Aggregate Demand for Goods and Services
Goods and services model depicts aggregate demand of the gross domestic as comprised of the following:
We will write a custom Essay on National Output Determination. Goods and Services Model specifically for you
301 certified writers online
- Demands of the government (GD)
- Investment demand (ID)
- Consumption demand (CD)
- Current Account demand. (Exports-Imports)
Disposable income determines the country’s consumption demand for goods and services model.
To come up with linear consumption function elements such as autonomous consumption and the marginal propensity to consume are included (Suranovic 264). The relationship between disposable income and consumer demand is that when the former increase, the latter tend to increase and if otherwise, then consumption demand will decrease. Concerning the marginal propensity to consume, its increase will inflict an increase in the consumption demand. Where MCPc decrease, the consumption demand will tend to decrease.
In a goods and services model, assumptions are that the investment demand is exogenous. As such, it depends on neither gross net product nor the interest rates.
To simplify this model, there is an urge not to consider any effect caused by these two variables (Suranovic 265).
This is the demand by the government for the goods and services produced in an economy. It is considered as exogenous as it does not depend on the two variables i.e. GNP and the rate of interests.
Export and Import Demand
This is the demand for locally produced goods by other economies. Both domestic real currency and disposable income are fundamental determinants of a current account demand in the goods and services model.
The difference in prices depicted by the exchange rate occurs when there is a demand for locally made goods by others.
The correlation between this real exchange rate and current account demand is positive. Similarly, disposable income correlates positively with the current account demand (Suranovic 267).
The Aggregate Demand Function
Aggregate demand relates positively when a change is inflicted on governmental demands, real exchange rate, and investment demands.
The Keynesian Cross Diagram
A Keynesian cross diagram represents the equilibrium level of the income of an economy in the goods and services market model. In this diagram, the aggregate demand function is plotted against the GNP. Equilibrium exists at the point where AD equals GNP. For this to happen, three conditions must prevail. They include: Positive slope demonstrated by AD function, the gradient of AD must be less than one and finally, the range that AD function crosses the vertical axis must be positive.
Goods and Services Market Equilibrium Stories
Where the Gross Net Product is higher than the rate of equilibrium, there is an excess of supply. Consequently, inventories accumulate. It is from the surplus that firms in an economy cut production thus equating the Gross Net Product and the Aggregate demand. This leads to the achievement of equilibrium. This warrants a raise in production, and as a result, GNP keeps on rising until it becomes equal to the Aggregate demand (Suranovic 272).
Effect of an Increase in Government Demand on Real GNP
When the government demand increases increase in an economy, the result is that the real GNP will tend to increase. It is also true to mention that a decrease in governmental demand will lead to a fall in the real GNP.
Effect of an Increase in the U.S. Dollar Value on Real GNP
The U.S dollar relates with the real GDP in a way that an increase in the dollar value causes a decrease in the real Gross Net Products. Furthermore, if the value of the dollar decreases, it will unquestionably result in to increase in GNP.
Get your first paper with 15% OFF
The J-Curve Effect
J curve theory shows a short-run exception seen in the standard assumption, as applied in the Goods and Services model, and in which trade deficit is caused by the depreciation of the currency (Suranovic 275).
Still, from J representation, the current account first tends to fall for a certain period but reaches a point where it begins to rise. This happens due to the depreciation of the currency. As such, a trade that is in the deficit will tend to rise initially but fall later due to depreciation of the currency (Suranovic 277).
Suranovic, Steve. International Finance. New York, NY: Flat World Knowledge, L.L.C. 2010. Print.