Unit 14 - Unemployment and fiscal policy Flashcards
What is Autonomous Consumption
The fixed amount one will spend independent of income
c0
What is Marginal Propensity to Consume
the change in consumption when disposable income changes by one unit
c1
What is Marginal Propensity to Save
Only part of an increase in income is consumed; the rest is saved:
1 − c1
What the Aggregate Demand formula
Aggregate consumption + Investment
c0 +c1Y + I
Aggregate consumption = c0 + c1Y
Autonomous Consumption + Consumption that depends on income
What is the multiplier
What is the equation for the multiplier
The total change in output can be greater than the initial
change in aggregate demand. This is represented by the Multiplier:
1/1-c1
Y = c0 + c1Y + I
Y - c1Y = c0 + I
Y(1-c1) = c0 + I
Y= 1/1-c1 * (c0+I)
Multiply multiplier by (c0 + I) to find national GDP change
What is the Goods Market Equilibrium
When Y = AD
Income/output = Aggregate Demand
Where is credit-constraints and and consumption smoothing reflected within the Multiplier Model
Reflected in the slope of the AD line and the size of the multiplier
What is Precautionary saving
An increase in saving to restore wealth to its target level
When will a firm decide to:
Consume extra income
Save extra income/repay debts
Invest (at home or abroad)
Owner’s discount rate (p)
Interest rate on assets (r)
Net profit rate on Investment (||)
Consume when p > r >= ||
Save when r > p >= ||
Invest when || > p >= r
What factors could increase Investment
Higher expected rate of profit increases investment, holding r constant - (improvement in the supply side conditions in the economy means more profit for projects at the same interest level)
A forecast fall in the price of energy or wages, or a fall in taxation over the life of the project will increase investment.
Improvement in business environment (such as fall in the risk of expropriation by the government) also increases investment
What is the Aggregate Investment function
An equation that shows how investment spending in the economy as a whole depends on other variables (interest rate and profit expectations)
What is a fall in Risk of Expropriation
An improvement in the security of property rights so that there is a smaller chance that the government or another powerful actor (such as a landowner, like Bruno in Unit 5, who might threaten a smallholder) will take over ownership of the investment project
What components make up Aggregate demand
How is this represented in a formula
Aggregate Demand =
Consumption +
Investment +
Government Spending +
Net Exports
AD = c0 + c1(1 - t)Y + I + G + (x - mY)
formula for disposable income (and aggregate consumption)
(1 - t) Y where t is tax
The marginal propensity to consume, c1, is the fraction of disposable income (not pre-tax income) consumed.
therefore Aggregate consumption is written as c0 +c1 (1 - t)Y
What is the marginal propensity to import
The fraction of each additional unit of income that is spent on imports (m)
How could the Aggregate Demand function be affected
A higher interest rate reduces investment spending, shifting down the aggregate demand curve
A higher expected post-tax rate of profit raises investment spending, shifting up the aggregate demand curve
How could Imports, Exports and taxes affect the AD curve and the multiplier diagram
A higher marginal propensity to import reduces the size of the multiplier: This makes the aggregate demand curve flatter
An increase in exports shifts the aggregate demand curve up in the multiplier diagram
An increase in the tax rate reduces the size of the multiplier: This makes the aggregate demand curve flatter
The unemployment benefit scheme and proportional tax rate are examples of what
Automatic stabilizers - they automatically offset an expansion or
contraction of the economy
How can the Government stabilise economic fluctuations
Government spending is large and exogenous (e.g. health and
education)
Higher tax rate lowers the multiplier
Unemployment insurance helps households smooth
consumption
Deliberate intervention via fiscal policy
What is Austerity policy
When the government tries to improve their budgetary position
This can be harmful in a recession as they might attempt to cut spending or increase taxes to increase budget, decreasing AD and worsening recession
What is the governments budget balance
Government Revenue such as tax (T) - Government spending such as on benefit schemes (G)
Budget in balance: G = T
Budget in deficit: G > T
Budget in surplus: G < T
The government must borrow to cover the gap between spending and revenue, by issuing bonds
What is fiscal stimulus
When a government cuts taxes (to encourage private sector spending) or increases government spending (in a recession). This is to tackle a drop in AD and encourage an increase
What effect do recessions and expansions have on the multiplier
The multiplier is higher in recessions than in expansions
What is Government debt
sum of all the bonds sold over time to finance budget deficit – matured bonds (repaid debt)
what is Sovereign Debt Crisis
A situation in which government bonds come to be considered risky (default risk)
What is the debt-to-GDP ratio
Level of indebtedness of a government relative to the size of the economy
