fiscal policy
changing government spending or taxes in order to treat the ailments facing the economy
automatic stabilizers
a way to achieve fiscal policy; if GDP is increasing, tax revenues will increase as a result of rising incomes; if GDP decreasing, the amount of money in circulation decreases, transfer payments and subsidies from the government increase which increases d
discretionary stabilizers
these are short-term changes in taxes and government spending that takes place when Congress decides they are needed
contractionary fiscal policy: decrease government spending and/or increase taxes
what discretionary stabilizers fix inflation?
expansionary fiscal policy: increase government spending and/or decrease taxes
what discretionary stabilizers fix unemployment?
recognition lag; administrative lag; operational lag; expansionary bias; political business cycle; export effect; crowding-out effect; effectiveness of decreasing taxes
what are problems with fiscal policy?
because consumption makes up about 70% of GDP spending, and investment is the most volatile of the four components of GDP
why do policy makers target consumption and investment to encourage economic growth?
disposable income
income - taxes
marginal propensity to consume (MPC)
determines how a change in disposable income is likely to affect consumption
marginal propensity to save (MPS)
determines how likely a change in disposable income is to affect saving
MPC = change in consumption / change in income
what is the formula for MPC?
MPS = change in saving / change in disposable income
what is the formula for MPS?
MPC + MPS = 1
what is the relationship between MPC and MPS?
spending multiplier
describes the ripple effect any change in spending as on our economy
1/MPS or 1/1-MPC
what is the formula for spending multiplier?
tax multiplier = -MPC / MPS
what is the formula for tax multiplier?
if underestimate, fiscal policy changes will add too much money to the economy, causing inflation; if overestimate, fiscal policy changes will not influence the economy enough to overcome the problem of unemployment
why is it important for the government to understand MPC of customers?
balanced budget multiplier
the factor by which a change in both spending and taxes changes real GDP; always equals one
Aggregate Supply / Aggregate Demand graph
represents
all
goods and services produced in the entire economy
consumer wealth
(when consumers have more money, they purchase more goods and services);
consumer expectations
(when expect econ will grow in future, purchase more);
consumer indebtedness
(when ow less money, purchase more);
taxes
(when disposable income
what are changes in consumer spending (C) that are determinants of aggregate demand?
interest rates
(when interest rates low, cost of borrowing low, investment increases);
profit expectations
(when businesses expect high profits, purchase more capital, investment increases);
business taxes
(when business taxes low, investment increases);
what are changes in investment (I) that are determinants of aggregate demand?
if gov spending increases, amt of goods/services purchased in an econ increases
how does a change in gov spending affect aggregate demand?
national income abroad
(when income of consumers overseas increases, exports rise);
exchange rates
(when dollar depreciates relative to other currencies, exports rise)
what are changes in foreign trade (X-M) that are determinants of aggregate demand?
domestic resource availability
(decrease domestic input prices lead to increase in AS);
prices of imported resources
(decrease foreign input prices lead to increase in AS);
market power
(ability to avoid costs of competition lead to increase AS);
changes
what are determinants of aggregate supply?
capital investment boom (or bust) - increases (or decreases) investment; rise (or fall) of the interest rate - decreases (or increases) investment or consumption; consumer boom (or bust) in the country of one of our major trading partners - increases (or
what are demand shocks and how do they affect AD?
an unexpected rise (or fall) in the price of essential inputs - shift AS left (or right); invention of a new tech (or sudden absence of tech) - shift AS right (or left)
what are supply shocks and how do they affect AS?
econ is in recession or a depression
how is the economy when equilibrium in Keynesian range (current GDP < potential)?
healthy econ, where increases in GDP respond with acceptable increases in the price level
how is the econ when equilibrium is in intermediate range (current GDP = potential)?
econ is at full production and any further increase in AD will only drive up the price level
how is the econ when equilibrium is in classical range?
long-run aggregate supply (LRAS)
a measure of potential output; always drawn as a vertical line because it is independent of price level
the quality and quantity of human and physical capital available; the productivity of the factors of production; the availability of tech
what is LRAS determined by?
recessionary gap
what occurs when the equilibrium quantity of output is below potential output
inflationary gap
real GDP is greater than potential GDP
Phillip's Curve
shows the relationship between unemployment and inflation
cause movements along the LRPC, not a movement of the LRPC itself
how does changing inflation rate affect LRPC?
AD i --> PL i, RGDP i, CRU d, move up SRPC (inflation i and CRU d);
AD d --> PL d, RGDP d, CRU d, move down SRPC (inflation d and CRU i);
SRAS i --> PL d, RGDP i, CRU d, SRPC shift left;
SRAS d --> PL i, RGDP d, CRU i, SRPC shift right
what are the four types of shock and their effects? (i=increase, d=decrease)