2 - Unemployment and the fiscal policy

Question 1

in the economy as a whole what must you have?

Answer 1

cat just have a demand side you must have a supply side, incorporate this in explanation of short run fluctuations

Question 2

what is the short run?

Answer 2

some factors are fixed and others variable, so what happens in the short term, can change some of them

Question 3

what is the long run?

Answer 3

mor epermenent changes, all factors are variable

Question 4

what is meant by descriptive analysis in this chapter?

Answer 4

• simple multiplier model
• complete multiplier model
• complete multiplier model with supply side

(how it works)

Question 5

what is the presecritve analysis in this chapter?

Answer 5

• can fiscal policy be used to stabilise th economy?
• should fiscal policy be used to stabilise economy?

(how it should work?)

Question 6

what is the simple multiplier model?

Answer 6

only looks are the demand side
deals with consumption and investment

(C+I)

Question 7

what is the equation for C?

Answer 7

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

Question 8

what is meant by Co?

Answer 8

• autonomous level / substance level

- financial crisis, things you have to spend money on no matter what, regardless of your income

Question 9

what is meant by C1 x Y?

Answer 9

• 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

Question 10

what is meant by marginal propensity to consume?

Answer 10

• the proportion of disposable income that individuals spend on consumption
• if you had one extra unit of input how much would you spend

Question 11

how can marginal propensity to consume differ from people to people?

Answer 11

if you have over draft you can go over one but many people do not

varies across countries

Question 12

what is th equation for investment?

Answer 12

I (r, p, P )
investement rate

profit rate

discount rate

Question 13

what’s the difference between investment and consumption?

Answer 13

in consumption once its gone its gone

Question 14

what is investment rate?

Answer 14

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

Question 15

what is the multiplier model?

Answer 15

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

Question 16

what is profit rate?

Answer 16

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

Question 17

what is discount rate?

Answer 17

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

Question 18

what does investment depend on?

Answer 18

investment rate

Question 19

in the keynesian model what is assumed?

Answer 19

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)

Question 20

what is the market clearing condition?

Answer 20

aggregate supply = aggregate demand

or y (income) = aggregate demand

Question 21

when Y is factored out, what is the formula for the multiplier model (simple)?

Answer 21

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)

Question 22

what is the multiplier effect?

Answer 22

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

Question 23

what is the complete multiplier model equation?

Answer 23

AD = C + I + G + NX

Question 24

if G is introduced into the model what happens?

Answer 24

• 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)

Question 25

what is the consumption equation when the government is introduced

Answer 25

C = Co + C1 (1 - t) Y

Question 26

what is meant by (1-t) ?

Answer 26

government tax

Question 27

what happens when NX is introduced

Answer 27

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

Question 28

how is imports determined?

Answer 28

M = m x y

m =marginal propensity to import

Question 29

what is the marginal propensity to import?

Answer 29

amount tha imports increase or decrease when unit rise or decline with disposable income

Question 30

what is the full multiplier equation?

Answer 30

Y = 1 / 1 - C1 (1 - t) + m (co + I + G + X)

Question 31

once G + NX are introduced what happens to the economy?

Answer 31

usually becomes smaller as the denominator is bigger

Question 32

wha is the last step in the multiplier model?

Answer 32

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

Question 33

what elaborates the supply side/

Answer 33

th production function

Question 34

what is the production function.

Answer 34

relates quantity of factor input used by a business to the amount of output that results

Question 35

what is the fiscal policy?

Answer 35

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

Question 36

what are three ways to dampen economic fluctuationss?

Answer 36

• 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

Question 37

what is the purpose of the fiscal policy?

Answer 37

• 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

Question 38

what is expansionary fiscal policy?

Answer 38

• 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

Question 39

what is deflationary fiscal policy?

Answer 39

• 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

Question 40

what are the factors that the success of fiscal policy depends on?

Answer 40

• 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

Question 41

does fiscal policy work?

should we use it?

Answer 41

keynsian yes: in a recession it increases AD, causing higher output, creation of jobs

classic: no just just causes inflation in the long run