Unit 3 - Feb 27 (Fiscal Policy)

Fiscal Policy - changes in the expenditure or tax revenue of the federal government.

• 2 Tools
• Taxes - government can increase/decrease taxes.
• Spending - government can increase/decrease spending.
• Fiscal Policy is enacted to promote our nation's economic goals: 
• Full employment
• Price stability
• Economic growth

Deficit, Surpluses, and Debt

• Balance budget
• Revenue = expenditure
• Budget deficit
• Revenue < expenditure
• Budget surplus
• Revenue > expenditure
• Budget debt
• Deficit - surplus
• Government must borrow money, when it runs a budget deficit.
• Government can borrow from 
1. Individuals (taxing)
2. Corporation
3. Financial institutions
4. Foreign entities / foreign government

Fiscal Policy has 2 options

• Discretionary Fiscal Policy (action)
• Expansionary Fiscal Policy - think deficit.
• Contractionary Fiscal Policy - think surplus.
• Non-discretionary Fiscal Policy - no action.

Discretionary vs. Automatic Fiscal Policy

• Discretionary - increasing/decreasing government spending and or taxes in order to full employment.
• Automatic - unemployment compensation and margin tax rates are examples of automatic policies that help mitigate the effects of recession and inflation.

Contractionary vs. Expansionary 

• Contractionary - policy designed to decrease AD.
• Strategy used to control inflation
• Expansionary - policy designed to increase AD.

Recession is countered with expansionary policy.

• Increase government spending.
• Decrease taxes.

Contractionary - inflation countered.

• Increase government spending.
• Decrease taxes.
• Unemployment increases.

Automatic/Built-in Stabilized - anything that increase the government budget deficit during a recession and increase it's budget surplus during inflation without regulating explicit action by policy makers (Transfer payment).

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 that falls with GDP.

Unit 3 - Feb 26 (Interest Rate vs. Investment Rate)

Investment - money spent or expenditure on:

• New plans (factories)
• Capital equipment (machinery)
• Technology (hardware/software)
• New homes
• Inventories (goods sold by producers)

Expected Rate of Return

• How does business make investment decision?
• Cost/benefit analysis.
• How does business determine the benefits?
• Expected rate of return.
• How does business count the cost?
• Interest cost.
•  How does business determine the amount of investment they undertake?
• Compare expected rate of return to interest cost.
• Expected cost > interest cost, then invest.
• Expected cost < interest cost, then don't invest.

Real (r %) vs. Nominal (n %)

• Differences?
• Nominal - observable rate of interest.
• Real - subtracts out inflation(π %) and is only known ex post facto.
• Real interest rate (r %)
• r % = i % - π %
• What determine the cost of investment decision?
• The real interest rate (r %).

Investment Demand Curve (ID)

• Downward sloping.
• Why?
• When interest rate is high, fewer investments are profitable.
• When interest rate is low, more investments are profitable.
• Determinants
1. Cost of production
2. Business tax
3. Technological changes
4. Stock of capital
5. Expectation

Unit 3 - Feb 25 (Classical vs. Keynesian)

Changes in the Equilibrium Price Level and Output

AS/AD Practices

Unit 3 - Feb 21 (Ranges of AS)

3 Ranges of AS

1. Horizontal/Keynesian - includes only level of real output, that are less than full employment. Implies that economy is in a recession.
2. Vertical/Classical - the economy reaches its full capacity full output. Increase in price level equal to constant production.
3. Intermediate - expansion of real output and price level. Actual GDP can actually exceed full employment. 

Shift in AS

Unit 3 - Feb 20 (Aggregate Supply)

Long run vs Short run

• Long run - period of time where the input prices are completely flexible and adjust to changes in price level. In long run, the level of real GDP supplied is independent of the price level.
• Short run - period of time where the input prices are sticky and do not adjust to changes in the price level. In short run, the level of real GDP supplied is directly related to the price level.

Long run aggregate supply (LRAS) - marks the level of full employment in the economy (analogous to PPC).  

Changes in short run aggregate supply (SRAS)

. an increase in SRAS is seen as a shift to the right (--->)

. a decreases in SRAS us seen as a shift to the left (<---)

. the key to understanding shifts in SRAS is per unit cost of production.

. per-unit production cost : Total input cost / Total output.

Determinants of SRAS

1. Input prices

     . increase in resource prices : SRAS (<---)

     . decrease in resource prices : SRAS (--->)

. Domestic resource prices

     _ Wages (75% of all business costs)

     _ Cost of capital

     _ Raw materials (commodity prices)

. Foreign resource prices

     - Strong money = lower foreign resource prices

     - Weak money = higher foreign resource prices

. Market power - monopolies and cartels that control resources control the price of those resources

2. Productivity

. Productivity: Total output / Total input

     - more productivity equals lower unit production cost = SRAS (--->)

     - lower productivity equals higher unit production cost = SRAS (<---)

3. Legal-institutional environment

. Taxes and subsidies

     - taxes ( money to government) on businesses increase per unit production cost = SRAS (<---)

     - subsidies (money from government) to business reduce per unit production  cost = SRAS (--->)

. Government regulation

     - government regulation creates a cost of compliance = SRAS (<---)

     - deregulation reduces compliance costs = SRAS (--->)

Full Employment - equilibrium exists when AD intersects SRAS and LRAS at the same point. 

Recessionary Gap - exists when equilibrium occurs below full employment output. 

Inflationary Gap - exists when equilibrium occurs beyond full employment output. 

Change in AD

C, Ig, G, Xn - Increases

AD ---> : Increases - RGDP, PL, Inflation (π). 

             Decreases - Unemployment. 

Change in SRAS

Increase -  Productivity 

Decrease - Input Price

SRAS ---> : Increases - RGDP. 

                Decreases - PL, Inflation (π), Unemployment. 

Unit 3 - Feb 19 (Aggregate Demand)

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

Increase in A.D.

Decrease in A.D.

3 Reasons A.D. is a downward sloping
   1. Real balance effect
. when the price level is high households and businesses cannot afford to purchase as much output.
. when the price level is low households and businesses can afford to purchase more output.
   2. Interest-rate effect
. a higher price level increases the interest rate which tends to discourage investment.
. a lower price level decreases the interest rate which tends to encourage investment.
   3. Foreign purchases effect
. a higher price level increases the demand for relatively cheaper imports.
. a lower price level increases the foreign demand for relatively cheaper us exports.

Shifts in Aggregate Demand (A.D.)
  . change in consumption (C), investment (Ig), government purchases (G), and net exports (Xn).
  . a multiplier effect that produces a greater change then the original change in 4 components
. Increases in A.D. = A.D. move right (--->).
. Decreases in A.D. = A.D. move left (<---).

Determinants of A.D.
1. Consumption spending
 . Consumer Wealth
     . more wealth : more spending (--->)
     . less wealth : less spending (<---)
 . Consumer Expectations
     . positive expectations : more spending (--->)
     . negative expectations : less spending (<---)
 . Household Indebtedness
     . less debt : more spending (--->)
     . more debt : less spending (<---)
 . Taxes
     . less taxes : more spending (--->)
     . more taxes : less spending (<---)
2. Investment spending
 .Real Interest Rate
     .lower real interest rate : more investment (--->)
     .higher real interest rate : less investment (<---)
 .Expected Returns
    .higher expected returns : more investment (--->)
    .lower expected returns : less investment (<---)
 .Expected returns are influenced by
     1. Expectations of future probability
     2. Technology
     3. Degree of excess capacity (existing stock of capital)
     4. Business taxes
3. Government spending
     .more government spending (--->)
     .less government spending (<---)
4. Net Exports
  .Exchange Rates (International value of money)
      .strong money : more imports and fewer exports (<---)
      .weak money : fewer imports and more exports (--->)
  .Relative Income
     .strong foreign economies : more exports (--->)
     .weak foreign economies : less exports (<---)