Unit 14 - Unemployment and fiscal policy

Question 1

What is Autonomous Consumption

Answer 1

The fixed amount one will spend independent of income

c0

Question 2

What is Marginal Propensity to Consume

Answer 2

the change in consumption when disposable income changes by one unit

c1

Question 3

What is Marginal Propensity to Save

Answer 3

Only part of an increase in income is consumed; the rest is saved:

1 − c1

Question 4

What the Aggregate Demand formula

Answer 4

Aggregate consumption + Investment

c0 +c1Y + I

Aggregate consumption = c0 + c1Y

Autonomous Consumption + Consumption that depends on income

Question 5

What is the multiplier

What is the equation for the multiplier

Answer 5

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

Question 6

What is the Goods Market Equilibrium

Answer 6

When Y = AD
Income/output = Aggregate Demand

Question 7

Where is credit-constraints and and consumption smoothing reflected within the Multiplier Model

Answer 7

Reflected in the slope of the AD line and the size of the multiplier

Question 8

What is Precautionary saving

Answer 8

An increase in saving to restore wealth to its target level

Question 9

When will a firm decide to:

Consume extra income
Save extra income/repay debts
Invest (at home or abroad)

Answer 9

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

Question 10

What factors could increase Investment

Answer 10

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

Question 11

What is the Aggregate Investment function

Answer 11

An equation that shows how investment spending in the economy as a whole depends on other variables (interest rate and profit expectations)

Question 12

What is a fall in Risk of Expropriation

Answer 12

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

Question 13

What components make up Aggregate demand

How is this represented in a formula

Answer 13

Aggregate Demand =
Consumption +
Investment +
Government Spending +
Net Exports

AD = c0 + c1(1 - t)Y + I + G + (x - mY)

Question 14

formula for disposable income (and aggregate consumption)

Answer 14

(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

Question 15

What is the marginal propensity to import

Answer 15

The fraction of each additional unit of income that is spent on imports (m)

Question 16

How could the Aggregate Demand function be affected

Answer 16

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

Question 17

How could Imports, Exports and taxes affect the AD curve and the multiplier diagram

Answer 17

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

Question 18

The unemployment benefit scheme and proportional tax rate are examples of what

Answer 18

Automatic stabilizers - they automatically offset an expansion or
contraction of the economy

Question 19

How can the Government stabilise economic fluctuations

Answer 19

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

Question 20

What is Austerity policy

Answer 20

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

Question 21

What is the governments budget balance

Answer 21

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

Question 22

What is fiscal stimulus

Answer 22

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

Question 23

What effect do recessions and expansions have on the multiplier

Answer 23

The multiplier is higher in recessions than in expansions

Question 24

What is Government debt

Answer 24

sum of all the bonds sold over time to finance budget deficit – matured bonds (repaid debt)

Question 25

what is Sovereign Debt Crisis

Answer 25

A situation in which government bonds come to be considered risky (default risk)

Question 26

What is the debt-to-GDP ratio

Answer 26

Level of indebtedness of a government relative to the size of the economy