3/6/2107

HOW DOES THE GOVERNMENT STABILIZES THE ECONOMY?
Fiscal Policy - actions by congress to stabilize the country changes in the expenditures or tax revenue of the federal government

2 tools of Fiscal Policy
Taxes government can increase or decrease taxes spending - government can increase or decrease spending

Fiscal Policy is enacted to promote over nation economic goods full employment price stability, economic growth

Deficits, Surpluses, and Debt
Balanced Budget => Revenues = Expenditures
Budget Deficits => Revenues < Expenditures
Budget Surplus R>E
Gov't Debt =>Sum of all D - Sum of all S

Government must borrow money what it runs a budget deficit government borrows from  
- individuals 
-corporations
- financial 

Fiscal Policy 

1. Discretionary Fiscal Policy (action)
• Expansionary fiscal policy - used during a deficit
• Contractionary fiscal policy - used during a surplus
2. Non Discretionary Fiscal Policy (no action)

3 Types of Taxes

1. Progressive Taxes
• Takes a larger % of income from high income groups
2. Proportional Taxes
• Takes the same % of income from all groups
3. Regressive Taxes 
• Takes a larger % from the low income groups

Contractionary Fiscal Policy (The Brake)

• Laws that reduce inflation and GDP
• Decrease government spening
• Tax increases
• Combinations of the two

Expansionary Fiscal Policy (The Gas)

• Laws that reduce unemployment and increase GDP
• Increase government spending  
• Decrease taxes on consumers 

Automatic or Built in stabilizers

• Anything that increases the governments budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policy makers

2/24/2017

The Spending Multiplier Effect 
An initial change in spending (C,I,G,Xn) cause larger change aggregate spending or Aggregate demand
Multiplier = Change in AD/ Change in Spending

Why does this happen?
expenditures and income flow continuously which sets off a spending increase in the economy

Calculating
Multiplier = 1/-MPC or 1/MPS

Multiplier are positive when there is an increase in spending and negative when there is a decrease.

Tax Multiplier ( it is always negative)
When the government taxes, multiplier works in reverse
WHY??? because how many is leaving the circular flow

= -MPC/1-MPC or -MPC/MPS
If there is a tax cut then the multiplier is because there is now more money in the circular flow

REASONS WHY PRICES TEND TO BE INFLEXIBLE OR "STICKY" IN A DOWNWARD DIRECTION. 
Due to menu cost
Fear of price wars
Wage Contracts
Min.Wage
Moral/ effect and productivity


Recession horizontal range - low output /GDP low / unemployment high
AS Intermediate range - upward sloping/ output expand / total spending expand
LR vertical range - firms cant not respond to increase in demand by increasing output FULL EMPLOYMENT

2/23/2017

Consumption and Savings 
Disposable Income (DI)
Income after taxes or net income
DI = Gross Income - Taxes
2 Choices with Disposable income, household can either
-Consume (Spend Money on goods and Services)
-Save ( not spend money on goods and services)

Consumption
Household Spending is the ability to consume is constrained by the amount of disposable income
- the propensity to save
Do households if DI equals 0?
-Autonomous Consumption
-Dis saving

APC = C/DI = % DI that is spent 

Average saving 
Household not spending
The ability to save is constrained by the amount of disposable income
The propensity to consume

Do household save if DI = 0
No
APS = S/DI = % THAT IS  NOT SPENT

APC AND APS
APC + APS = 1
1- APC = APS
1- APS = APC
APC > 1 DISSAVING

MPC AND MPS
Marginal Propensity to consume
Change in C/ Change in DI
% of every extra dollar demand that is spent

Marginal Propensity to save
Change in S/Change in DI
% of every extra dollar earned that is saved
MPC +MPS = 1
1 - MPS = MPC
1 - MPC = MPS

Determinants
-wealth
-exception
-household debt
-Taxes

2/21/2017

What is investment?
Money spent or expenditures on:
New plants ( factories),
Capital equipment (machinery),
Technology (hardware and software),
New homes,
Inventories (good sold by producers)

Expect Rates of Return
How does business make investment decisions?
cost/benefit analysis
How does business determine the benefits?
expected rate of return
How does business count the cost?
interest rate
How does business determine the amount of investment they undertake?
Compare expected rate of return to interest cost if expected return > interest cost, then do not invest

Real (r%) v Nominal (n%)

What is the difference? Nominal is the  observable rate of interest
Real subtract out inflation and is only know ex post Fatco
What then determines the cost an investment decision?

The real interest rate (r%)

Investment Demand Curve
What is the shape of the investment demand curve?
-downward sloping

Shifts in investment Demand
-cost of production 
-business taxes
-Technological change 
-stock of capital
-expectations 

Aggregate supply
The level of real GDP that firms will produce at each price level (PL)

Long run period of time where input prices are completely flexible and adjust to changes in the price level
In the long-run the level of Real GDP supplied is in dependent of the price- level

Short run period of time where input minus are sticky and do not adjust to changes in the price level
In the short run the level of real GDP supplied directly related to the price level

Long Run Aggregate Supply
The long run Aggregate supply or LRAS marks the level of full employment in the economy (analogous to PPC)

Short Run Aggregate Supply
Because input prices are sticky in the short run, the SRAS is upward sloping

Changes in SRAS
an increase in SRAS is seen shift to the right ->
a decrease in SRAS is seen as a shift to the left SRAS <-

The key understanding shifts in SRAS is per unit cost of production
Per unit production cost equals Total input cost/ Total output

Determinants of SRAS to shift
-input prices
-productivity 
-Legal-institutional environment

Input prices
domestic resources (in the U.S) 
-wages (75% of all business costs)
-cost of capital
-raw materials (commodity prices)

Foreign Resources Power
Strong $= lower foreign resources prices
Weak $= higher foreign resources prices

Market Power
-monopolies and cartels that control resources
control the price of these resources

Increase in resource prices = SRAS <=
Decrease in resource prices = SRAS => 

Productivity = Total output/ Total Inputs
More Productivity = Lower unit Production cost = SRAS =>
Lower Productivity = Higher unit Production cost = SRAS <=

Legal institutional

Taxes and Subsides
Taxes( $ to government) on business increase in per unit production cost = SRAS <=
Subsides ( $ to government) to business reduce per unit production cost = SRAS =>

Government Regulation 
-Government regulation creates a cost of compliance = SRAS <=
-Deregulation reduces compliance cost = SRAS =>

2/17/2017

Increase in Aggregate Demand
Determinants of AD
Consumption (C), Gross Private Investment (IG), Government Spending (G), Net exports (Xn)

1) Change in consumer spending, Consumer wealth (boom in market), Household indebtedness, Taxes

2) Change in investment spending, Real interest Rates (price of borrowing $), Future Business Expectations, Productivity and Technology, Business taxes

3) Change in government spending (war), (decrease in defense spending)

4) Change in Net exports (X-M), exchange rates, national income compared to aboard

AD= GDP = C+I+G+Xn
Government spending AD->
Less Government spending AD<-

2/16/2017

Aggregate Demand Curve

AD is the demand by consumers business, government and foreign countires
Changes in price level cause a move along the curve not a shift of the cruve

AD= C+I+G+Xn

The relationship between the price level and the level of real gap is inverse

3 Reason ( Why is AD downward sloping)
1. Wealth effect

• Higher prices reduce purchasing power of a dollar 
• This desires the quint of expenditures 
• Lower price level increase purchasing power and increase expenditures 

2. Interest-Rate effect

• As price level increase, lenders need to charge higher interest rate to get a real return on their loans 
• Higher interest rate discourage consumer spending and business investment 

3. Foreign Trade effect 

• When U.S price level rises, foreign buyers purchase fewer U.S goods and Americans buy more foreign goods 
• Export fall and import rise causing real GDP demanded to fall ( Xn decreases) 

Shifts in Aggregate Demand 

There are two parts to a shift in AD 

• a change in C,Ig,G, and/or Xn
• multiplier effect that produces a greater change than the original change on components 

Increase in AD= AD -> 

Decrease in AD=AD<-