Unit 3

3-7-17

Fiscal Policy

How govt stabilize eco.

• Actions by congress to stabilize economy

Fiscal Policy

• changes in expenditures or tax revenues of federal govt
• 2 tools of fiscal polic
• taxes govt can increase or decrease taxes 
• spending govt can increase or decrease spending
• Fiscal policy is encoded to promote our nations economic goals: full employment, price stability, economic growth

Deficit, Surplus, Dept

• Balanced budget
• revenues = expenditures
• Budget deficit
• revenues< expenditures
• Budget Surplus
• revenue> expenditures
• govt debt
• sum of all deficits - sum of all surpluses
• Govt must borrow money when it runs a budget deficit
• Govt borrows from
• individuals, corporations, financial institution, foreign entities of foreign

Fiscal policy 2 options

• Discretionary Fiscal Policy(action)
• expansionary fiscal policy- think deficit
• constractionary fiscal policy- think surplus
• Non Discretionary Fiscal Policy (no action)

3 types of taxes

• 1- progressive taxes- takes a larger percent of income from high income group
• ex: current federal income tax system
• 2- proportional taxes (flat rate)- takes same % of income from all income groups
• 3- Regressive tax- takes larger percentage from low income groups

Contractionary Fiscal Policy

• laws that reduce inflation, decrease GDP
• decrease govt spending
• tax increase
• combinations of the two

Expansionary FP

• law that reduce unemployment and increases GDP
• increase govt spending
• decrease tax on consumers
• combinations of the two

Automatic/Built in stabilizer

• Anything that increases govt budget deficit during recession and increases its budget surplus during inflation without requiring explicit action by policymakers
• 1- transfer payments
• welfare checks, food stamps, unemployment checks
• 2- progressive income tax
• automatic stabilizers take 33-50% out 

Unit 3

2-26-17

MPC and MPS

Spending Multiplier effect

• initial change in spending (C,Ig,G,Xn) causes larger change in aggregate spending/ (AD)
• multiplier = Δin AD/Δin spending or ΔAD/ΔGDP
• why does this happen?
• expenditures and income flow continuously which set off spending increase in economy

Calculating spending multiplier

• multiplier = 1/(1-MPC) or 1/MPS
• Multilier are (+) when there is an increase in spending and (-) when there is a decrease

Calculate tax multiplier

• when govt taxes, the multiplier works in reverse
• bc now money is leaving circular flow
• Tax multiplier (note: it's negative)
• formula = -MPC/(1-MPC) or -MPC/MPS
• If there tax - cut, multiplier is positive bc there now more money in circular flow 
• Range 1- employment is high, roduction is low
• Range 2- unemployment is medium out put is high
• Range 3 - output high unemployment   

Unit 3

2-23-17

Consumption and savings

Disposable income (DI)

• income after taxes/ net income
• DI= gross income - taxes
• 2 choices, disposable income, households can either
• consume (spend money on goods and services) 
• save(not spend money on goods and services)

Consumption

• household spending
• ability to consume is contained by
• amount of disposable income
• propensity to save
• Do households consume if DI = 0?
• autonomous consumption
• Dissavings
• APC = C/DI % DI that is spent

Savings

• Household not spending
• ability to save is constrained by
• amount of disposable income
• propensity to consume
• Do households save if DI = 0? - No
• APS = S/DI% DI that not spent

APC and APS

• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1 Dis-savings 
• -APS dis-savings

MPC and MPS

• Marginal Propensity to consume
• ΔC/Δ DI
• % of every extra dollar earned that is spent
• Marginal Propensity to save 
• ΔS/ΔDI
• % of every extra dollar earned that is saved
• MPC + MPS = 1
• 1- MPC = MPS
• 1- MPS = MPC

Determinants of C and S

• Wealth
• Expectations
• Household debt
• Taxes

  

Unit 3

2-21-17

Interest 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
• cost/ benefit analysis - how business make investment
• how business count cost?
• invest cost
• How business determine amount of investment they undertake
• if expected return > interest cost, then invest
• if expected return < interest cost, then do not invest 
•  Real(R%) vs.Nominal(I%)
• How you compute real interest rate (R%)?
• r%= i% - π%
• nominal is observable rate of invest, real subtract out inflation ( π%) and is only known ex post factor
• what determines cost of investment decision?
• real interest rate (R%)
• Investment(ID) Demand curve shifts in (ID)
• shape of investment demand curve
• downward shaping
• Shifts in (ID)
• cost of production
• business taxes
• technology change
• stock of capital
• expectations

Aggregate supply

• Level of real GDP that firms produce at each price level (PL)
• long run vs. short run
• long run
• will be vertical
• period of time where input prices are completely flexible and adjust changes in price level
• level of real GDP supplied is independent at price level
• short run
• period where input prices sticky and do not adjust to changes in price levellevel of RGDP supplied directly related to price lvl
• Long run aggregate supply (LRAS)
• Yf is full employment
• bc inut prices are sticky SRAS is upward sloping
• Short run aggregate supply(SRAS)
• SRAS increase a shift to the right
• SRAS decrease a shift to the left 
• Per unit production cost= total input cost/ total output
• Determinate of SRAS
• Input price, productivity legal institutional environment
• Input
• Domestic resources prices
• wage(78% of business costs)
• price of capital  
• raw material (commodity prices)
• foreign resources price
• strong $- lower foreign resources prices
• weak= higher foreign resource prices
• Market Power
• monopolies and cartel that control resources control rice of those resources
• increase in resource prices = SRAS<-----
• decrease in resources prices= SRAS------>
• Productivity
• total output/total input
• more productivity = lower unit production cost = SRAS ----->
• lower productivity = higher unit production cost = SRAS<-----
• legal institution environment
• Taxes and subsides
• taxes ($ to govt) to business reduce per unit production cost=  SRAS <---
• subsides ($ to govt) on business reduce per unit production cost = SRAS--->
• govt regulation creates a cost of compliance= SRAS----->
• Deregulation reduces compliance cost = SRAS ---->

Unit 3

2-16-17

Aggregate Demand Curve

• Aggregate Demand curve
• AD is demand by consumers, businesses, government and foreign countries 
• changes in price level cause move along curve not shift on curve
• inverse relationship between price level and level of RGDP

• 3 reasons why AD downward sloping
• 1- wealth effect
• higher prices reduce purchasing power of $
• decreases quantity of expenditures
• lower price level increase purchasing power and increase expenditures
• 2- interest rate effect
• As price level increases, lenders need to charge higher interest rates to get real return on their loans
•  higher interest rates discourage consumer spending and business investment
• 3- Foreign trade effect
• When U.S, price level increases, foreign buyers purchases fewer U.S. goods and americans buy more foreign goods
• exports fall and imports rise causing RGDP demanded to fall. (Xn decreases)
• Shift in AD
• 2 parts to shift in AD
• A change in GDP
• multiplier effect that produces greater change than original change in 4 component
• Increases in AD=AD right
• Decrease in AD=AD left  
• 4 determinate of AD 
• 1-GDP: C, IG, G, Xn
• 2: Change in investment spending
• real interest rates (price of borrowing $)
• (if interest rate increases/decreases)
• future business expectations (High expectations)
• productivity and technology (new robots)
• business taxes (higher corporate taxes mean)
• 3: Change in govt spending
• war, nationalized health care, decrease defense spending
• 4 : change in net exports (X-M)
• exchange rates
• if U.S, dollar depreciates relative to euro
• national income compared abroad
• if major importer has a recession
• AD= GDP
• "if U.S. gets a cold, Canada gets Pneumonia
• Govt spending
• more govt spending AD ------->
• less govt spending AD <------- 

REALLY?!? LAST MINUTE STUDYING AGAIN?