Lecture 2: Understanding the Demand-Side in the Long Run PDF

Closed (Global) Economy **[What determines the demand for goods and services?:]** Decisions are forward-looking, with accounts being taken of the future as well as the present. - Consumers think about what sort of income they're going to earn in the future and what their consumption plans m...

Closed (Global) Economy **[What determines the demand for goods and services?:]** Decisions are forward-looking, with accounts being taken of the future as well as the present. - Consumers think about what sort of income they're going to earn in the future and what their consumption plans might be. - **Assumption:** as an aggregate, households have +ve savings. The basic *Life Cycle Model* assumes that individuals try and smooth their consumption over time (e.g. save when working to fund retirement) to maximise the present value of lifetime utility. - Firms' capital investment is based upon the value-maximising model where firms determine capital investment to maximise the present value of current and future expected profits. - The value of a firm shouldn't just represent its current but also its future profitability. - Governments make decisions on policy variables (taxes and expenditure) and we take them as EXOGENOUS. - Assume it is independent of anything going on in the economy. **[Consumption:]** Consumption is the major component of aggregate demand at around 50-60% of total demand for most advanced economies. C = b(Y-T), where C is consumption, b is the *marginal propensity to consume* (0\