Fiscal Policy

• Changes in the expenditures or tax revenues of fiscal gov't
• - 2 Tools of fiscal policy

• Taxes - government can increase or decrease taxes
• Spending- government can increases or decreases spending
• Fiscal- is enacted to promote our nation's economic good: full employment, price stability, economic growth

Deficits, Surplus and Debt

• Balance budget
• - revenues =Expenditures

• Budget deficit
• - Revenue < expenditures

• Budget Surplus
• - revenues > expenditures

Government debt
- sums of all deficits - sums of all surpluses

Government must borrow money when it runs a budget deficit

Government borrows from
- individuals
- corporations
-financial institutions
-foreign entities or foreign government

Fiscal Policy Two options

• Discretionary Fiscal Policy-think deficit
• Contractionary Fiscal Policy-think surplus

- Non-Discretionary Fiscal Policy (action)
Discretionary v automatic fiscal policies

• 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 & marginal tax rates are examples of automatic policies that help mitigate the effect of recession and inflation. Automatic fiscal policy takes places with out policy makers having to respond to current economic problems

Contractionary VS Expansionary
Fiscal Policy

• contractionary fiscal policy- policy designed to decreased aggregate demand
• - strategy for controlling inflation

Expansionary fiscal policy - policy designed to increase aggregate demand

• strategy for increasing GDP, combatting a recessionary &reducing unemployment

Expansionary Fiscal policy
-increase government spending (G ^)
- decrease  taxes (Tv)
* notice that the PL increase

Contractionary Fiscal Policy

• decrease government spending
• Increase

Automatic or Built- In stabilizers.
* anything that increases the government increases its budget deficit during a recession and increases its budget surplus
Without requirement explicit action by policy makers

Economic Importance
- taxes reduces spending and AD
- reductions in spending are desirable when the economy is moving toward inflation
- increases in spending are desirable toward recession

Transfer payment
a. welfare check
b. food stamping
c. unemployment checks
d. corporate dividends
e. social security
f. veteran benefits

Progressive Tax system
*  Average tax rate ( tax revenue/ GDP)

Proportionary Tax System
* Average Tax rate remains constant as GDP changes

Regressive Tax System
* Average tax rate falls

The Spending Multiplier Effect

• An inital change in spending (C,Ig,G,Xn) causes a larger change in Aggregate Spending or Aggregate demand
• Multiplier =CHnage in AD/ Change in spending
• multiplier = Change in Aggregate Demand/ Change in C,Ig,G,Xn

The Spending Multiplier effect

• why does this happen?
• -expenditures and income 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 the MPS.
• Multiplier = 1/1 -MPC or 1/MPS
• Multipliers are (+) when there is an increase in spending and (-) when there is a decrease in spending

Calculating Tax Multiplier

• When the government taxes the multiplier it works inverse
• why?
• - because how money is leaving the circular flow
• Tax Multiplier (Note : It's Negative)
• -- = -MPC/1-MPS or -MPC/MPS
• If there is a tax-cut, then the multiplier is +, because there is now more money in the circular flow

Consumption and Saving

Disposable Income

• Income after taxes or net income
• DI = Gross Income - Taxes

2 choices

* with disposable income, household

- consume (spend money on goods, and services )

- save (not spend money on goods & services)

Consumption

• Household spending 
• the ability to consume is constrained by the amount of disposable income
• the propensity to save

* Do households consume if DI = O

- Autonomous consumption

-Dis-saving

• APC = C/ DI = DI that is Spent saving
• house hold NOT spending
• the ability to save is constrained by the amount of disposable income
• the propensity to consume

Do house holds save if DI + O

- NO

• APS = S/DI=%DI that is not spent

APC and APS

• APC+APS=1
• 1-APC = APS
• 1-APS =APC
• APC > 1.: dis-saving
• -APS.: Dis-saving

MPS and MPC

*Marginal Propensity to consume 

- change in C/ change in DI

-% of every extra dollar earned that is spend

* Marginal Propensity to save

- change in S/ change in DI

-% of every extra dollar earned that is save 

- MPC + MPS = 1

-1-MPC=MPS

-1-MPS=MPC

Three Schools of Economics

Classical
The main People

• John B. Say
• Adam Smith
• David Ricardo
• Alfred Marshall

What Classical Economics believe in

• Competition is good
• Invisible-Hand Market will take care of it's self
• Say's law supplies creates its own demand 
• AS- Determines output
• economy is always close to or always at full employment
• in the long run the economy will balance at full employment
• Trickle down effect will help the rich first then help everyone else later
• savings(leakage)= investment considered an (injection) because we invest
• prices and wages are flexible downward 
• no involuntary unemployment
• no reason you shouldn't be employed 
• what ever output is produced will be demanded no government intervention 

Keynesian

The Main Person

• John Mainer Keynes

What Keynesian Economics believe in

• Competition
• AD is key and not AS
• leaks cause constant recession 
• savings cause recessions 
• believed in ratchet effects and sticky wages Block Say's laws
• In the long run we are all dead
• demand creates its own supply there fore
• savers =/ Investment and save for different reasons
• the economy is not always close to or at full employment
• prices and wages are inflexible downward
• mono-plastic competition 
• there is government intervention
• fiscal or monetary policy 

Monetary 

The main people

• Allen Green's Span
• Ben Bernanke

What Monetary believed in

• Congress can time policy options
• government best control the health of the economy, by regulating banks and interest rates
• easy money- recession
• tight money- inflation
• change required reserves if needed
• Use bands through open market operation
• use interest rate to change the discount rate, the discount rate, federal fund rate. 

LRAS

Long Run Aggregate Supply (LRAS)

• Represents a point on an economies production possibility curve
• Any time LR, vertical, always stable at full employment 
• LRAS, doesnt change as the Price level changes

What causes shifts?

1. Change in resources
2. Change in technology
3. Economic Growth

Investment Demand Curve (ID)

Investment Demand Curve (ID)

what is the shape of the investment down curve?
- downward sloping

why?
- when interest rates are high, fewer investments are profitable;when interest rates are low more investments are profitable

• changes ink r% causes changes in Ig. Factors other than r% may shift the entire 

Shifts in Investment Demand (ID)

- cost of production 

• lower cost shift ID->
• high cost shift ID <-

- business taxes

• lower business taxes shift ID ->
• higher business taxes shift ID<-

- Technological change

• new technology shift ID->
• lack of technology change shift ID<-

-Stock of Capital 

• If an economy is low on capital, then ID ->
• If an economy has much capital then ID <-

-Expectations

• positive expectations shift ID ->
• Negative expectations shift ID <-

Full Employment

• Full employment equilibrium exists where AD intersects SRAS & LRAS at the same point

Recessionary GAP

• A recessionary gap exists when equilibrium occurs below full employment out put

Recessionary GAP <- AD decreases

• The Gap that exists whenever equilibrium real
• GDP year is less than full-employment real GDP as shown

inflationary GA

•  An inflationary GAP exists when equilibrium occurs beyond full employment output

Investment Demand
Interest Rate

what is investment

• money spent of expenditures on:
• - new plant (factories)
• - capital equipment (machinery)
• - technology (hardware software)
• - new homes
• - Inventories (goods sold by produces

Expected Rate of Return

• How does business determine the benefits?
• - how does business count the cost
• - Interest Cost
• How does business determine the amount of investment my undertake
• - compare expected rate of return to interest cost
• if expected return> interest cost
• if expected return< interest cost then do not interest.

Real (r%) v. Nominal (I%)

• what's the difference?
• -Nominal is the observable rate of interest. real subtract out inflation (pie%) and is only known ex post factor
• how do you complete the real interest rate (r%)
• r%= I%- pie%
• what then determine the cost of an investment decision?
• - the real interest rate (r%)

Aggregate Supply

Aggregate Supply

• The level of real GDP (GDPr) that firms will produce at each price level (PL)
• Real GDP= Out put

Long run v Short run

Long Run

• period of time where input prices are completely flexible and adjustments to change in the price level
• in the Long run, the level of real GDP supplied is independent of the price level

Short Run

• period of time when input prices are sticky and do not adjust to changes in 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)

• the long run aggregate supply or in the economy (analogous to ppc)
• Because input prices are completly flexible in the long-run changes in the price level do not change firm's real profits and therefore. do NOT Change firms level of full employment

Long Run

Short Run

• Because input prices are sticky in the shrt run, in the SRAS is upward sloping
• an increase in  GDPr, a decrease goes to the right and left
• The key to understand shifts in SRAS is per unit cost of production.

Per unit cost of production
total input/ total output = per unit cost of production

Changes in SRAS (decreases)

• Determinants of SRAS (all following affect production cost
• input prices
• productivity
• legal-institution environment

Input Prices

Domestic Resource Prices

• - wages (75% of all business cost)
• - cost of capital
• -raw material (commodity prices)

Foreign Resource Prices

• -Strong $ = lower foreign resources prices
• - weak $ = higher foreign resources pries

Market Power

• -Monopoly and cartels that control resources
• Increases in resource prices in= SRAS <-
• Decreases in resource prices= SRAS ->

Productivity
productivity = total out put/ total input

• more productivity= lower unit production cost = SRAS ->
• lower productivity = higher unit production cost= SRAS <-

Legal- Institutional Enviornment

• Taxes ($ to gov't) on business increase per unit production cost = SRAS <-
• Subsides ($ form gov't) to business reduce per unit productivity cost = SRAS ->

Government Regulation

• - government regulation creates a cost of compliance = SRAS <-
• - deregulation reduces compliance cost- SRAS-> 

Consumption

Household spending is affected by
-consumer wealth

• more wealth = more spending (AD shifts ->)
• less wealth = less spending (AD shifts <-)

-consumer expectations

• Positive expectations = more spending (AD shifts ->)
• Negative expectations = less spending (AD shifts <-)

-Household Indebtedness

• Less debt= more spending (AD shifts ->)
• more debt= less spending (AD shifts <-)

-Taxes

• less taxed = more spending (AD shifts ->)
• more taxes= less spending (AD shifts <-)

Gross Private Investment
- Investment spending sensitive to

The Real Interest Rate

• Lower Real Interest Rate =more investment (AD shifts ->)
• Higher Real Interest Rate = less investment (AD shifts <-)

Expected Returns

• High Expected returns =more investment (AD shifts ->)
• Lower expected returns = less investment (AD shifts <-)

- Expected returns are influenced by

• Expectations of future profitability
•  Technology
• Degree of excess capacity (existing stock of capital)

Government Spending

• More Gov't spending (AD ->)
• Less Gov't spending (AD <-)

Net Exports

• Net exports are sensitive to:
• - exchange rates (international value of a $)
• strong $ = more imports and fewer exports (AD<-)
• Weak $= fewer imports and more exports=(AD ->)

- Relative income

• strong foreign economies= more exports =(AD ->)
• weak foreign economies = less exports= (AD <-)

Aggregate Demand (AD)

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 the price level and the level of real GDP is inverse

Aggregate Demand Curve




Three Reasons AD is downward sloping

Real-Balance Effect

• When the Price-level is high household and businesses cannot afford to purchase as much out put.
• when the price-level is low households and businesses can afford to purchase more output

Interest Rate Effect

• A higher price level increases that interest rate which tends to discourage investment
• a lower price level decreases the interest rate which tends to encourage investment

Foreign-Purchase Effect

• A higher price level increases the demand for relatively cheaper imports
• A lower price level increases the foreign demand for relatively cheaper U.S exports

Shifts in Aggregate Demand (AD)

• There are 2 parts to shirts in AD
• - change in C, Ig, G, and/or Xn
• - multiplier effect that produces a greater change than the 4 components
• -- increases in AD= AD ->
• -- decreases in AD= AD <-

Increases in Aggregate Demand

Decreases in Aggregate Demand

Unemployment

Unemployment - is the percentage of people who don't have jobs, but are in the labor force

Labor Force - is the number of people in a country that are classified as either employed or unemployed.

Not in The Labor Force

1. kids
2. military personnel
3. mentally insane
4. prison
5. retired
6. stay at home parents
7. discouraged (homeless, lazy, try to get a job but are either under or over qualified, people who stopped looking for jobs)

Unemployment Rate Equation

# of unemployed

-------------------------------------- x 100

# Of unemployed + employed 

Labor force = # of unemployed + of employed


Types Of Unemployed

Frictional

• Between Jobs
• Quit Job for a better job
• Graduated from college and looking for one
• actively looking for a job

Structural 

• associated with a lack of skills of a declining industry
• Ex: High School drop out cant read or write 
• Technology changes

Seasonal 

• School bus drivers
• Santa, Easter Bunny
• Construction Workers
• Jobs that are done during a certain season of a year

Cyclical

• associated with down terms in the business cycle, had for society and individuals
• trough, then cyclical plays

What is full employment ???

Occurs when there is no cyclical employment in the economy

(Natural rate of unemployment -NRU) 4%-5%

Why is Unemployment bad?

"There is not enough consumption" GDP

"it creates to much poverty"

" too much government assistance"

why is Unemployment good?

less pressure to raise waged

more workers available for future expansion

OKUN'S Law

For every 1 percent of unemployment above the NRU (Natural Rate of Unemployment) causes a 2% decline in Real GDP

Inflation

Inflation- a rise in general price level of prices

Measuring inflation 2%-3%
a. Inflation rate- measures the percentage increase in the key indicator of economy health

1. Deflation- decline in general price level
2. Disinflation

b. Consumer Price Index- measures inflation by tracking a yearly price of fixed basket of goods and services

- indicates change in the cost of living and price level

Solving Inflation Problems 

a. finding inflation rate using market basket data

current year market basket value - base year market basket value

__________________________________________x 100

Base year market basket value                                   

b. Find inflation rate using price indexes

current year price index- base year price index

____________________________________x 100

Base year price index

c. estimating inflation using the rule of 70

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

Years needed to double inflation= 70

_________________________

annual inflation rate

d. Determining Real Wages

real wages is equal to nominal wages

-----------------------------------------x 100

over the price level 

e. Finding Real Interest Rate

Real Interest rate= nominal rate - premium

1. Real Interest Rate- the cost of borrowing or lending money adjusted to
2. Nominal Interest rate- the unadjusting cost of borrowing or lending money 

IV causes of inflation

a. demand-pull inflation- it is caused by an excess of demand over out put that pulls prices upward

b.  Cost-Push inflation- it is caused by a rise in per unit production cost due to increasing research cost

V Effects of Inflation

anticipated- you know it was going to hurt

Unanticipated- you have no idea of the sudden changes

Hurt by Inflation

• Fixed income leaders/ creditors
• savers

Help by Inflation

• borrowers

colors are equations

circular flow chart

1. In the flow chart, there are two markets . they divide into the Resource Market and the Product Market. Households play a role in the Resource Market by sending Supply and receiving money income, while Businesses send Costs and receive Demands. Households give Consumer Expectation to the Product Market while receiving goods and services. Businesses gives goods and services to the Product Market while receiving revenue.

2. Adding up all of the income earned by households and firms in a single year is the Income Approach and can be calculated by adding wages, rents, interest, profit, and statistical adjustment. Adding up the market value of all domestic expenditures made on final goods and services are considered Expenditure Flows and can be calculated by using "GDP = C + Ig + G + Xn"

3.GDP is the statistics on production of goods and income for a certain country during a year. A foreign-owned factory in the US would avoid certain taxes compared to a US owned factory.

4.GDP makes sure it does not count the same item multiple times, by not including certain things as GDP. These consist of Intermediate goods which are basically items that are not considered as the finished product, Secondhand goods that are considered used, Non Market activity, Financial Transactions, and Gifts.