MPC & MPS

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

Investment Demand Curve

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.

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) 

		Price	Wages	Employment Level	Implications
Keynesian Range	Recession	Fixed	Fixed	Flexible	Output depends upon changes in employment levels
Intermediate		Flexible	Fixed	Flexible	Output depends upon changes in price and the employment level.
Classical Range	Inflation	Flexible	Flexible	Fixed	Output independent of changes in the price level

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

Aggregate Supply

The level of Real GDP (GDPr) that firms produce at each Price Level (PL)

                                                       
                                                           Long Run v. Short Run

Long Run	Short Run
Period of time where input prices are flexible and adjust to prices in the change level	Period of time where input prices are sticky and don’t adjust to changes in the price level
In the long run, the level of Real GDP supplied is independent of the price level	In the short run, the level of Real GDP supplied is directly related to the price level

                                                          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