MACRO-unit two Flashcards
Saving Schedule/function
Saving= Disposable income-consumption
Consumption Schedule/function
Reflects the direct consumption and disposable income relationship
Break even income
The point where households will spend all their earned income
APC
Average propensity to consume (percentage of income consumed)
Consumption/income
APS
Average propensity to save (percentage of income saved)
Saving/income
MPC
Marginal propensity to consume
Change in consumption/change in income
MPS
Marginal propensity to save
Change in saving/change in income
MPC+MPS=
1
Determinants of consumption and saving
1) wealth (wealth effect shifts consumption schedule up and saving down)
2) borrowing
3) expectations
4) real interest rates
When will investment be undertaken?
If the expected rate of return (r) = or > real interest rate (i)
Investment demand curve determinants
1) costs of acquiring/maintaining capital goods
2) business taxes
3) technology
4) stock of capital goods
5) business expectations
Where does the variability of investment come from?
1) variability of expectations
2) durability
3) irregularity of innovation
4) variability of profits
Multiplier effect usage
determines how large an increase in GDP is due to an increase of spending
What is the relationship between spending and GDP?
Direct
Multiplier equations
change in real GDP/initial change in spending
1/1-MPC or 1/MPS
Why is initial change in spending generally associated with investment?
Because of investment’s volatility
change in consumption, net export, and gvnmt purchases also lead to the multiplier affect
Why do levels of investment generally change?
Due to changes in real interest rates or shifts of the investment demand curve
APC and APS equation
point on consumption curve/point on 45 degree line
point on savings curve/point on 45 degree line
APC+APS=1
Relationship between APC and APS
inverse
Why is AD downsloping?
Real-balances effect, interest-rate effect, and foreign purchases effect
Real-balances effect
Inflation causes a reduction in purchasing power leading to less consumer spending
Interest-rate effect
With a specific supply of money, a higher price level increases the demand for money which raises the interest rate and lowers investment purchases
Foreign purchases effect
An increase in one countries price level relative to the price levels in other countries reduces the net export component of that country’s aggregate demand
Determinants of Aggregate Demand
Changes in the level of spending my consumers, businesses, government and foreign buyers
Immediate short run aggregate supply curve
Both input and output prices are fixed
Curve is a horizontal line
Short run aggregate supply curve
Nominal wages and input prices are fixed, output prices vary
Upsloping, relatively steep to the right of full employment and relatively flat to the left
Long run aggregate supply curve
All prices vary
Vertical curve at the full employment level
Determinants of aggregate supply
Input prices, productivity, and legal-institutional environment
What happens with an increase of aggregate demand to the right of full employment output?
Inflation and a positive GDP gap
What happens when the AD curve shifts to the left of the full employment output?
Recession, negative GDP gap and cyclical unemployment
Cost push inflation
Result of a decrease in aggregate supply which leads to a negative GDP gap
Why are prices inflexible downward?
1) fear of price wars
2) menu costs (lowering prices creates other costs)
3) wage contracts
4) morale, effort, and productivity
5) minimum wage
Aggregate demand
amount of a nation’s GDP that buyers collectively desire to purchase at each price level
What makes up the majority of business costs?
Wages and salaries
What happens with a decrease in wages?
Per unit production costs are reduced which causes the aggregate supply curve to shift right
Productivity
Total output/total input
Legal institutional environment effect on supply
1) changes in taxes and subsidies
2) changes in the extent of regulation
Net export effect
the change in real GDP that occurs when an increase in the price level leads to a change in the relative prices of imports and exports
How does a change in real interest rate affect the investment demand?
Changes the point not the curve
“Too much money chasing too few goods”
Demand pull inflation
Crowding out
When the government needs to borrow money for discretionary policy, they end up discouraging private investment. This happens because the gvnmt causes the demand to go up causing the interest rate to go up. This is bad because private investment is better than gvnmt investment.
Automatic stabilizers
Aspects of our structure that already help to stabilize
- spend more in recessions and less when its doing well
ie: unemployment insurance
Discretionary policy (fiscal)
BY CHOICE
congress must pass a law
ie: tax cuts
Problems of timing with fiscal policy
1) recognition lag
2) administrative lag
3) operational lag
Why won’t the US go bankrupt?
1) refinancing
2) taxation
Fiscal policy
Use of government spending and/or tax collection to influence the economy
Stimulus package
Government spends money to stimulate the economy
Expansionary fiscal policy
The goal is to get GDP to rise and it is used to avoid a recession or to help a recession
-increased government spending
-tax cuts
The outcome is that more is spent on goods and services which increases demand and raises output and gdp (prices will rise too)
Contractionary fiscal policy
Goal is to temper economic growth because too much growth can lead to inflation. It is used during expansion or a peak of the business cycle
-decreased government spending
-tax increases/elimination of tax cuts
Outcome is that there is less spent on goods and servises which leads to decreased demand and more stable prices
Is medicare discretionary?
No
Limits and criticisms of fiscal policy
1) difficult to change spending levels
2) entitlement spending (social security, medicare, vets)
3) lots of lags (inside lags- recognition and administrative, outside lags-operational)
4) political pressure (huge role in passing a law)
5) must be coordinated with monetary policy
6) often offset by local and state governments
7) concerns over impacts on deficit and debt
Recession
Any time real output<full employment
CEA
council of economic advisors
Changes that occur without congressional action
Non-discretionary or automatic
Budget deficit
Government spending in excess of tax revenues
Budget surplus
tax revenues in excess of government spending
Net taxes=
tax revenue-(transfers and subsidies)
Built in stabililzer
anything that increases the government’s budget deficit or reduces surpluses
Tax rate=
Tax revenue/GDP
Relationship between GDP and taxes in a progressive tax system
tax rate rises with gdp
Relationship between GDP and taxes in a proportional tax system
tax remains constant
Relationship between GDP and taxes in a regressive tax system
tax falls when gdp rises
An economy is more stable if the tax system is..
progressive
