Discussion sheets 2 Flashcards
Per-worker production function
The relationship between real GDP per hour worked and capital per hour worked, holding the level of technology constant
Key assumption to long run economic growth
Capital is subject to diminishing returns
Law of diminishing returns: as more capital per worker is added to the production process, output per worker increases at a decreasing rate
Labor Productivity
Refers to the amount of goods and services that a worker can produce from each hour of work
Total output (real GDP)
Total # of hours of labor used to produce that output
Who are on demand side in a lonable funds market?
spenders/borrowers
Whose on the supply side in a lonable funds market?
savers/lenders
Equilibrium in lonable funds market
Interest rate and investment (quantity of lonable funds)
Demand curve for lonable funds shifters - Krugman
Changes in perceived business opportunities
Changes in the government’s borrowing
Supply curve for lonable funds shifters - krugman
Changes in private savings behavior
Changes in capital inflows
Marginal propensity to consume
MPC = Changes in consumption
Change in desposable income
= ∆C
∆YD
MPC =
The slope of the consumption function
Consumption function
The relationship between consumption spending and disposable income
Disposable income
National income - (Taxes - Government transfer payments)
Disposable income* =
National income - Net Taxes
Net Taxes =
Taxes - Transfers
Marginal propensity to save:
= Change in saving
Change in disposable income
= ∆S
∆YD
National Income =
Consumption + Savings + Taxes
Y = C + S + T
MPC + MPS =
1
Aggregate Expenditure Model
A macroeconomic model that focuses on the relationship between total spending and real GDP, assuming the price level is constant
Aggregate expenditure =
Consumption + Planned investment + Government purchases + Net exports
AE = C + I + G + NX
Actual investment =
(Planned investment) + (Unplanned change in inventories)
AE + unplanned change in inventories =
GDP
Macreconomic equilibrium occurs when
AE = GDP
*there is no unplanned change in inventories
When AE < GDP
inventories will rise
GDP and total employment will fall
production will fall
When AE > GDP
Inventories will fall
GDP and total employment will rise
Production will increase
The Multiplier Effect
The proces by which an increase in autonomous expenditure leads to a larger increase in real GDP
Autonomous expenditure
Expenditure that does not depend on the level of GDP
Multiplier =
∆Y
∆Autonomous expenditure
Multiplier* =
1
1 - MPC
The AD curve shows:
The relationship between the price level and the quantity of real GDP demanded by households
Why is the AD curve downward sloping?
Assum that G is determined by government policy and is not affected by the price level
Wealth effect: changes in the price level affect C
Interest-rate effect: change in the price level affect I
International-trade effect: changes in the price level affect NX
Variables that shift the AD curve
Changes in government policy -Monetary and Fiscal Policy
Changes in the expectations of households and firms
Changes in foreign variables (exchange rates)
Long-Run Aggregate Supply (LRAS)
Long-run relationship between the price level and quantity of real GDP supplied (vertical line)
*does not depend on the price level, because it is determined only by labor, capital, and technology
Short-run Aggregate Supply (SRAS)
short-run relationship between the price level and quantity of real GDP supplied (upward sloping curve)
Why is SRAS upward sloping?
because prices of inputs rise more slowly than prices of final goods and services (sticky wages and prices)
Variables that shift the SRAS:
Increase in the labor force and the capital stock
Technological change (change in productivity)
Expected changes in the future price level
Unexpected changes in the price of an important natural resource (oil)
Goals of Fiscal Policy
Government can change taxes and government expenditures to achieve various macroeconomic policy objectives
- Stable Prices
- High Employment
- Economic Growth
Automatic stabilizers
Government spending and taxes that change automatically with business cycles
*NOT considered fiscal policy
ex. unemployment insurance claims
Expansinoary Fiscal Policy
Government reduces taxes or increases government spending to shift AD right
Increases GDP and Prices
Contractionary Fiscal Policy
Government increases taxes or reduces government spending to shift AD left
Decreases GDP and Prices
Limits of Fiscal Policy
Fiscal policy can be poorly timed - if government implements a tax cut when a recession is about to end, AD can shift too far right, and the result will be higher inflation
Fiscal policy is tougher to reverse than monetary policy because it takes time to vote on tax cuts/spending bills, while the Fed only has to conduct open market operations
Multiplier effect
How an initial increase in autonomous expenditures leads to a series of increases in consumption spending
Why is the tax multiplier (in absolute value) smaller than the government purchase multiplier?
The fraction of the tax cut that households save and spend on imports will not increase aggregate demand
Crowding out
How increasing government spending can cause private expenditures to decrease (sensitivity to the interest rate)
Budget defecit
Government expenditures > tax revenue
Budget surplus
Government expenditures < tax revenue
Cyclically adjusted Budget deficit/surplus
The deficit or surplus that the federal government would have if the economy were at potential GDP
*Shows would would happen if the business cycles were not occurring
**Used to determine the true size of the deficit/surplus
Tax Wedge
The difference between pre-tax and post-tax return to an economic activity
Income tax
Lower income taxes increase the quantity of labor supplied in the economy, which can increase aggregate supply
Corporate Income Tax
Lower corporate income taxes allow firms to have more money that they can use for investment of for reserach and development, which can potentially increase the pace of technological change
Taxes on Dividends and Capital Gains
Lowering taxes on stock dividend payments and capital gains payments can increase the supply of loanable funds from households to firms and increase savings and investment and lowering the quilibrium real interst rate
Economic Effect of a Tax Reform
Tax reforms can increase the size of the labor force, and the amount of investment in a new capital and newer technology, so the result is that it can increase potential GDP growth further
Government purchases Multiplier
∆Y
∆G
=
1
1 - MPC
Government purchases Multiplier with taxes
∆Y
∆G
=
1
1 - MPC (1 - t)
Tax Muliplier
∆Y
∆T
=
- MPC
1 - MPC
Balanced budget Multiplier (∆G = ∆T)
∆Y
∆G
+
∆Y
∆T
= 1
Lump-sum tax
Yd = Y - T
Tax rate
Yd = (1 - t) x Y
