Economic Adjustment And Fiscal Policy Flashcards
What is the LRAS set by?
Available Land / Labor / Capital
Available Technology
Available Efficiency and Productivity
What is the long run aggregate supply curve?
The maximum output possible at a given time
Fixed level of GDP
What does not change the LRAS but changes the SRAS
Changes in input costs
What occurs when there is a recession or weak economy?
The AD/AS equilibrium point is below potential
Recessionary Gap
What occurs with an overheated economy?
The AD/AS equilibrium point is beyond potential
Inflationary gap
What will happen with the R Gap and I Gap over time?
Will fix itself
What is the key factor for the R Gap and the I Gap
Input prices
How are input prices affiliated with the R Gap
Recession will reduce input prices
Businesses respond by “hiring” cheaper inputs
SRAS will shift outward - increasing GDP and decreasing PL
How are input prices affiliated with the I Gap
Tight resource markets (L,L,C) will increase input prices
Businesses will employ fewer resources
SRAS will shift inward - VERY PAINFUL ADJUSTMENT!
What is the idea of classical economics? What is it based on?
The economy will fix itself
Based on supply driven economy - supply creates income needed to buy output
Describe the classical economic idea concerning interest rates
People increase savings during recession
This decreases real rate of interest meaning that businesses will increase investment
Describe the flexible wages/prices classical economic idea
Input prices decrease during recession
Businesses love cheap inputs and will increase supply
What does classical economics believe the gov should do?
Get out da way!
What is the thought of Keynesian economics? What is the central aspect?
Economy will not self adjust
Demand
What is the Keynesian idea regarding interest rates
They decrease during a recession, but why would a business borrow for capital during a recession????
What is the Keynesian idea when it comes to inflexible wages and prices
People resist lowered wages and so businesses will not increase hiring
“Sticky wages”
What does Keynesian economics believe the gov should do?
Stimulate agg demand through
Decreases taxes
Increased transfer payments
Increased gov spending
What does Keynesian fiscal policy do?
Adjusts either taxes, gov spending, or trans payments to influence aggregate demand
What is the goal of expansionary fiscal policy
To fix the R Gap by increasing agg demand
What is the goal of contractionary fiscal policy
Fix the I gap by decreasing agg demand
How do you solve an R Gap or I Gap problem
Identify the gap amount
Determine the multiplier from the MPC ; Determine the tax multiplier
Divide the gap amount by the regular multiplier- amount of change in gov spending
Then divide gap amount by tax multiplier- amount change in tax or trans payments
What happens to the fiscal policy as the MPC goes down
Fiscal policy increases
What must the gov do when using expansionary fiscal policy
Borrow money which means running a budget deficit
From where does the gov borrow the money from
Factor market - form of bonds
Amount of money the gov spends
Outlay
When revenues are greater than outlays
Budget surplus
What is reagonomics other known as
Supply side economics
What are the main goals of reagonomics
Target tax cuts toward supply side of economy
Increase labor hours of workers
Increase amount of capital investment to increase LRAS
What taxes are cut for reagonomics
Personal income tax
Tax on savings account
Corporate income tax
Capital gains tax
What is the thought process or reagonomics for cutting personal income tax
To increase a worker’s desire to work
What is the thought process of reagonomics for cutting tax on savings account
To increase saving rate therefore increasing capital borrowing
What is the thought process
Of reagonomics for cutting corporate income tax
More spending on capital gains
What is the thought process of reagonomics for cutting capital gains tax
Increase desire to own stocks and invest in the market
What is the purpose of reagonomics for cutting the taxes
Trying to shift supply curve outward
What group of people does reagonomics seem to benefit
Rich people
What were the actual effects of reagonomics
Small effects of tax cuts
Effects stronger on demand side
More uneven distribution of income
HUGE budget deficits
What was the impact of reagonomics
Same as Keynesian policy
What does contractionary fiscal policy cause when the budget is balanced?
A budget surplus
Multiplier when MPC = .9
10
Multiplier when MPC = .8
5
Multiplier when MPC = .7
4
Multiplier when MPC = .66
3.33
Multiplier when MPC = .6
2.5
Multiplier when MPC = .5
2
