2 - Unemployment and the fiscal policy Flashcards
in the economy as a whole what must you have?
cat just have a demand side you must have a supply side, incorporate this in explanation of short run fluctuations
what is the short run?
some factors are fixed and others variable, so what happens in the short term, can change some of them
what is the long run?
mor epermenent changes, all factors are variable
what is meant by descriptive analysis in this chapter?
- simple multiplier model
- complete multiplier model
- complete multiplier model with supply side
(how it works)
what is the presecritve analysis in this chapter?
- can fiscal policy be used to stabilise th economy?
- should fiscal policy be used to stabilise economy?
(how it should work?)
what is the simple multiplier model?
only looks are the demand side
deals with consumption and investment
(C+I)
what is the equation for C?
Co + C1 x Y
if you do a graph it is usually correlated, clear linear function
e.g. more money you have the more consumption
what is meant by Co?
- autonomous level / substance level
- financial crisis, things you have to spend money on no matter what, regardless of your income
what is meant by C1 x Y?
- variable amount
- C1 less than one but greater than 0 (e.g. if you had £1 you would spend some of it but save some)
- C1 = marginal propsentiy to consume
- how much will you consume if you earn that income
- consume proportion of income
what is meant by marginal propensity to consume?
- the proportion of disposable income that individuals spend on consumption
- if you had one extra unit of input how much would you spend
how can marginal propensity to consume differ from people to people?
if you have over draft you can go over one but many people do not
varies across countries
what is th equation for investment?
I (r, p, P )
investement rate
profit rate
discount rate
what’s the difference between investment and consumption?
in consumption once its gone its gone
what is investment rate?
firms behaviour and includes households e.g. when looking ar people investing in properties, or something durable
key determinant in multiplier model
if interest rate goes up there is a lower demand for investment
what is the multiplier model?
The multiplier model is an idea developed by Keynes which demonstrates that the additional economic activity generated by injecting a certain amount of money into a system exceeds the original sum
what is profit rate?
when economy in very bad times investor ends up with no profit
so profit rate is correlated with investment rate
rate of return on a an investment, if interest is low, profit rate is likely to be higher
what is discount rate?
subjective measure of impatience, higher impatience and lower demand for investment e.g. if your sick you will consume more and invest less as a discount rate is high
what does investment depend on?
investment rate
in the keynesian model what is assumed?
that there is no supply side in the multiplier model
short run model so it assumes that supply side satisfies demand (output always in excess supply)
what is the market clearing condition?
aggregate supply = aggregate demand
or y (income) = aggregate demand
when Y is factored out, what is the formula for the multiplier model (simple)?
Y =
1 / 1 - MPC (C1) x (Co + 1)
so if MPC = 60%
then your Y increases by 2.5
your spending becomes someones income to be spent (multiplier)
what is the multiplier effect?
occurs when somebodies consumption is somebody elses incomes and keep going
if a drop was to happen in the multiplier effect then whole economy would drop
what is the complete multiplier model equation?
AD = C + I + G + NX
if G is introduced into the model what happens?
- G : public goods and services, public investment
- if G increases so does the whole AD of the economy
- ## tax : affecting the consumption equation (introduction of G brings in tax)
what is the consumption equation when the government is introduced
C = Co + C1 (1 - t) Y
what is meant by (1-t) ?
government tax
what happens when NX is introduced
X = exports depends on the worlds income (exogenous)
net export is demand by the rest of the world, are your products important to others
- if your product can be substituted easily then your NX will fluctuate really high (e.g. coffee)
- NX = Exports - impor
how is imports determined?
M = m x y
m =marginal propensity to import
what is the marginal propensity to import?
amount tha imports increase or decrease when unit rise or decline with disposable income
what is the full multiplier equation?
Y = 1 / 1 - C1 (1 - t) + m (co + I + G + X)
once G + NX are introduced what happens to the economy?
usually becomes smaller as the denominator is bigger
wha is the last step in the multiplier model?
to fill the gap between keynesian world and reality world
thi sis because in the real world there is a supply side and this is the ga
what elaborates the supply side/
th production function
what is the production function.
relates quantity of factor input used by a business to the amount of output that results
what is the fiscal policy?
use of spending and tax policies to influence economic conditions (stabilise economy)
changing the levels of taxation and government sounding in order to influence AD and economic activity
what are three ways to dampen economic fluctuationss?
- size of gov
- unemployment benefits = few people save enough to smith consumption even if self inure
- gov can intervene = deliberalty to stabilise aggregate demand using fiscal policy
what is the purpose of the fiscal policy?
- stimulate economic growth in a period of a recession
- keep inflation low
- fiscal policy aims totsbilisie economic growth, avoiding a boom and bust economic cycle
often use din conjunction with monetary policy
what is expansionary fiscal policy?
- involves increasing AD
- government will increase spending (G) and cut taxes (T) lower taxes will increase consumers spending because they have more disposable income (C)
- ned to worsen government budget deficit and the gvermnmet well need to increase borrowing
what is deflationary fiscal policy?
- decreasing AD
- cut gov spending and increase taxes, higher taxes will reduce consumer spending (C)
- tight fiscal policy will tend to cause an improve in the government budget deficit
what are the factors that the success of fiscal policy depends on?
- size of the multiplier, if multiplier large then changes in gov spending will have bigger overall effect
- state of economy, most effective in deep recession, where monetary is insufficient
does fiscal policy work?
should we use it?
keynsian yes: in a recession it increases AD, causing higher output, creation of jobs
classic: no just just causes inflation in the long run
