Midterm 2 Flashcards
• Labour Force equation
(unemployed + employed)
• Unemployment Rate equation
= U/LF (unemployed/labour force)
• Labour Force Participation Rate equation
LF/Working Age Population*100
• Employment to Population Ratio equation
= E/Working Age Population*100
• Frictional:
people between jobs, such has between schooling and first job, “downtime
• Structural Unemployment:
Pool of jobless workers ill-suited for jobs that are available
• poor job training and education
• Cyclical Unemployment:
a global shortage of jobs in the labour market
• Minimum Wage Laws:
“if the wage is kept above the equilibrium level for any reason, the result is unemployment”
• Applies only to low-skilled workers
• An extremely emotive issue
• Does reduce the growth in employment, but doesn’t “kill jobs”
Unions
• Unions set wages way above the Eq, resulting in Qd lowered, with a higher Qs, resulting in unemployment
Efficiency Wages:
- going wage exceeds equilibrium level
- the employers pay a super competitive wage voluntarily
done in order to increase productivity
• Why does the AD curve have a negative slope?
• Aggregate Wealth Effect: price goes up, real wealth goes down, consumption spending goes down, GDP goes down
Exchange Rate Changes: if price goes up, Canadian goods and services become less competitive, net export spending goes down, GDP goes down
• Price goes up, GDP goes down (vice versa)
Shifts in the AD curve:
- Any factor except price which causes an increase in expenditure (I, X, G, C) will shift the AD curve to the right
- Any factor except price which causes expenditure to decrease (Im, T, S) will shift AD to the left
- Injection increases, withdrawal decreases
- ANY change in price means move along the AD curve
Aggregate Supply:
•
2 types: SRAS, LRAS
Positive because any short run aggregate supply curve, physical productivity and input prices are held fixed
Price goes up, its more or less profitable to produce, so GDP goes up
• Shifts in SRAS curve:
• If productivity falls, and/or if input levels fall, and/or input prices rice, shift SRAS to the left
• Long run AS:
• Is a vertical P-GDP space at the natural rate of output where production factors are fully employed
• The vertical form implies that there is no mathematical relationship between the two variables
•
• Why is the LRAS vertical?
• The long-run equilibrium level for real GDP depends on the factor endowments of land, labour, capital, and the technology of production, which have nothing to do with the price level
•
Input prices, especially wages, eventually catch-up to any change in output prices, and thus the aggregate output level will end up where it started
• Shifts in the LRAS curve:
- The natural rate of output also called potential GDP
- This is thought to be the long-run equilibrium for real GDP
- Same factors cause LRAS to shift as SRAS, EXCEPT for changes in wages or other input prices
- LRAS will expand (contract), and the curve will shift to the right (left) if there is an increase (decrease) in any of the endowments of the factors of production, or if there is an improvement in the technology of production
• Positive shock to AD:
spending goes up, aggregate demand shifts right, equilibrium price and quantity go up
• Due to great times, there is upward pressure on wages
• This causes SRAS to go right, EQ price goes up, Q goes down
• Eventually we end up back at potential GDP
• Negative shock to AD:
spending goes down, so AD goes down (AD shifts left)
• Equilibrium price, quantity goes down
• Economy enters a recession
• Due to hard times, after a long adjustment period, there is a downward pressure on wages
• Causes SRAS shift right
• Equilibrium P goes down, Quantity goes up
• Eventually, recession ends, and the real GDP grows back to its natural rate
• Negative Shock to AS:
at each possible price, production costs rise, causing SRAS shift left
• Equilibrium price up, quantity down
• Called stagflation
Positive shock to AS (temp)
output increases and price decreases
The classical and neo-classical approaches
- both recommend that the economy be allowed to right itself
- Hard times cause wages and input prices to fall
- SRAS expands
- After a long, painful adjustment period, price goes down and quantity goes up
- One way to remedy the situation is for the government to cause an increase in AD
- AD shifts right, equilibrium P and Q go up
- End up with even higher prices than before, but the economy is back to its natural state of output
• Negative shock to LRAS:
•
climate change
Stabilization Policy:
• Deliberate, conscious effort of the government to intervene in the macroeconomy with an eye toward influencing the course of Equilibrium P or Q (real GDP)
Monetary policy
• is executed by the bank of Canada
Fiscal policy
• is carried out by finance departments, and involves changing T and/or G
• Expansionary fiscal policy
- to stimulate AD, the government either increases G and/or cuts taxes
- Causes AD to shift right
- P, Q go up
Contractionary fiscal policy
- to contract AD, the government either decreases G and/or raises taxes
- causes AD to shift left
- P, Q go down
• Multiplier Effect:
- The basic idea is that if the government increases spending (which it is doing now), this increase in spending has an effect on AD that causes it to expand again and again
- Ultimately by much more than the initial expansion of AD
- Geometrically, it is the magnitude of the horizontal shift in AD
• Interpretation of multiplier effect
the change in total spending (C + I + G + NX) which results from a $1 change in government spending.
• ***Exam Question: why the multiplier is important:
the higher the value for the multiplier, the more powerful; fiscal policy will be, and conversely the lower the value of the multiple, the less potent fiscal policy will be***
• (MPC) marginal propensity to consume =
fraction of each additional $ of income that goes to consumption spending as opposed to saving
• Suppose MPC = 0.8, no imports, taxes, and that G increases by $100 million
• Same value as in the textbook
• spending increases immediately by $100 million in round #1
• The initial impetus of D G triggers a RIPPLE effect of successive rounds of changes in induced spending
• Each induced increase to spending gets smaller and smaller
• Therefore, the cumulative sum of the changes in spending approach a limit, and AD will stop shifting
• The higher the value of the MPC:
- the higher the value of the multiplier, as less income leaks out of the circular flow in the form of savings
- The higher the impact of a change in G on aggregate expenditure
• Midterm what is the relationship between MPS and MPC
they are directly correlated, MPS goes up, MPC goes down
• MPC shows the higher the impact of change in G on aggregate expenditure
• fiscal policy is good because:
- effective means to remedy the negative economic shocks, simulative fiscal policy is an increase in government spending and/or decrease taxes
- all about simulative fiscal policy when the economy is in a negative output gap, lower level of GDP than the natural GDP, LORD KEYNES over to you
• fiscal policy is bad because:
Argue that the lags are long (the time between the occurrence of the negative shock and the intervention)
• Information lag
• Formulation lag
• Implementation lag
• By that time, the intervention might no longer be appropriate
• Tend not to have faith in the efficacy of government to accomplish anything
•
• Automatic Stabilizers:
• Automatic stabilizer is fiscal policy that is built into the government’s tax and expenditure apparatus that self-activates
• When in a recession, UI payments increase and total tax revenue decreases
• • This causes AD right
• But not sufficient to bring about an end to the
•
• recession
– When beyond potential GDP, UI payments
• decrease and total tax revenue increases
This causes AD left
•
• Deficits and Debt:
- Fiscal Deficit=T–G<0
* Fiscal Surplus=T–G>0
Debt is…
• a STOCK quantity referring to
• total amount owed
– No time frame
– Sum of all prior deficits and surpluses
Deficit is…
- a FLOW quantity referring to shortfall PER TIME PERIOD
- Benefits of debt-financed deficits
- – VERY politically popular because it’s “free extra spending”
- – Address negative AD and/or SRAS shocks
- – Can finance investments in infrastructure that
- increase AS in both the short-run and the long-run
- If it’s PRODUCTIVE public investment
The Keynesian view is
that macroeconomy is inherently vulnerable and unstable. Sometimes it performs well on its own, but often it does not. The government should frequently intervene in the form of fiscal and/or monetary policy in order to stabilize the macroeconomy.
stagflation
high inflation despite low economic growth and high unemployment
Ricardian equivalence
• Ricardian equivalence means when the government generates a ton of debt, people see that taxes will increase in the future and they will save more
3 lags in fiscal policy
informational
formulation
implementation
Why is tax multiplier negative?
It’s a leakage/withdraw from the circular flow, as are savings, imports.
Multiplier formula for government spending
1/(MPC-1)
