level, or what we call aggregate demand, is composed of consumption, investment, government expenditures, and then opening up to the rest of the world. We have the net exports, which is the difference between exports by the U.S. and imports by the U.S. or any other economy. So aggregate demand, which we are going to note as Z, is equal to consumption plus investment plus government expenditures plus net exports. And the net exports is the difference between exports and imports. So this is domestic, this is external. When we look at the data, we find that these elements have different magnitudes, but by and large in most economies, consumption constitutes the largest component. It's the largest component of aggregate demand. Investment is also important, but investment is especially important in terms of determining movements of aggregate demand in the short run. It tends to be the most volatile component of aggregate demand. Therefore, we need to pay attention to movements in investment as a way of understanding where the economy is heading. That's where you hear when economic news comes, one of the things that people look at is changes in the housing market in terms of new constructions. If there's an increase in new constructions, that means that investment is increasing, the economic sentiments are improving, that is likely to lead to higher growth. Also we pay attention to consumption, because an increase in consumption means that households are feeling good about the economy. They are seeing their incomes rising or expect their incomes to rise. Therefore they can afford to increase consumption. So the movements in the private expenditures is going to be important in understanding where the economy is heading. The way we understand consumption is that it's a result of a number of key factors. One is income. Obviously, the more income you have, the more you can afford to consume. But what you consume is your net income after having paid for taxes. So consumption is typically viewed as a function of income. So there is a part of consumption which is not dependent on income. Even people who don't have income are consuming, either from savings that they have accumulated in the past, or other non-income sources. But then the part that depends on income is this one, where we're saying that consumption is a function of net income, income minus taxes. And this coefficient, C1, is going to be very important in our analysis. We call it the marginal propensity to consume. So by how much does your consumption increase when you get an increase in income? And we believe that we typically see that this depends on the levels of income. People who are at the minimum consumption level are going to consume the bulk of the increase in income, whereas people in the higher income category consume only a smaller fraction of the increase in income. So when we want to understand now what is the equilibrium in the goods market, equilibrium in the goods market is going to be determined by where income is equal to demand, or output is equal to demand. This will be our condition for equilibrium in the goods market. So output is used for consumption, investment, government expenditures, and some exported to the rest of the world. Now that means that we can actually determine the conditions for equilibrium in the goods markets. So for equilibrium in the goods market, we can say that equilibrium is achieved when output is equal to demand. Now we know that demand is the sum of consumption, investment, government expenditures, and export minus import. But we also know that consumption is determined by disposable income, net income, plus then we add investment, government expenditures, export minus imports. So this is our condition for equilibrium in the goods market. We can then rewrite this to only have income on the left-hand side, so to see what are the components of the aggregate demand that determines actually equilibrium in the goods market. When we rewrite this, we can have it in the following form. Now we're going to live out for the moment. For the moment, we're going to look only at domestic demand, live out exports and imports. So our equation is going to be simplified. This has been left out. What does this equation say? It says that equilibrium, as we saw before, is when output is equal to aggregate demand. But we can see that there are key parameters that are going to determine equilibrium in the economy. One is dependent on the marginal propensity to consume, which is C1. But you can also see here some interesting components. This is autonomous consumption, investment, government expenditures, and taxes. Let's focus on these two, government expenditures and taxes. These are the key elements of fiscal policy that the government can use to influence the economy. What this equation says is that when the government increases government expenditures, since this is additive, there's a positive sign here, that means that income output is going to increase. You can increase government expenditures to stimulate output. And that's what, generally, many times governments do, to stimulate the economy, they increase government expenditures. In contrast, you can see that if you increase taxes, when government increases taxes because of this negative sign here, we will see that income declines. But the question is by how much? By using this equation, we can see that if government increases government expenditures, the increase in income that results from that change is equal to the change in government expenditures divided by 1 minus C1. Now because 1 minus C1 is what we called marginal propensity to consume, which is the fraction of income that you consume, if you get an increase in the income, we know that if you get an increase of $100, the maximum you can spend additionally is 100. So the marginal propensity to consume must be less than 1. So that's very important. Now since marginal propensity to consume is less than 1, that means that 1 over 1 minus C1 is greater than 1, which means that if government expenditures increase by $1, output is going to increase by more than $1. I repeat, if the government were to increase expenditures by $1, output in the economy would increase by more than $1. You ask me why? One of the reasons, the key reason is that when government increases expenditures, it's either building roads, building schools, that means that it's giving an opportunity for people to earn income. That earned income is going to be spent and the spending is going to give opportunities for firms to produce more goods and services and so on and so on. So the initial $1 is going to produce more income. That's what we call the income multiplier. So the government has an opportunity to stimulate the economy by increasing government expenditures. If the government increases taxes, we have a result which is in the opposite direction. So an increase in government in taxes is going to reduce income. So if taxes increase, income is going to go down and we see that the changing income is going to be equal to the changing taxes divided by 1 minus 1. Sorry, there's a C1 minus C1 divided by 1 over minus C1. From this equation, you can see that the change in income is negative. You increase taxes, you reduce income, but it's less than the change in government income that was due to the change in government expenditures. So the increase in income from increasing government expenditures is in absolute value larger than the decline in income due to the change in taxes by $1. Which means that the government has a larger impact on the economy through expenditures than the negative impact on the economy through an increase in taxes. So these are two important elements of fiscal policy that the government uses on a regular basis to stimulate the government expenditures, the government who increases its expenditures, to slow down the government who will reduce, will increase taxation. For example, if they believe that government, the economy is growing too fast. So we can see here that we have a way of quantifying the impact of fiscal policy on the economy. So to summarize, the equilibrium in the goods market is determined by output equal to aggregate demand, which is comprised of consumption by households, investment by firms, expenditures by the government in the closed economy. We open the economy, we have to add exports minus imports. We saw that once we get the equilibrium in the goods market, we actually have a way of examining the impact of government expenditures and taxes on the economy using the multiplier, which depends significantly on the marginal propensity to consume. Okay, so we have...