Fiscal policy
-Changes in the expenditures or tax revenues of the federal government.
-2 tools of fiscal policy:
1) Taxes - government can increase / decrease taxes.
2) Spending
Deficits, Surplus, and Debt
Balance budget
-Revenue = Expenditure
Budged deficit
-Revenue < Expenditures
Budget surplus
-Revenue > Expenditures
Government Debt
-Sum of all deficits - Sum of all surplus
Government must borrows $ when it runs a budget deficit.
Borrows from...
- Individuals
- Corporations
- Financial Institutions
- Foreign Entities
Discretionary fiscal policy. (action)
- Expansionary fiscal policy: Think deficit.
- Contractionary fiscal policy: Think surplus
Non-Discretionary fiscal policy. (no action)
Discretionary Vs. Automatic fiscal policy
- Increasing or decreasing government spending and or taxes in order to return the economy to full employment. Discretionary policy involves policy makers doing fiscal politics in response to an economic problem.
- Unemployment compensation and marginal tax rates are EX. of automatic policies that help mitigate the effects of recession and inflation. Automatic fiscal policy takes place without policy makers having to respond to current economic problems.
Contractionary Vs. Expansionary fiscal policy
Contractionary
- Policy designed to decrease aggregate demand
+ Strategy for controlling inflation.
Expansionary fiscal policy
- Policy designed to increase aggregate demand
+ Strategy for increasing GDP combating the recession and reducing unemployment.
* Increase government spending G goes up
* Decrease Taxes T goes down
Contractionary fiscal policy
-Inflation is countered with contractionary policy
Decrease government spending. G goes down
Automatic built in stabilizer
-Anything that increases the government budget deficit during a recession and increases its budget surplus during an inflation without requiring explicit action by policy makers.
EX. Transfer payment, welfare, food-stamps, unemployment checks, corporate dividends, social security, and veterans ben.
Progressive tax system
-Average tax rate (Tax rev / GDP) rises with GDP.
Proportional tax system
-Average tax rate remains constant as GDP change
Regressive tax system
-Average tax rate falls with GDP
Sunday, March 1, 2015
Unit 3 (2/20/15) consumption and savings
Disposable income (DI)
-Income after taxes or net income.
-DI = gross income multiplied by taxes.
2 choices...
1. Consume (spend $ on goods and services)
2. Save (not spend money on goods and services)
Consumption
Household spending: the ability to consume is constrained by...
-The amount of disposable income.
-The propensity to save.
Do households consume if DI = 0?
-Autonomous consumption
-Dis-saving
APC = C / DI = % DI is spent
Saving
Household not spending.
The ability to save is considered by...
-The amount of disposable income.
-The propensity to consume.
Do households save if DI = 0?
-No.
APS = S / DI = % DI is not spent
APC and APS
* APC + APS = 1
* 1 - APC = APS
* 1 - APS = APC
* APC > 1.: Dis-saving
* -APS.: Dis-saving
Marginal propensity to consume.
* ΔC / ΔDI
* % of every dollar earned that is spent
Marginal propensity to save.
* ΔS / ΔDI
* % of every extra dollar earned that is saved.
The spending Multiplier effect.
An initial change in spending ( C, Ig, G, and Xn) causes a larger change in aggregate spending, or aggregate demand (AD)
* Multiplier = Change in AD / Change in spending
* Multiplier = Change in AD / Δ C, Ig, G, or Xn
Why does this happen?
-Expenditures and income flow continuously, which sets off a spending increase in the economy.
-The spending multiplier can be calculated from the MPC or the MPS
* Mulitplier = 1 / 1 - MPC or 1 / MPS
Multipliers are positive when there is an increase in spending and negative if there is a decrease in spending.
Calculating the tax multiplier
When government taxes, the multiplier works in reverse.
Why?
- Because now money is leaving the circular flow.
* Tax Multiplier (negative) = -MPC / 1 - MPC or -MPC / MPS.
If there is a tax cut, then the multiplier is positive, because there is more money in the circular flow now.
-Income after taxes or net income.
-DI = gross income multiplied by taxes.
2 choices...
1. Consume (spend $ on goods and services)
2. Save (not spend money on goods and services)
Consumption
Household spending: the ability to consume is constrained by...
-The amount of disposable income.
-The propensity to save.
Do households consume if DI = 0?
-Autonomous consumption
-Dis-saving
APC = C / DI = % DI is spent
Saving
Household not spending.
The ability to save is considered by...
-The amount of disposable income.
-The propensity to consume.
Do households save if DI = 0?
-No.
APS = S / DI = % DI is not spent
APC and APS
* APC + APS = 1
* 1 - APC = APS
* 1 - APS = APC
* APC > 1.: Dis-saving
* -APS.: Dis-saving
Marginal propensity to consume.
* ΔC / ΔDI
* % of every dollar earned that is spent
Marginal propensity to save.
* ΔS / ΔDI
* % of every extra dollar earned that is saved.
The spending Multiplier effect.
An initial change in spending ( C, Ig, G, and Xn) causes a larger change in aggregate spending, or aggregate demand (AD)
* Multiplier = Change in AD / Change in spending
* Multiplier = Change in AD / Δ C, Ig, G, or Xn
Why does this happen?
-Expenditures and income flow continuously, which sets off a spending increase in the economy.
-The spending multiplier can be calculated from the MPC or the MPS
* Mulitplier = 1 / 1 - MPC or 1 / MPS
Multipliers are positive when there is an increase in spending and negative if there is a decrease in spending.
Calculating the tax multiplier
When government taxes, the multiplier works in reverse.
Why?
- Because now money is leaving the circular flow.
* Tax Multiplier (negative) = -MPC / 1 - MPC or -MPC / MPS.
If there is a tax cut, then the multiplier is positive, because there is more money in the circular flow now.
Unit 3 (2/19/15) The three schools of economics
The three school of economics
1. Classical
2. Keynesian
3. Monetary
1. Classical
-Adam Smith: Invisible hand, market will function by itself
-John B. Say: Say's law, supply creates its own demand
-David Ricardo
Alfred Marshall
-The economy is always close to or is at full employment.
-Trickle down effect: Help the rich first everyone else later.
-AS = AD at full employment equilibrium.
-In the long run the economy will balance at full employment.
-AS determines output
-Savings (Leakage) = investment (injection)
-Savings increase with interest rates
-Prices and wages are flexible downwards.
-Laisseze Faire.
2. Keynesian
-Economy is not always close to or at full employment.
-There is government intervention.
-Fiscal policy.
-John Maynard keynes: competition is flawed, AD is AD is keyed and not AS. (AD determines its own output and demand creates its own supply.)
-Leaks cost constant recessions.
-Savings cos recession.
-Savors and investors save and invest for different reasons.
-Savings are inverse to the interest rate.
-Ratchet effect and sticky wages block say's law.
-Prices and wages are inflexible downward.
-Since there isn't a mechanism capable to determine full employment, in the long run we are all dead.
-Do add stabilizer
-Use expansionary and contractionary policy.
3. Monetary
-Allen Greenspan
-Ben Bernanke
-Fine tuning is needed
-Voters wont allow contractionaryn options.
-Congress cant time policy action
-Institute tight money/easy money
-We change required reserved of needed .
-We buy and sell bonds through open market operations.
-We use interest rates to change the discount rates and the federal fund rate.
1. Classical
2. Keynesian
3. Monetary
1. Classical
-Adam Smith: Invisible hand, market will function by itself
-John B. Say: Say's law, supply creates its own demand
-David Ricardo
Alfred Marshall
-The economy is always close to or is at full employment.
-Trickle down effect: Help the rich first everyone else later.
-AS = AD at full employment equilibrium.
-In the long run the economy will balance at full employment.
-AS determines output
-Savings (Leakage) = investment (injection)
-Savings increase with interest rates
-Prices and wages are flexible downwards.
-Laisseze Faire.
2. Keynesian
-Economy is not always close to or at full employment.
-There is government intervention.
-Fiscal policy.
-John Maynard keynes: competition is flawed, AD is AD is keyed and not AS. (AD determines its own output and demand creates its own supply.)
-Leaks cost constant recessions.
-Savings cos recession.
-Savors and investors save and invest for different reasons.
-Savings are inverse to the interest rate.
-Ratchet effect and sticky wages block say's law.
-Prices and wages are inflexible downward.
-Since there isn't a mechanism capable to determine full employment, in the long run we are all dead.
-Do add stabilizer
-Use expansionary and contractionary policy.
3. Monetary
-Allen Greenspan
-Ben Bernanke
-Fine tuning is needed
-Voters wont allow contractionaryn options.
-Congress cant time policy action
-Institute tight money/easy money
-We change required reserved of needed .
-We buy and sell bonds through open market operations.
-We use interest rates to change the discount rates and the federal fund rate.
Unit 3 (2/18/15)
Investment demand curve (ID)
Shape?
-Downward sloping
Why?
-When interest rates are high, fewer investments are profitable; when interest rates are low more investments are profitable.
changes in r% causes changes in Ig. Factors other than r% may shift entire ID curve.
-Cost of production
*Lower cost shifts ID to the right. (Vice Versa)
-Business taxes
*Lower Shits ID to the right. (Vice Versa)
-Technology change
*New technology shifts ID to the right,
*Lack of technology change shifts ID to the left.
-Stock of capital
*If economy is low on capital ID shifts to the right.
*If economy has much capital ID shifts to the left.
-Expectations
*Positive expectations ID shifts to the right. (Vice Versa)
Long run AS
-It is always vertical at full employment
-It represents a point on the economies production possibility curve
-Does not change as the price level changes, only thing that changes long run AS is the same things that change PPC outwards.
*Resources
*Technology
*Economic Growth.
Unit 3 (2/17/15)
Full employment
Full employment equilibrium exist where AD intersects SRAS and LRAS at the same point .
Recessionary gap
Exist when equilibrium occurs below full employment output.
Inflationary gap
Exist when equilibrium occurs beyond full employment output.
Invest rates and investment demand
Investment: money spent or expenditures on:
-New plants (factories)
-Capital equipment (machinery)
-Technology (hardware and software)
-New homes
-Inventories (goods sold by producers)
Expected rates of return
How do businesses make investment returns
-Cost/Benefit analysis
-How does business determines the benefits
-Expected rate of returns
How does business count the cost?
-Interest cost
How does business determine the amount of investment thy undertake?
-Compare expected rate of return to interest cost
*If expected return > interest: Invest (Vice Versa)
Real (R%) Vs. Nominal (I%)
Whats the difference?
-Nominal is the observable rate of interest. Real subtracts out inflation (π%) and is only known ex post facto.
How do you compete the real interest rate (R%)
-R% = I% - π%
What the determines the cost of an investment decision?
-The real interest rate (R%)
Full employment equilibrium exist where AD intersects SRAS and LRAS at the same point .
Recessionary gap
Exist when equilibrium occurs below full employment output.
Inflationary gap
Exist when equilibrium occurs beyond full employment output.
Invest rates and investment demand
Investment: money spent or expenditures on:
-New plants (factories)
-Capital equipment (machinery)
-Technology (hardware and software)
-New homes
-Inventories (goods sold by producers)
Expected rates of return
How do businesses make investment returns
-Cost/Benefit analysis
-How does business determines the benefits
-Expected rate of returns
How does business count the cost?
-Interest cost
How does business determine the amount of investment thy undertake?
-Compare expected rate of return to interest cost
*If expected return > interest: Invest (Vice Versa)
Real (R%) Vs. Nominal (I%)
Whats the difference?
-Nominal is the observable rate of interest. Real subtracts out inflation (π%) and is only known ex post facto.
How do you compete the real interest rate (R%)
-R% = I% - π%
What the determines the cost of an investment decision?
-The real interest rate (R%)
Unit 3 (2/12/15)
2/12/15
Aggregate supply - The level of real GDP that firms will produce at each level. (PL)
Long run Vs. Short run.
Long:
- Period of time where input prices are completely flexible and adjust to change in price level.
- Level of GDP is supplied and is independent of the price level.
Short:
- Period of time where input prices are sticky and do not adjusts to changes in the price level.
- The level of real GDP supplied is directly related to the price level.
Long run aggregate supply (LRAS)
- Marks the level of full employment in the economy (analogous to PPC)
- Because input prices are completely flexible in the long run changes in price level do not change firms real profits and therefore do not change firms level of output. This means that LRAS
vertice at the economy's level level of full employment.
Short run aggregate supply (SRAS)
- Because input prices are sticky in the short run, the SRAS is upward sloping.
Changes in SRAS
- Increase in SRAS is seen as a shift to the right. -->
- Decrease in SRAS is seen as a shift to the left. <--
-Key to understanding shifts in SRAS is per unit cost of production.
Per unit production cost:
Total input cost / total output
Determinants of SRAS
(all affect unit production cost)
- Input prices
- Productivity
- Legal institutional environment
*Input Prices:
Domestic resource prices
-Wages
-Cost of capital
-Raw material (commodity prices)
Foreign resource prices
-Strong $: Lower foreign resource prices
-Weak $: Higher foreign resource prices
-Market power Monopolies and cartels that control resources control the price of those resources
Increase in resource prices SRAS shifts to the left. <--
(Vice Versa)
*Productivity
Total output / total inputs
More productivity = Lower unit production cost = SRAS shifts to the right -->
(Vice Versa)
*Legal institutional environment
- Taxes ans subsidies
Taxes: ($ to gov't) on business' increase per unit production cost. SRAS shifts to the left <--
Subsides: ($ from gov't) to business reduce per unit production cost SRAS shifts to the right. <--
Government regulation creates a cost of compliance SRAS shifts to the left. <--
Deregulation reduce compliance cost SRAS shifts to the right. -->
Aggregate supply - The level of real GDP that firms will produce at each level. (PL)
Long run Vs. Short run.
Long:
- Period of time where input prices are completely flexible and adjust to change in price level.
- Level of GDP is supplied and is independent of the price level.
Short:
- Period of time where input prices are sticky and do not adjusts to changes in the price level.
- The level of real GDP supplied is directly related to the price level.
Long run aggregate supply (LRAS)
- Marks the level of full employment in the economy (analogous to PPC)
- Because input prices are completely flexible in the long run changes in price level do not change firms real profits and therefore do not change firms level of output. This means that LRAS
vertice at the economy's level level of full employment.
Short run aggregate supply (SRAS)
- Because input prices are sticky in the short run, the SRAS is upward sloping.
Changes in SRAS
- Increase in SRAS is seen as a shift to the right. -->
- Decrease in SRAS is seen as a shift to the left. <--
-Key to understanding shifts in SRAS is per unit cost of production.
Per unit production cost:
Total input cost / total output
Determinants of SRAS
(all affect unit production cost)
- Input prices
- Productivity
- Legal institutional environment
*Input Prices:
Domestic resource prices
-Wages
-Cost of capital
-Raw material (commodity prices)
Foreign resource prices
-Strong $: Lower foreign resource prices
-Weak $: Higher foreign resource prices
-Market power Monopolies and cartels that control resources control the price of those resources
Increase in resource prices SRAS shifts to the left. <--
(Vice Versa)
*Productivity
Total output / total inputs
More productivity = Lower unit production cost = SRAS shifts to the right -->
(Vice Versa)
*Legal institutional environment
- Taxes ans subsidies
Taxes: ($ to gov't) on business' increase per unit production cost. SRAS shifts to the left <--
Subsides: ($ from gov't) to business reduce per unit production cost SRAS shifts to the right. <--
Government regulation creates a cost of compliance SRAS shifts to the left. <--
Deregulation reduce compliance cost SRAS shifts to the right. -->
Unit 3 (2/11/15)
Aggregate demand - shows amount of real GDP that private, public, and foreign sector collectively desire to purchase at each possible price level.
Relationship between price level and the level of real GDP is inverse.
Reasons why AD is downward sloping.
- Real balance effect:
When price level is high households and businesses cannot afford to purchase as much output. (Vice Versa)
-Interest rate effect:
Higher price level increase interest rule which tends to discourage investment. (Vice Versa)
-Foreign purchase effect:
Higher price level increases demand for relatively cheaper imports.
Lower price level increased the foreign demand for relatively cheaper U.S. exports.
Shifts in aggregate demand.
- Change in C, Ig, G, and Xn
- Multiple effect that produces a greater cange than the original change in 4 compounds
Increase in AD: Shifts to the right.
Decrease in AD shifts to the left.
Consumption
Household spending is affected by...
-Consumer wealth
*More wealth: more spending AD shifts to the right.
*Less wealth: less spending AD shifts to the left.
-Consumer expectation
*Positive expectations; more spending AD shifts to the Right.
*Negative expectations: less spending AD shifts to the left.
-Household indebteners
*Less debt: more spending AD shits to the right.
*More debt: less spending AD shifts to the left.
-Taxes
*Less tax: more spending AD shifts to the right.
*More tax: less spending AD shits to the left. r
Gross private investment
Investment is sensitive to...
-Real interest rate
*Lower interest rate: more investment AD shifts to the right,
*Higher interest rate: less investment AD shifts to the left.
*Higher expected returns: more investment AD shifts to the right.
*Lower expected returns: less investment AD shits to the left.
Expected returns are influenced by
-Expectations of future profitability
-Technology
-Degree of excess capacity
-Business
Government spending
*More government spending AD shifts to the right.
*Less government spending AD shits to the left.
Net exports
sensitive to...
-Exchange rates (international vale of money)
*Strong: more imports and few exports AD shifts to the left.
*weak: Fewer imports and more imports Ad shifts to the right.
-Relative income
*strong foreign economies: more exports AD shift to the right.
*Weak foreign economies: less exports AD shifts to the left.
Relationship between price level and the level of real GDP is inverse.
Reasons why AD is downward sloping.
- Real balance effect:
When price level is high households and businesses cannot afford to purchase as much output. (Vice Versa)
-Interest rate effect:
Higher price level increase interest rule which tends to discourage investment. (Vice Versa)
-Foreign purchase effect:
Higher price level increases demand for relatively cheaper imports.
Lower price level increased the foreign demand for relatively cheaper U.S. exports.
Shifts in aggregate demand.
- Change in C, Ig, G, and Xn
- Multiple effect that produces a greater cange than the original change in 4 compounds
Increase in AD: Shifts to the right.
Decrease in AD shifts to the left.
Consumption
Household spending is affected by...
-Consumer wealth
*More wealth: more spending AD shifts to the right.
*Less wealth: less spending AD shifts to the left.
-Consumer expectation
*Positive expectations; more spending AD shifts to the Right.
*Negative expectations: less spending AD shifts to the left.
-Household indebteners
*Less debt: more spending AD shits to the right.
*More debt: less spending AD shifts to the left.
-Taxes
*Less tax: more spending AD shifts to the right.
*More tax: less spending AD shits to the left. r
Gross private investment
Investment is sensitive to...
-Real interest rate
*Lower interest rate: more investment AD shifts to the right,
*Higher interest rate: less investment AD shifts to the left.
*Higher expected returns: more investment AD shifts to the right.
*Lower expected returns: less investment AD shits to the left.
Expected returns are influenced by
-Expectations of future profitability
-Technology
-Degree of excess capacity
-Business
Government spending
*More government spending AD shifts to the right.
*Less government spending AD shits to the left.
Net exports
sensitive to...
-Exchange rates (international vale of money)
*Strong: more imports and few exports AD shifts to the left.
*weak: Fewer imports and more imports Ad shifts to the right.
-Relative income
*strong foreign economies: more exports AD shift to the right.
*Weak foreign economies: less exports AD shifts to the left.
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