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.

Graph 9 - Investment Demand

i - Interest = cost of doing.

Reasons to borrow money:

_ Business

_ Mortgage

_ Education 

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

Graph 8 - Consumption and Savings Link

C_{2 - consumption increase at every level of DI.}

_{The poor and rich are spending more.}

DI = Consumption + Saving

If C increase, then S decrease.

MPC + MPS = 1

Graph 7 - Savings Function

Graph 6 - Consumption Function

Unit 3 - Feb 25 (Classical vs. Keynesian)