Fiscal policy


Gov't can stabilize the economy by

Fiscal Policy- action by congress to stabilize the economy.

Changes in the expenditures or tax revenues of the federal gov't
.
2 tools
Taxes- gov't cant increase or decrease
Spending- gov't can increase or decrease

FP is enacted to promote por nation's economic goals: full employ., price stability, economic growth.

Deficits, Surpluses, and Debts
Balanced
Revenues= Expenditures
Budget Deficit
Revenues < Expenditures
Budget Surplus
Revenues > Expenditures
Gov't Debt= sum of all deficits- sum of all surpluses

Disposable Income- Income after taxes or net income

DI= Gross Income- Taxes


2 choices w/ DI
Consume or Save

Consumption
Household spending
The ability to consume is contracted by
-the amount of disposable in.
-the propensity to save
Do households consume if DI=0
-Autonomous Consumption
-Dissaving
APC= C/DI that is spent saving

Saving
-Household not spending
-the ability to save is constrained by amount of disposable income
-the propensity to consume
Do households save if DI=0? No

APS =S/ DI= DI that is not spent

APC and APS
APC & APS= 1
1-APC= APS
1-APS=APC

APC >1- Dissaving
-APS: Dissaving

MPS & MPC

-Marginal propensity to consume
change in consumption/ change in disposable income
-% of every extra dollar earned that is spent

-Marginal Propensity to Save
-change in savings/ change in disposable income
-% of every extra dollar earned that is saved
MPC+MPS= 1
1-MPC= MPS
1-MPS= MPC

Determinants
-expectations
-household debt
-taxes


Spending Multiplier Effect
 An initial change in spending causes a larger change in aggregate spending or aggregate demand.

Multiplier= Change in AD/ Change in spending


Expenditures an income flow continuously which sets off a spending increases in the economy.

Spending Multiplier= 1/1-MPC or 1/MPS

Multipliers are pos. w increase of spending and neg. when there is a decrease.


Tax multiplier
- always negative, works in reverse
-MPC/1-MPC or -MPC/MPS

if there is a tax cut then the multiplier is pos.

Reason Prices might be sticky in a downward sloping direction
-menu costs
-price war
-wage contrasts
-minimum wage
-morale, effort, and productivity

What is Investment?
-Money spent or expenditures on:
-New plants (factories)
-Capit. Equipment (machinery)
-Technology(hardware & software)
-New homes
-Inventories(good sold by producers)

Expected Rate of Return
-How does business make investment decisions
-cost/benefits analysis
How does business determine the benefits?
-Expected ratio of return

How does business count the cost?
-Interest costs

How does business determine the amount of investment they undertake?
Compare expected rate of return to interest cost

If expected return> interest cost, then invest
                            < interest cost, then dont

Real (R%) v. Nominal (i%)
Whats the difference?
-Nominal is the observance rate of interest. Real subtracts out inflation (pi%) and is only known as expost facto

How do you compute the real?
r%= i%-pi%

What determines the amount of an investment decision
The real interest rate(%)

Investment Demand Curve (ID)
-Downward sloping

Shifts
-cost of production
-business taxes
-Tech changes
-Stock of capital
-expectations

Aggregate supply
- The level of Real GDP that firms will produce at each price level. (PL)
Long Run- Period of time where input prices are completely flexible and adjust to changes in PL.
The level of real GDP supplied is independent of PL.
Short run- POT. where input are sticky and do not adjust to changes in PL. The level of Real GDP supplied is directly related to the PL.
LRAS- Long run Agg. Supply- marks the level of full employment in the economy (analogous to PPC)
SRAS- Because input prices are sticky in the short run, the SRAS is upward sloping.

An increase in SRAS shifts right, decrease shifts left


Per unit production cost= total input cost/total output

Determinants of SRAS
all affect unit produced
-input prices
-productivity
-legal institutionalized environment


Domestic Resources Prices
-Wages (75% of all business costs)
-Cost of capital
-Raw materials
Foreign Resources Prices
-Strong $= lower FRP
-Weak $= higher FRP

Market power
-Monopolies and canels that control resources, control the price of those resources.
Increase in resources prices= SRAS shift left
Decrease- shifts right.

Productivity= total output/total inputs

More productivity=lower init productivity cost= SRAS shift right

Lower productivity= higher unit production cost = SRAS shift left

Legal Institutional Environments
-Taxes and subsidies
-Taxes($ to gov't)
Increase per unit production cost= SRAS shifts left
-subsidies($ from gov't) to business reduce per unit production cost= SRAS shifts right.

Government Regulation
-Gov't Reg. creates a cost of compliance= SRAS shifts left
-Deregulation reduces compliance costs= SRAS

Aggregate demand curve

AD is the demand by consumers businesses, gov't, and foreign countries.

Changes in price level cause a move along the curve not a shift of the curve.

AD= C+ I+ G+ Xn


-The relationship between the price level of real GDP is inverse and vice versa.


Why AD is downward
-Wealth effect- Prices increase. purchase power of dollar decreases.
-Decrease the quantity of expenditures 
-Lower prices level increases. purchasing power increase and increase expenditures.

-Interest Rate effect
As PL increases, lenders need to charge.

Higher interest rates to get a real return on their loans
Increase rates increase discourage consumer spending and businessinvestment.

-Foreign Trade effect 
When US price levels increase, foreign buyers purchase fewer U.S goods and Americans buy more foreign goods.

Exports fall and imports rise causing real GDP demanded to fall (Xn deceases)

Shifts in AD 

Two ways 
- A change in C+Ig+ or Xn 
-Multiplier effect that produces a greater change than the original change in 4 components
Increase in AD= AD shifts right, decrease shfts left

Determinants of AD
-Consumption
-Gross Private Investment
-Gov't Spending
-Net Exports

Change in consumer spending 
-consumer wealth(boom in stock market)
-consumer expectations- (people fear a recession)
-households indebt (more consumer debt)
-Taxes( decreases in income taxes)

Change in Investment Spending 
-Real interest Rates(price of borrowing)
                               (If interest rate increasing)
                               ( If interest Rate decreasing)
Future Business Expectations (High Expectations)
Productivity and technology (New robots)
Business Taxes (Higher corporate Taxes)

Change in gov't spending
-War
-Nationalized Health Care
Decrease in defense spending

Change in Net exports 
-Exchange rates
-(If the US dollar depreciates relative to the euro)
Nat'l Income compared to Abroad
(if a mjor importer has a recession)
(if a US has a recession) 
"If the US gets a cold, Canada gets Pneumonia) 

AD= GDP= C+I+G+Xn

Government Spending
More Gov't spending (AD shifts right)
Less Gov't spending (AD shifts left)