Econ-Chapter 11 Flashcards
Say’s Law
supply creates its own demand,
if you supply a good, you demand something of equal value in return
works in a barter economy
Say’s law holds even in a money economy because
the interest rate adjusts to eliminate shortages or surpluses of funds
say’s law relies on
free market adjustments of interests rates that guarantees that there cannot be a general overproduction or underproduction of goods
potential GDP
where output is at its maximum given our inputs and technology
the relationship between potential output and unemployment
since wages adjust to eliminate shortages and surpluses, we must always be at our potential
gut of goods
happens because market might not adjust quickly to huge systemic changes-such as earthquakes or war
real business cycle theory
much of business cycle comes from real shocks to productivity
keynes beliefs that markets might not
reach equilibrium quickly
keynes idea of animal spirits
the economy starts at full employment then , irrationally pessimistic feelings that are called this spread throughout the economy, now people want fewer goods causing prices to fall
keynes addition to the “pizza place example”
prices of output adjust first, but two things prevent resource prices , including wage, form changing quickly
The output (pizza) price falls
firms cut wages
mistake nominal wage cuts for real wage cuts
Workers might have contracts
have to eventually fire workers
however, when output of pizza falls ..
keynes left out how people could search of nonexistent higher paying wages for over a decade
keyenes fails to explain with labor contracts
people who loose their job could then find lower paying jobs leaving no unemployment
recessionary gap
keynes called the difference between potential and GDP and the recessionary equilibrium’s GDP this
in a recessionary gap
unemployment is higher than the natural rate of 5.5%
inflationary gap
the difference between potential GDP and the actual GDP this
inflationary gap unemployment would be
lower than the natural 5.5%
Keynes said
the great depression as because labor markets refused to adjust and the gov. needed to spend more, tax cut policies, and direct gov. spending
fiscal policy
the policy of using spending and taxes to cure inflationary and recessionary gaps
in a recessionary gap the gov. should
spend more than it taxes, to create employment
in an inflationary gap the gov. should
tax more than it spends, to create a surplus
James Buchanan
keyenes ideas for running recessionary gaps-would be followed
but the idea for inflationary gaps-would not be followed
Where does the money come from to run deficits to cure recessionary gaps
- taxes, redirects spending
- money creation,leaves output unchanged
- borrowing,increased demand for loanable funds which will raise interest rates
friedman and schwartz’s 1971 book
is an unchallenged claim that money creation fuels inflation without increasing long run growth
if demand increases, the new equilibrium is only half that
businesses and firms are now crowded out of the loanable funds market
no free lunch when
borrowing locally, and borrowing domestically won’t have to pay back until long run)
Greece
spent a lot financed through foreign sources
germans were able to pay and greece
Keynes fits under the make-work fallacy rule
the idea that jobs have value other than the value of goods and services that the labor produces
The economic stimulus Act of 2008
authorized sending checks to taxpayers-calling the payments “tax rebates”
people who didn’t even pay taxes could receive this “rebate”
takes nine months to elapse
HOWEVER
- most recessions are shorter than the time-lapse of nine months
- politicians don’t usually know when an economic problem begins
Fiscal policy is subject to the following lags
The data lag, the legislative lag,the transmission lag,the effectiveness lag
The data lag
the time it takes to realize there is a problem
the legislative lag
politicians do not agree on spending and taxes and, even if they think there is a problem, they will fight about it
the transmission lag
once the policy goes into affect, it takes time to go into affect.
transmission lag exampple
highways- surveying must be done property purchased environmental surveys bids must be taken for the construction construction company must build road
Effectiveness lag
a completed project or policy does not instantly have its full effect
It takes how long for a fiscal policy to be full in affect
2 and a half years, happens after the problem is resolveed
2009 stimulus package
was counterproductive, money was not spent on roads and bridges to put people to work
shovel-ready jobs
three issues
- not understanding how the fiscal policy could help the economy
- make-work fallacy and dismiss gov. calculation problem
- how the lags in the process are not relevant to fiscal policy
paul Krugman
displayed his love of broken windows as an economic stimulus after 9/11 attacks by referring to the damage caused to New York
Keyens theory on the great depression could only work if
workers must refuse to work at lower paying jobs for years in order for his theory to explain the great depression
the chain of economical events
- milton freidman and anna schwartz-TGD- the fed destroyed money supply
- the monetary and banking crises led to the stock market crash in 1929, us wealth down hill
- prez. herbert-raised gov. spending to reduce unemployment
- roosevelt-paper money, backed by gold
- roosevelt-new deal
robert higgs
his research showed how the economy during the great depression made it impossible to save for the future, this was referred to as “ regime uncertainty”
Effects after the new deal, and war starts..
- economy focused more on the troops, which caused shortages to the ppl.
- predication of economic disastor
- cut business taxes
Supply Side Economics (SSE)
is a long run policy in which the government reduces the cost of value creation through production and trade in order to promote more value creation.
affects of SSE
demand for labor increases
supply of labor
leads to expansion
SSE concentrates on
value creation, not on spending, ad keynesian economics does.
spending happens due to value creation
depends on creative ppl to help the economy
keynesian economics focuses on
governments overcoming the calculation problem to plan the economy
friedmans’s Permanent Income Hypothesis in designing tax cuts
he showed that tax cuts would affect someones behavior if it is permanent.
aka- SSE would not be good
marginal rates - only recommends changes in marginal tax rates which means
those that change as income, investment, or the other desired value creation activities change.
lump sum tax cut
this would not affect her willingness to expand her practice.
SSE likes- broad based tax cuts
affect a wide range of economic activity, not targeted tax cuts , that only affect narrow categories , and give no incentive to value.
SSE disliked
electric cars
Laffer curve
show the relationship between tax rates-the percentage paid-tax reveunes-the dollars the government receives.
if we are to the right of the man of the curve..
we cut taxes and tax revenues rise
