Unit 3: Fiscal Policy

3/06/17

Fiscal Policy 

• Fiscal Policy

- Actions by congress to stabilize the economy.

- 2 Tools to Fiscal Policy 

1. Taxes- Government can increase or decrease taxes
2. - Spending- Government can increase or decrease spending 

- Fiscal policy is used to promote our nations economic goals: full employment, price stability, and economic growth .

• Deficit, Surpluses, and Debt

*Balanced Budget

- Revenues ( bring in)= Expenditures (spend)

*Budget Deficit

- Revenues < expenditures

*Budget Surplus

- Revenues> expenditures 

*Government Debt

- Sum of all deficits- sum of all surpluses 

- The government can borrow money when it runs a budget deficit, They can borrow from...

- Individuals

-Corporations

-Financial institutions

-Foreign entities 

•  Options of fiscal Policy 

1. Discretionary fiscal policy (action by congress)
2. Expansionary fiscal policy (think deficit)
3. Contractionary fiscal policy ( think surplus)
4. Non-discretionary fiscal policy (no action)

• 3 Types of Taxes 

- Progressive Tax- Takes a larger % of income from high income groups

- Proportional Tax- Takes the % of income from all income groups 

- Regressive Taxes- Takes a larger % from low income groups ( takes more from poor people)

• Contractionary Fiscal Policy

- laws that reduce inflammation, decrease GDP and close the inflationary gap 

-  they can either decrease government spending or increase taxes or a combination of the two 

•  Expansionary fiscal policy 

- laws that reduce unemployment and increase GDP and close a recessionary gap 

- they can either increased government spending or decrease taxes are consumers or a combination of the two 

•  Automatic or built in stabilizers 

- anything that increases the government budget deficits during a recession and increase its budget surplus during installation without requiring explicit action by policymakers 

•  Transfer payments 

- welfare checks 

- food stamps 

- unemployment checks 

- corporate dividens

-  social Security 

- veterans benefits 

Unit 3: Consumption and Savings

2/23/27

Consumption and Savings 

• Disposable Income 
  

- Income after taxes or net income

-DI= Gross income-Taxes

-2 Choices with disposable income households 

1. Consume (spend money on goods and services)
2. Save ( not spend money goods and services)

• Consumption 

- Household spending

- the ability to consume is constrained 

- The mount of disposable income  

- The propensity to consume

-Do households save if DI=0? No

-APS= S/DI= % DI that is not spent

• Average Perpencitry to Consume/ Save (APS) (APC)

- APC+APS=1

-1-APC=APS                *https://www.youtube.com/watch?v=mjU1w9jwYwY ( diposible income)

-1-APS=APS

-APC>: Disaving

-APS: Disaving

• Marginal Perpencity to Consume/ Save (MPC)(MPS)

-MPC

- Change in consumption/ change in disposable income

-% of every extra dollar earned 

-MPS

- Change in savings/ change in disposable income

- % of every extra dollar earned is saved 

-MPC-MPS=1

-1-MPC=MPS

-1-MPS=MPC

• Determinants of C and S
  

- Wealth

- Household Debt

- Expectations

- Taxes

2/24/17

• Spending Multiplier Effect

- An initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending or aggregate demand.

-Multiplier= Change in AD/ Change in spending 

- Expenditures- Income and flow continuously which sets off a spending increase in the economy.

• Calculating the Spending Multiplier

- The spending multiplier can be calculated from the MPC or MPS

- Multiplier=1/ MPC OR 1/1-MPS

- Multipliers are positive where there is an increase in spending and negative when there is a decrease.

• Calculating Tax Multiplier 

- When the government taxes, the multiplier works in reverse  because now money is leaving the circular flow.

- -MPC/1-MPC or -MPC/MPS

- If there is a ta cut , then multiplier is positive because there is now more money in the circular flow.

2/27/17

Reasons why prices tend to be sticky or inflexible in a downward direction...

1. Fear of price wars 
2. wage contracts 
3. minimum wage 
4. Menu Costs
5. Moral effort and productivity 

• 3 Ranges of AD

- Range 1: Output is low, relative to the economy and full employment output; unemployment increases and GDPr decreases.
- Range 2: Output expands as spending increases.
- Range 3: The AS is vertical in the log-run, because the only effects would increase in AD we are already at full employment or an increase in demand by increasing output.

2/28/17

• Classical School 

- The trickle down theory: Help the rich first and then everyone else
- In the LR the economy will balance at full employment output
- The invisible hand

• Keynesian School 
  

- AD is key not AS
- In the LR we are dead
- Leaks cause recessions
- Saving causes recesssions

Unit 3: Aggregate Supply

2/21/17

• Aggregate Supply- Level of real GDP that firms will produce at each price level
• 2 types of aggregate supply

1. Long run- Period of time where input prices are completely flexible and adjust to change in the price level 

 - Vertical line in the middle of the graph= Long run
     2. Short Run- Period of time where input prices are sticky and do not adjust to changes in the price level.
- In the short run the level of GDPr supplied directly to the price level

Long Run Aggregate supply
-The LRAS  marks the level of full employment in the economy                                                       

-The LRAS  marks the level of full employment in the economy                                                    

Short Run Aggregate supply              

 -Because the input are sticky the SRAS is are upward slopping

-an increase in SRAS is as a shift to the right

- a decrease in SRAS is seen as a shift to the left.

- The key to understanding shifts in SRAS is id per unit cost cost of production 

- Per unit cost =(total input cost/ total output

Determinants of SRAS 

• Input prices

- domestic resource prices

- wages (75% of all business costs)

-cost of capital 

-raw materials (commodity prices)

* Foreign resource prices 

-Strong $= lower foreign resource

-weak $= higher foreign resource 

*Market Power 

-Monopolies and cartels that control resources control the price of those resources

- increase in resource prices= decrease in SRAS 

- decrease in resource prices = increase in SRAS

• Productivity

- Productivity= total output/ total inputs

- More productivity = lower unit production 

- lower productivity = higher unit production 

• Legal Institutional Environment

- Taxes and subsidies 

- taxes on businesses increase per unit production

-subsidies to businesses reduce per unit costs 

-Government regulation 

- Government regulation creates a cost of compliance 

-deregulation reduces compliance cost

Unit 3: What is Invetment

2/21/17

Investment

• Investment- Money spent or expenditures on...
  

-New plants (factories)

-capital equipment (machinery)

-technology (hardware and software)

-new homes

-inventory

•  Expected rates of return

*How do businesses make investment decisions?

-cost/benefits analysis

*How do businesses determine the benefits?

-expected rates of return

*How do businesses determine the amount of investments they should undertake?

-Compare expected rate of return too interest of cost

-If the expected rate of return is greater than interest cost = investment
- if the expected rate of return is less than the interest cost = no investment
-r%( real investment)= 1%(nominal rate)-π(inflation)

Investment Demand Curve (ID)

• The investment demand curve is downwards slopping because when the interest rates are high fewer investments are profitable; when interior rates are low more investments are profitable.
• Shifts in AD ...

- Cost of production

- 

- Technological change 

- Stock capital 

-Business taxes

Unit 3: Aggregate Demand

2/16/17

Aggregate Demand

• AD is the demand by consumers businesses, government and foreign countries.
• Changes in the price level cause a move along the curve not a shift of the curve.
• Aggregate Demand- Shows the amount of real GDP that the private, public , and foreign sector collectively desire to purchase at each possible price level.
• The relationship between price level and the level of real GDP is inverse.
• 3 Reasons why AD is Downward Slopping

1. Wealth Effect

-Higher prices reduce the purchasing power of money

-This decreases the quantity of expenditures
-Lower price levels increase purchasing power and increase expenditures

    

 2. Interest Rate Effect

- As price levels increase, lenders need to charge a higher interest rate to get a real return on their loans 

- Higher interest rates discourage consumer spending and business investments 

 3. Foreign Trade Effect

- When US price level rises, foreign buyers purchase fewer US goods and Americans buy more foreign goods 

- Exports fail and imports rise causing real GDP demanded to fall

• Shifts in Aggregate Demand

-There are 2 parts to shift in AD

- a change in  C.Ig,G, and/or Xn

-a multiplier effect that produces a greater change than original change in 4 components 

- Increase in AD= Right shift   Decrease in AD= Left shift in AD
2/17/17

• Determinants of AD

- Consumption (C)
- Gross private investment (Ig)
-Government (G)
- Net Exports (Xn)

• Consumption- Change in consumer spending 
  

- Consumer wealth: boom in stock market
- Consumer expectation: people fear a recession
- Household indebtedness: more consumer debt
- Taxes: a decrease in income tax

• Gross private investments- change in investment spending

- Real interest rates (price of borrowing money), if interest rates increase if interest rates decrease
- Future business expectations: high expectations
- Producing: productivity technology- new robots
- Business taxes: higher corporate taxes
- Government- Change in government spending
- War, national health care, decrease in defense spending.

• Net exports- change in net exports(x-m)

-exchange rates: if the US dollars depreciate it is relative to zero
- National income compared too abroad, if a major importer has a recession , if US has a recession
-" If the US gets cold Canada gets pneumonia."
AD= GDP=C+L+G+Xn

• Government Spending 

- more government spending= AD increasing
-less government spending = AD decreasing

Unit 2: Unemployment

3/9/17

Unemployment 

• Unemployment-  percentage of people who do not have a job in the labor force 
•  Unemployment rate- % of people who want a job but are not working 
• Unemployment rate =( # of unemployed/ # in labor force) x 100
• 4 types of unemployment...

1.  Frictional unemployment-  temporarily unemployed or between jobs 

-  individuals are qualified workers with transferable skills but they aren't working

    2.   Seasonal  unemployment -  due to time of the year and the nature of the job 

    3.   Structural unemployment -  changes in structure of the labor force make some skills obsolete 

- workers do not have transferable skills and these jobs never come back 

-  permanent loss of these jobs is called "creative construction"

    4.  Cyclical unemployment-  downturns in the business cycle 

-  As demand for goods and services falls demand for labor falls and workers are fired

• Standard unemployment rate - 4 to 5%
• Natural rate employment 

-  two of the three types of unemployment are unfavorable

-  frictional unemployment 

- structural unemployment 

-  together they make up the natural rate of unemployment,

 frictional + Structural = NRU

- Full employment =  no slip a cool employment full employment 

-Okund Law-  when unemployment rises 1% above the NRU gap falls about 2% 

Unit 2: Inflation

Continuation of 2/3/17...

• GDP deflator- Price index used to adjust from nominal GDP to real GDP.

-(Nominal GDP/Real GDP) x 100
- In the base year GDP deflator will always equal to 100
-Years after the base year the GDP will be greater than 100
-Years before the base year the GDP deflator is less than 100

• Consumer price Index (CPI)

- Measures inflation by tracking changes in the price of  a market basket goods ( cars, trucks, etc).
-(Price of market basket in current year/ Price of market basket in base year) x 100

2/6/17

Inflation 

• Inflation- Increase or rise in price, it reduces the "purchasing power" ( the amount of goods and services your money can buy) of money

• 3 causes of inflation

1. Printing too much money
2. Demand- pull inflation by an excess of demand over output that pulls public prices upward 
3. Cost push inflation- cause by a rise in per-unit production cost due to an increase in resource cost.

• Ideal inflation rate= 2 to 3%

- Inflation: (current year price index- base year price index)/base year price index x(100)

Rule of 70-used to calculate the number of years it will take for the price level to double at any given rate.

• Deflation- General decline in the price level.
• Disinflation- Occurs when the inflation rate itself declines
• Nominal interest rate- unadjusted cost of borrowing or lending money.
• Real interest rate- cost of borrowing or lending money adjusted for inflation 

- real interest rate = Nominal interest rate-expected inflation 

Unanticipated Inflation 

• Hurt by inflation ....

- lender – people who lend the money at fixed interest rates
- people with fixed incomes
-savers

• Helped by inflation....

- borrowers - people who borrow money
- A business where the price of product increases faster than the price of resources

• COLA (cost  of a living adjustment)-  some works have salaries that mirror inflation they negotiate wages that ride with inflation 
• Here is a video elaborating on inflation 

https://m.youtube.com/watch?v=UMAELCrJxt0