Thursday, March 3, 2016
Fiscal Policy & More
Fiscal policy
changes in the expenditures or tax revenues of the federal government
2 tools of fiscal policy
taxes: government can increase or decrease taxes
spending: government can increase or decrease spending
Deficits, Surpluses, and Debt
balanced budget: revenue = expenditures
budget deficit: revenues < expenditures
budget surplus: revenues > expenditures
government debt: (sum of all debts) - (sum of all surpluses)
government must borrow money when it runs a budget deficit
individuals
corporations
financial institutions
foreign entities or foreign governments
Fiscal policy
Discretionary Fiscal Policy (action)
expansionary fiscal policy (easy) : think deficit; combat a recession, increase government spending, decrease taxes
contractionary fiscal policy (tight) : think surplus; combat inflation, decrease government spending, increase taxes
Non-Discretionary Fiscal Policy (no action)
Discretionary
Increasing or decreasing government spending and/or taxes in order to return the economy to full employment. Discretionary policy involves policy makers doing fiscal policy in response to an economic problem.
Automatic
Unemployment compensation and marginal tax rates are examples 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.
Automatic or Built-In Stabilizers
Anything that increases the government's budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policymakers
Economic importance
Taxes reduce spending and aggregate demand
Reductions in spending are desirable when the economy is moving toward inflation
Increases in spending are desirable when the economy is heading toward recession
Transfer Payments
medicare, medicaid, social security, unemployment, food stamps, welfare
Taxes
Progressive tax system
average tax rate (tax revenue/GDP) rises with GDP
Proportional tax system
average tax rate remains constant as GDP changes
Regressive tax system
average tax rate falls with GDP
changes in the expenditures or tax revenues of the federal government
2 tools of fiscal policy
taxes: government can increase or decrease taxes
spending: government can increase or decrease spending
Deficits, Surpluses, and Debt
balanced budget: revenue = expenditures
budget deficit: revenues < expenditures
budget surplus: revenues > expenditures
government debt: (sum of all debts) - (sum of all surpluses)
government must borrow money when it runs a budget deficit
individuals
corporations
financial institutions
foreign entities or foreign governments
Fiscal policy
Discretionary Fiscal Policy (action)
expansionary fiscal policy (easy) : think deficit; combat a recession, increase government spending, decrease taxes
contractionary fiscal policy (tight) : think surplus; combat inflation, decrease government spending, increase taxes
Non-Discretionary Fiscal Policy (no action)
Discretionary
Increasing or decreasing government spending and/or taxes in order to return the economy to full employment. Discretionary policy involves policy makers doing fiscal policy in response to an economic problem.
Automatic
Unemployment compensation and marginal tax rates are examples 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.
Automatic or Built-In Stabilizers
Anything that increases the government's budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policymakers
Economic importance
Taxes reduce spending and aggregate demand
Reductions in spending are desirable when the economy is moving toward inflation
Increases in spending are desirable when the economy is heading toward recession
Transfer Payments
medicare, medicaid, social security, unemployment, food stamps, welfare
Taxes
Progressive tax system
average tax rate (tax revenue/GDP) rises with GDP
Proportional tax system
average tax rate remains constant as GDP changes
Regressive tax system
average tax rate falls with GDP
Interest Rates & Investment Demand/ Real (r%) v. Nominal (i%)
a. What is investment? Money spent or expenditures on:
1. New plants (factories)
2. Capital punishment (machinery)
3. Technology (hardware & software)
4. New Homes
5. Inventories (goods sold by producers)
b. Expected Rates of Return
How does business make investment decisions? Cost/ benefit analysis
How does business determine the benefits? Expected rates of return
How does business count the cost? Interest costs
How does business determine the amount of interest they undertake?
-compare expected rate of return to interest cost
* if expected return > interest cost, then invest
* if expected return < interest cost, don't invest
Real (r%) v. Nominal (i%)
What's the difference? Nominal is the observable rate of interest. Real subtracts out inflation and is known as an ex post facto.
1. New plants (factories)
2. Capital punishment (machinery)
3. Technology (hardware & software)
4. New Homes
5. Inventories (goods sold by producers)
b. Expected Rates of Return
How does business make investment decisions? Cost/ benefit analysis
How does business determine the benefits? Expected rates of return
How does business count the cost? Interest costs
How does business determine the amount of interest they undertake?
-compare expected rate of return to interest cost
* if expected return > interest cost, then invest
* if expected return < interest cost, don't invest
Real (r%) v. Nominal (i%)
What's the difference? Nominal is the observable rate of interest. Real subtracts out inflation and is known as an ex post facto.
SRAS (Short Run Aggregate Supply)
Nominal wages vs. Real and Sticky Wages:
Nominal wages: amount of money they work or receive per unit of time
Ex: ( tips waitress makes)
Real Wages: amount of goods and services a worker can purchase with their nominal wage
( real wages purchasing power of nominal wages) Determines what you can and can't buy
Sticky Wages- Nominal wage level is set according to an initial price level and doesn't vary due to labor contracts or other restrictions ( Keynesian)
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Price
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Wages
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Employment Level
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Implications
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Keynesian Range
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Recession
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Fixed
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Fixed
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Flexible
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Output depends upon changes in employment levels
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Intermediate
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Flexible
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Fixed
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Flexible
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Output depends upon changes in price and the employment level.
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Classical Range
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Inflation
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Flexible
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Flexible
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Fixed
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Output independent of changes in the price level
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Recessionary & Inflationary Gap
Recessionary Gap
A recessionary gap exists when equilibrium occurs below full employment output
Inflationary Gap
When equilibrium occurs beyond full employment output
A recessionary gap exists when equilibrium occurs below full employment output
Inflationary Gap
When equilibrium occurs beyond full employment output
Aggregate Supply
The level of Real GDP (GDPr) that firms produce at each Price Level (PL)
Long Run v. Short Run
Long Run v. Short Run
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Long Run
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Short Run
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Period of time where input prices are flexible and adjust to prices
in the change level
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Period of time where input prices are sticky and don’t adjust to
changes in the price level
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In the long run, the level of Real GDP supplied is independent of the
price level
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In the short run, the level of Real GDP supplied is directly related
to the price level
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Long Run Aggregate Supply (LRAs)
-Marks level of full employment on economy (analogous to PPC)
-Because input prices are completely flexible in the long run, changes in price level don't change a firm's real profits therefore it doesn't change a firm's level of output. This means the LRAS is vertical at the economy's level of full employment.
Changes in SRAS
Increase in SRAS is seen as shift rightward
Decreases in SRAS is seen as shift leftward
*SRAS shifts is per unit cost of production* (per unit cost of prod.= total input costs/ total input)
Determinants of SRAS
(all affect unit prod. cost)
1. Input Prices- Domestic Resource Prices (wages = 75%, capital, raw materials); Foreign Resource Prices; Market Power; Increase in Resource Prices= SRAS left while a decrease sends SRAS right
2. Productivity- total output/total input; More productivity = lower unit prod and send SRAS shifting to the right. Lower productivity = higher unit prod. cost sending SRAs left
3. Subsidies- money from governments to businesses to reduce unit prod. cost and sending SRAS to the right
Full Employment
Exists where AD intersects SRAS and LRAS at the same point
Aggregate Demand
Change in price level doesn't shift the curve, it causes a move along the curve
Why is AD downward slopping?
1. Real- Balance- Effect
Higher price levels reduce the purchasing power of money
This decreases the quantity of expenditures
Lower price levels increases purchasing power and expenditures
Ex: The balance in your bank was $50,000 but inflation erode you're purchasing power which will cause you to then reduce your spending
2. Interest Rate Effect:
What price level increases lenders need to charge higher interest rates to get a real return on their loans
Higher interest rates discourage consumer spending and businesses investments
3. Foreign Trade Effect
When US price level rises foreign buyers purchase fewer US goods and Americans buy more foreign goods
Exports fall imports rise causing real GDP demanded to fall ( XN decreases)
Shifters of Aggregate Demand
GDP=C + I+G+XN
Two parts to shift and AD:
Change in C,IG, G and/ or XN
Multiplier fact that produces a greater change than the original change in the 4 components
Increase in AD= AD shift to the right
Decrease in AD= AD shift 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 expectations:
Positive- more spending ( AD shifts to the right)
Negative- less spending (AD shifts to the left)
- Household indebtedness
Less debt = more spending ( AD shifts to the right)
Gross private investment:
Investment spending is sensitive to:
-Real interest-rate
Lower real interest rates = More Investment (AD shifts to the right)
Higher real interest rates = Less investment ( AD shifts to the left)
- Expected Returns
Higher expected returns = More Investment ( AD shifts to the right)
Lower expected returns= Less investment ( AD shifts to the left)
Expected returns are influenced bye...
- expectations of future profitability
- Technology
- degree of excess capacity (existing stock of capital)
- Business Taxes
More government spending (AD shift to the right) Increase
Less government spending ( AD shifts to the left ) decreases Decrease
Net exports:
Net exports are sensitive to
- Exchange rates ( International value of $)
Strong $= more imports and fewer exports= (AD shifts to the left )
Weak $ = fewer imports and more exports = (AD shifts to the right )
- Relative Income
Strong foreign economies = more exports = (AD shift to the right )
Week foreign economies = les exports = (AD shifts to the left )
Why is AD downward slopping?
1. Real- Balance- Effect
Higher price levels reduce the purchasing power of money
This decreases the quantity of expenditures
Lower price levels increases purchasing power and expenditures
Ex: The balance in your bank was $50,000 but inflation erode you're purchasing power which will cause you to then reduce your spending
2. Interest Rate Effect:
What price level increases lenders need to charge higher interest rates to get a real return on their loans
Higher interest rates discourage consumer spending and businesses investments
3. Foreign Trade Effect
When US price level rises foreign buyers purchase fewer US goods and Americans buy more foreign goods
Exports fall imports rise causing real GDP demanded to fall ( XN decreases)
Shifters of Aggregate Demand
GDP=C + I+G+XN
Two parts to shift and AD:
Change in C,IG, G and/ or XN
Multiplier fact that produces a greater change than the original change in the 4 components
Increase in AD= AD shift to the right
Decrease in AD= AD shift 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 expectations:
Positive- more spending ( AD shifts to the right)
Negative- less spending (AD shifts to the left)
- Household indebtedness
Less debt = more spending ( AD shifts to the right)
Gross private investment:
Investment spending is sensitive to:
-Real interest-rate
Lower real interest rates = More Investment (AD shifts to the right)
Higher real interest rates = Less investment ( AD shifts to the left)
- Expected Returns
Higher expected returns = More Investment ( AD shifts to the right)
Lower expected returns= Less investment ( AD shifts to the left)
Expected returns are influenced bye...
- expectations of future profitability
- Technology
- degree of excess capacity (existing stock of capital)
- Business Taxes
More government spending (AD shift to the right) Increase
Less government spending ( AD shifts to the left ) decreases Decrease
Net exports:
Net exports are sensitive to
- Exchange rates ( International value of $)
Strong $= more imports and fewer exports= (AD shifts to the left )
Weak $ = fewer imports and more exports = (AD shifts to the right )
- Relative Income
Strong foreign economies = more exports = (AD shift to the right )
Week foreign economies = les exports = (AD shifts to the left )
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