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econs > AD/AS model and Fiscal Policy > Flashcards

AD/AS model and Fiscal Policy Flashcards

1
Q

iWhat is the AD/AS model?

A

a macroeconomic model which illustrates the relationship between the aggregate levels of expenditure and output(which equals income)
- identifies the point of equilibrium
where AO = AE which determines the
current level of econ activity

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2
Q

What is aggregate demand?

A

illustrates the total amount of spending by all sectors in the economy at difference price levels AD
= AE
- AD is negatively sloped -> as the general level of prices in the economy increases, total spending in the economy falls

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3
Q

What are the 3 reasons why AD is negatively sloped?

A

income effect
- open economy effect
- interest rate differential

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4
Q

What are the factors affecting shifts in AD?

A

C+I+G+(X-M)

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5
Q

2 Factors affecting AD: Consumption

A
  • Income
  • interest rates
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6
Q

2 Factors affecting AD: Investment

A
  • interesst rates
  • investment sentiment
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7
Q

2 Factors affecting AD: govt

A
  • changes in govt spending
  • level of economic activity
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8
Q

2 Factors affecting AD: net exports

A

-exchange rates
- terms of trade

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9
Q

What is aggregate supply?

A

illustrates the total amount of output produced by producers at each general price level
- AS curve not infinitely positively sloped
- the economy has a finite amount of resources, therefore cannot increase
“output indefinently”

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10
Q

What is short run aggregate supply curve?

A

illustrates the ability of producers to increase output in the short term
- output can be increased and will put pressure on prices to rise

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11
Q

8 What are factors affecting SRAS

A
  • price of imports eg capital
  • ER (price of imported capital)
  • price of oil, wages
  • ToT (price of imported capitals)
  • supply shocks eg natural disaster
  • sales tax
  • technology
  • productivity
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12
Q

What is long run AS curve

A

represents the productive capacity of the economy where resources are fully employed -> productive capacity of the economy
- it demonstrates the full employment Ivl of output (NAIRU-non accelerating inflation rate of UE)
- full employment Ivl of output without high inflation

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13
Q

5 Factors affecting LRAS

A
  • investment
  • technology
  • productivity
  • education/efficiency
  • changes to workforce
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14
Q

Contraction graph of LRAS/SRAS

A
  • vertical line of LRAS, is where AD and SRAS intersects.
  • equilibrium OE/O(FE), PE
  • sustainable growth
  • stable prices
  • full employment at the NAIRU
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15
Q

5 characteristics of Peak graph of LRAS, SRAS

A

vertical line of LRAS, is left side of equilibrium OE,PE
- high growth, demand pull inflation
- equilibrium O(FE), PE
- creating expansion gap
- operating at a level of output higher than OE (increase inflation)

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16
Q

6 characteristics of Trough graph of LRAS/SRAS

A
  • LRAS right side of OE,PE
  • equilibrium PE, O(FE)
    -creating contraction gap
  • trough has lower employment, OE (where we are at) is lower than O(FE)
    (where we want to be)
  • high cyclical UE, low growth
  • operating at a level of output lower than OE
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17
Q

3 Notes about lras/sras

A
  • AD = SRAS -> where the economy is
    at (macroeconomic equilibrium OE)
  • LRAS-> where we want to be →>
    O(FE)
  • O(FE) - tells us where we want to be
    (full employment level of output)
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18
Q

What are the 3 EPO’s(economic policy objectives), target rate, types.

A

Full employment (target UE 4%)
- cyclical: follows business cycle

Stable prices (target 2-3% infl rate)
- Demand pull excess demand
- cost push not enough supply

Sustainable growth (target 3.5-4%)
- sources:
- demand factors
-supply factors
- increase efficiency (allocative, dynamic, technical(productive))

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19
Q

AE model to show cyclical UE (full employment) 3 characteristics

A
  • at y(fe) the economy is operating at a full employment level of Y, output where cyclical UE is zero
  • fall in AE from AE(fe) to AE(def) creates a stock buildup which results in a decrease in production which reduces demand for resources including creating cyclical (or demand efficient UE)
  • economy contracts to Y(def) and economy is now operating at a level of income, output below full employment - creating deflationary gap
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20
Q

AD/AS model to show cyclical UE(full employment) 3 characteristics

A
  • at O(fe)LRAS the economy is operating at a full employment level of output where cyclical UE is zero
  • fall in AD from AD to AD1 creates a stock buildup which results in a decrease in production which reduces demand for resources including creating cyclical UE (or demand efficient UE)
  • economy contracts to OE1 and economy is now operating at a level of output below full employment - creating deflationary gap
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21
Q

AE model to show demand pull inflation 3 characteristics

A
  • at y(fe) the economy is operating at a full employment level of Y, output where prices are stanle
  • rise in AE from AE(fe) to AE(inf) creates a stock rundown which results in a increase in production which increases demand for resources, including labour
  • economy expands to Y(inf) and economy is now operating at a level of income, output aove full employment - creating inflationary gap
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22
Q

AD/AS model to show demand pull inflation 3characteristics

A
  • at O(fe)LRAS the economy is operating at a full employment level of output where prices are stable
  • rise in AD from AD to AD1 creates a stock rundown which results in a increase in production which increases demand for resources including labour
  • economy expands to OE1 and economy is now operating at a level of output above full employment - creating inflationary gap
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23
Q

AD/AS model to show cost push inflation 3characteristics

A
  • at O(fe) LRAS the economy is operating at a full employment level of output where prices are stable
  • decrease in AS from SRAS to SRAS1 due to increase in costs of proud, decreasing supply/prod, results in rise from PE to PE1
  • economy contracts to OE1 and economy is now operating at a level of output below full employment
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24
Q

AD/AS model to show sustainable growth: demand source 3characteristics

A
  • at O(fe)LRAS the economy is operating at a full employment level of output where growth is sustainable
  • rise in AD from AD to AD1 creates a stock rundown which results in a increase in production which increase demand for resources including labour
  • economy expands to OE1 and economy is now operating at a level of output above full employment - creating inflationary gap
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25
Q

AE model to show sustainable growth: demand source 3characteristics

A
  • at y(fe) the economy is operating at a full employment level of Y, output where growth is sustainable
  • rise in AE from AE(fe) to AE(inf) creates a stock rundown which results in a increase in production which increases demand for resources, including labour
  • economy expands to Y(inf) and economy is now operating at a level of income, output above full employment - creating inflationary gap
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26
Q

AD/AS model for sustainable growth: supply/ increase efficiency source

A

-

27
Q

What is fiscal policy?

A
  • refers to the chnages in the levels of taxation and government expenditure to stabilise economic activity
  • a macroeconomic policy: focuses on stimulating economy
  • demand management policy
28
Q

What the 3 budget outcomes of fiscal policy

A

Budget surplus (T>G)
Budget Deficit (G>T)
Balanced Budget (G=T)

29
Q

What are the two types of fiscal policy?

A

Expansionary and contractionary
- has the ability to expand and contract to minimise economic flunctuations

30
Q

What is expansionary fiscal policy? what budget outcome?

A
  • Budget deficit
  • refers to a situation where govt exp exceeds tax revenue - the govt injecting more money than leaking therefore the flow of income rises resulting in a expansion in economic activity
  • high UE BD
31
Q

What is contractionary fiscal policy? what budget out come?

A
  • Budget surplus
  • refers to a situation where taxation exceeds govt exp - the govt leaking more money than injecting therefore the flow of income falls resulting in a contraction in economic activity
  • high inflation BS
32
Q

What is Discretionary FP?

A

refers to deliberate changes to the levels of taxation revenue and government expenditure in order to stabilise economic activity - known as structural budget outcome

33
Q

What is non discretionary FP?

A

refers to automatic changes to the levels of taxation revenue and govt expenditure in order to stabilise economy activity - known as cyclical budget outcome
- is an example of automatic stabilisers other than T and G. other automatic stabilisers is savings and imports
- automatically change during certain economic conditions so that flunctatuions in the business cycle is reduced

34
Q

What are 4 automatic stabilisers

A
  • savings
  • imports
  • taxation
  • government expenditure
35
Q

The automatic stabilisers in a TROUGH(low AE,AY,AO) : Savings

A
  • falls during an economic contraction and trough phase due to low AY
  • savings is a leakage therefore less income is leaking from flow of income
  • expansionary effect on the economy, reducing flunctuations (stabilising effects)
36
Q

The automatic stabilisers in a TROUGH(low AE,AY,AO) : taxation

A
  • falls due to less tax revenue, income, spending
  • a leakage therefore less income is leaking from flow of income
  • expansionary effect on the economy, reducing flunctuations (stabilising effects)
37
Q

The automatic stabilisers in a TROUGH(low AE,AY,AO) : govt expenditure

A
  • rises due to switch to public g/s - increase in demand
  • cyclical UE high so high demand for govt welfare
  • a injection therefore more income is being injected into flow of income
  • contractionary effect
38
Q

The automatic stabilisers in a TROUGH(low AE,AY,AO) : Imports

A
  • falls due to less spending, income
  • a leakage therefore less income is leaking from flow of income
  • expansionary effect on the economy, reducing flunctuations (stabilising effects)
39
Q

What are the three function of a government budget

A
  • allocative
  • distributive
  • stabilising (fiscal policy)
40
Q

What is financial requirement

A

amount of funds an entity (indiviudal, group, organisation) requires to borrow

41
Q

What is net financial requirement

A
  • difference between the amount of funds the govt requires minus the amount the ogvt has to lend, when implementing fiscal policy
    -> POSITIVE: required borrowed funds (budget deficit)
    -> negative: funds available to lend (budget surplus)
42
Q

3 Ways to finance a budget deficit

A
  • selling new govt bonds to domestic and/or overseas residents
    -> downside: causes crowding out
  • borrowing from the central bank RBA
    -> downside: increases supply which created inflationary effects
  • borrowing from overseas
    -> downside: appreciation of aud
43
Q

Budget deficit - expansionary fiscal policy effects 6 characteristics

A
  • to expand the economy during low periods of economic activity, the government will implement a budget deficit
  • spending exceeds tax revenue
  • financed by selling government bonds
  • attract investors to the public sector (govt) by increasing interest rates on govt bonds
  • this causes investors to shift away from private sector towards government
  • the private sector becomes crowded out
44
Q

What is the paradox of a budget deficit

A
  • increase in interest ratest attract investors to the government has contractionary effect on economy
  • govt borrow more to und deficit = increase govt debt
  • means the budget deficit will not be as expansionary as intended
45
Q

Fiscal policy during a contraction AE model 5characteristic

A
  • an implementation of a budget deficit is demonstrated by a increase in G, from G to change in G, due to an increase in IR on govt bonds
  • this causes AE to increase from AE(Def) to AE(fe) as investors attracts to high IR
  • creates stock rundown which results in an increase in production, which increases demand for resources including labour, decrease in cyclical ue
  • increases AY(Y(DEF) TO Y(FE), demonstrates multiplier effect as rise in AE results in a greater increase in AY.
  • expansionary effects to Y(FE), removing deflarionary gap
46
Q

Fiscal policy during a contraction AD/AS model 4 characteristics

A
  • economy is operating at a level below full employment (OE1, PE1)
  • increase in IR on govt bonds, increases AD1 to AD2.
  • economy expands to o(fe)
  • economy now operating at full employment, removing deflationary gap
47
Q

What are 3 uses of a surplus

A
  • increasing personala nd company tax rates
  • reducing or postponing spending on major projects
  • increasing excise taxes such as those applied on sales of cars, tobacco, alc
48
Q

Budget surplus - contractionary fp effects 4 characteristics

A
  • to contract the economy during high period of econ activity
  • no financial requirement
  • deter investors to shift away from public sector (Govt) by decreasing the IR on govt bonds.
  • causes investors to shift away from public sector and towards private sector, and private secotr becomes crowded in
49
Q

Fiscal policy during a expansion AE model 6 characteristics

A
  • an implementation of a budget surplus is demonstrated by a decrease in G, from G to change in G, due to a decrease in IR on govt bonds
  • this causes AE to decrease from AE(inf) to AE(fe) as investors attracts to high IR
  • creates stock buildup which results in an decrease in production, which decreases demand for resources including labour
  • decreases AY(Y(inf) TO Y(FE), demonstrates multiplier effect as fall in AE results in a greater decrease in AY.
  • conftractionary effects to natural Y(FE), NAIRU removing inflationary gap
    -decreases demand pull inflation
50
Q

Fiscal policy during a expansion AD/AS model 4 characteristics

A
  • economy is operating at a level above full employment (OE1, PE1)
  • decrease in IR on govt bonds, decreases AD1 to AD2.
  • economy contracts to o(fe)
  • economy now operating at full employment, removing inflationary
51
Q

What is Commonwealth Govt Securities(CGS)

A

most important method of govt borrowing is by selling govt bonds, known as CGS

52
Q

What is gross debt?

A

total amount of borrowing by the govt
- no. of CGS isued

53
Q

What is net debt

A

gross debt minus the total govt lendings

54
Q

F3 Trends in gross debt and net debt over the decade

A

over the past decade, gross debt has increased at a faster rate than net debt indicating higher growth in govt borrowing than lending,
- indication of the large number of consecutive budget deficits over the time period
- actual budget surplus of 22.1b in 2022-23 - contractionary
- first surplus since gfc 2007-08
- a deficit of 28.3b in 2024-25 - expasnionary
predicted a deficit of 42.8b in 2025-26 - relatively expansionary as budfet deficit increase
- current planned budget out come 2024-25: deficit of 28.3 billion

55
Q

Planned vc Actual budget outcomes

A
  • budget delivered in may of each year and is a statement of the govt’s estimated exp(G) and revenue (T) for the next fiscal year
  • economicc conditions can change and alter budget estimates
  • revision of budget estimated occur in December or January, govt issues as assessment of economic conditions
56
Q

Why the planned budget differs from actual budget 5

A
  • prevailing economic conditions since last budget
    -> palans don’t always equal reality
  • changes in economic activity domestically
    -> downturns can result in a pallned surplus evaporating
    -> downturns may be less severe than predicted so smaller deficit could accur
  • global economic events like GFC, recessions
    -> changes in global demand
  • exogenous factors
  • Er movements, ToT, non economic events
57
Q

Automatic and discretionary changes that happened in 2020

A
  • increasig G spending included:
    -> jobseeker, jobkeeper(discretionary
    -> spending on infrastrucutre
    -> suport for covid hit industries
    -> support for retraining and apprenticeships

-falling T included:
-> falling company profits(Decrease in tax revenue)
-> falling h/h income (fall in income revenue)
- discretionary tax cuts

58
Q

How can fiscal policy enforce full employment?

A
  • expansionary stancr on fiscal policy -> implement a budget deficit
  • budget defifct will increase AD(AE) creating stockrundown, increase output, demand for resources including labour-> decrease in cyclical UE
59
Q

How can fiscal policy enforce price stability?

A
  • contractionary stance on FP -> implement budget surplus
  • will decrease AD(AE) - reduces inflationary pressure caused by overheated economy
  • AD falls causing dmenad pull inflation
60
Q

How can fiscal policy enforce sustainable growth?

A
  • expasnionary FP when the economy is experiencing a trouth/contraction
  • increase in AD by reducing income tax rate + corporate tax
    -> increase AD by increase spending in infrastructure +welfare+public g/s
  • increase ad -> stocm rundown
  • increase output (demand source of growth)
61
Q

4 types of time lags

A
  • recognition lag
  • decision lag- inside lag(govt)
  • implementation lag - inside lag (govt)
  • effect lag- outside lag (outside govT)
62
Q

What are 6 strengths of fiscal policy

A
  • outside lag is shorter than MP
  • controls the spending tap ->injection/withdrawal of funds in the economy
  • direct policy (G is a component of AE)
  • more effective in a trough than MP
  • influences by automatic stabilisers
  • selective - as govt can target specific industries/sectors
63
Q

What are 6 weaknesses of fiscal policy?

A
  • recognition lag
    -inside lags is longer than mp
  • crowing in/out means fiscal policy Is not as contractionary/expansionary as intended
  • political constraints
  • federal budget conflicts with state budget
  • inflexible -> difficult to change the budget->mid year budget adjustment

econs (6 decks)

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