Unit 3 National income and Price determination Flashcards
1
Q
3.1 v1: What is the AD/AS model?
A
It is a graph where the aggregate price level is the the vertical axis and the real GDP is on the horizontal axis.
There are two slopes:
- The downwards sloping slope representing aggregate demand (AD)
- The upwards sloping slope representing short-run aggregate supply curve. (SRAS)
2
Q
3.v1: What the the equilibrium of the AD/AS model?
A
Where the (AD) and (SRAS) meet or where both PL and Y meet.
3
Q
3.1v1: What value does real GDP represent and what does the value belong to?
A
Real GDP measures the dollar value of aggregate output.
Real GDP equals aggregate output. To produce more output there needs to be a change in the number of workers.
Real GDP and employment are positively related.
4
Q
3.1: What does real GDP equal, what does is measure, and what does it tell us?
A
Real GDP =
Aggregate output which is changed by a change in employment or number of workers. Aggregate output is equal to
Aggregate spending of which the formula is Consumption (C) + Investment (I) + Government (G) + (Exports (X) - Imports (M)) (Xn). Aggregate spending is equal to
Aggregate income of which the formula is Wages (W) + Rent (R) + Interest (I) + Profit (P)
Real GDP measure changes in aggregate output which tells us what’s happening to aggregate spending, aggregate income, and unemployment rate.
5
Q
3.1 v1: What does Y stand for?
A
Y is a symbol used by economists to represent income
Y = Symbol for income
6
Q
3.1 v1: What is the aggregate price level a measure of?
A
The aggregate price level is a measure of inflation not an inflation rate
7
Q
3.1 v1: What is Aggregate demand
A
The demand for all goods and services purchased in a product market.
Aggregate demand = Aggregate spending (X+I+G+Xn)
8
Q
3.1 v1: What does the downwards sloping AD curve represent?
A
The curve represents the inverse relationship between the aggregate price level and the quantity of aggregate output demanded.
Price level (PL) is on the vertical and quantity of aggregate output demanded (QAD) is on the horizontal with the slope being downwards.
9
Q
3.1 v2: What causes a change in aggregate output demanded and movement along the aggregate demand curve in the AD/AS model?
A
The change is only caused by a change in price level in the AD/AS model
10
Q
3.1 v2: What is the real wealth effect / Real balances effect?
A
It is a reason for why the AD curve slopes downwards. It is the effect when a change in price level causes the purchasing power of a given amount of wealth to change.
11
Q
3.1 v2: If you have 11k dollars and the aggregate price level is 100, what happens to the purchasing power of 11k dollars when the aggregate price level turns to 110?
A
The purchasing power of 11k dollars is lower than expected. In other words your real wealth has decreased. This is an example of the real wealth effect
12
Q
3.1 v2: What causes movement to the left and right of the AD curve in terms of the real wealth effect.
A
when PL rises, purchasing power of a given amount of wealth falls, leading to people buying fewer goods and services decreasing QAD shifting the curve to the left. When PL decrease the opposite happens.
13
Q
3.1 v2: What is the Interest rate effect?
Note: Price of money is the interest rate
A
A reason for why the AD curve slopes downwards. When PL changes the demand for money changes leading to a change in the interest rate causing a change in the cost of goods and services bought with borrowed money.
14
Q
3.1 v2: What causes movement to the left and right of the AD curve in terms of the interest rate effect.
A
When PL increases people need more money to buy goods and services causing a decrease in sales leading to a decrease in QAD shifting the curve to the left. When PL decreases the opposite happens.
15
Q
3.1 v2: What is the Exchange rate effect / Foreign purchases effect?
A
It is a reason why the AD curve slopes downwards. When PL changes in a country their goods and services will be relatively more or less expensive to foreign purchasers causing a change in the quantity demanded of the country’s exports.
16
Q
3.1 v2: What causes movement to the left and right of the AD curve in terms of the Exchange rate effect
A
When PL increases become goods become relatively more expensive to foreign purchasers leading to less foreign people buying goods and services causing a decrease in QAD shifting the curve to the left. When PL decreases the opposite happens.
17
Q
3.1 v3: What causes change in aggregate demand?
A
Any change to C, I, G, X, or M.
18
Q
3.1 v3: What do Exports (X) and imports (M) represent?
A
Exports= The domestic purchases of Goods and services by foreigners buyers.
Imports = The foreign purchases of goods and services by domestic buyers.
19
Q
3.1 v3: What causes change to Consumption (C)
Note: P stands for positive relation while I stand for inverse relation for the relation between the factor and consumption of goods and services.
A
Factors of:
- Wealth: P
- Income: P
- Income taxes: I
- Expectation of economic conditions: P
- Interest rates: I
As these factors change, consumption of goods and services may decrease or increase.
20
Q
3.1 v3: What are interest rate sensitive components of consumption?
A
Consumer goods and services paid for with borrowed money.
21
Q
3.1 v3: What causes change to investment (I)
Note: P stands for positive relation while I stand for inverse relation for the relation between the factor and consumption of goods and services.
A
Changes in the factors of:
- Expectation of economic conditions: P
- Interest rates: I
- Unplanned changes in business inventories: I
22
Q
3.1 v3: What is Investment spending in the aggregate expenditure formula and what does it include?
A
It refers to Gross private domestic spending which includes:
- Spending on productive capacity or capital stock
- Residential spending: spending on homes
- Business spending: Spending on amount of goods to sell.
23
Q
3.1 v3: What changes in the factors of AD does the Fiscal policy include.
Label the factors with either a indirect or direct effect on aggregate demand and whether the effect is positive or inverse.
A
Fiscal policy:
Changes in Taxation: When Taxation (T) decreases consumption (C) increases because disposable income (Yd) goes up. The opposite it true.
Changes in (T) has a indirect, inverse, effect on aggregate demand (C).
Changes in government spending: When government spending (G) increase Aggregate demand (AD) increase because government spending (G) is a factor of aggregate demand (AD). The opposite is true.
Changes in (G) has direct, positive effect on aggregate demand (G).
24
Q
3.1 v3: What changes in the factors of AD does the Monetary policy include.
A
Monetary policy:
- Changes in interest rates: When interest rates increase interest rate sensitive components of consumption decrease decreasing Investment. The opposite is true.
This indirectly inversely affects both investment and consumption.
25
3.1 v3: What causes change to Net exports (Xn)?
Note: P stands for positive relation while I stand for inverse relation for the relation between the factor and consumption of goods and services.
Changes in the factors of:
- Relative income
- Relative prices
- Exchange rates
Exports (X) and AD are positively related. Import (M) and AD are inversely related.
26
3.1 v3: How are increases and decrease or changes in the factors AD represented on a graph?
If C, I, G, X increase or M decrease the AD curve will shift to the right.
If C, I, G, X decrease or M increase the AD curve will shift to the left.
27
3.2 v1: What is autonomous expenditure? Give examples.
It is the independent spending of something
Autonomous = independent
expenditure = spending of something
C, I, G, Xn spend money regardless of their income.
This means that C, I, G, Xn spend money independent of income.
28
3.2 v1: What is the formula to calculate disposable income and where does disposable income go?
Yd = Gross income - Income Tax. Yd is either spent on consuming or saving.
29
3.2 v1: What is APC and APS and what are the formulas for them?
APC is the average propensity of Yd that is spent on consuming and APS is the average propensity of Yd that is saved.
APC = Consumption / Disposable income
APS = Saving / Disposable income
30
3.2 v1: What is MPC and MPS and the formulas for them.
MPC is the percentage of an additional 1$ earned in Yd that is spent. MPS is percentage of an additional 1$ earned in Yd that is saved.
Marginal propensity to consume = Change in consumption / change in Yd
Marginal propensity to save = Change in saving / change in Yd
Ex: 1$ earned is 0.6$ is spent of saving while 0.4 is spent of consuming
31
3.2 v1: What happens as MPC decreases?
As MPC decreases the total aggregate demand decreases and vice versa. This means that they are positively related.
32
3.2 v1: What will a 1$ change in autonomous expenditures result in?
Is this a function of AD?
It will cause a change in total expenditures (AD) greater than 1 because one persons spending is another persons income.
The amount by which AD changes as a result of a change in autonomous expenditures is a function of AD
33
3.2 v2: What does MPC and MPS added together equal?
MPC + MPS = 1 Because MPC and MPS are both a percentagesof an additional 1$ earned in disposible income
34
3.2 v2: What does Expenditure multiplier quantify?
What is the formula for the spending multiplier?
The total change in AD that results from the initial change in autonomous spending.
Spending multiplier = 1 / (1 - MPC) = 1 / MPS
35
3.2 v2: How do we find the change in total expenditures, total change in income, total change in aggregate expenditures, and total change in real GDP?
Multiply the initial change of any sort of spending (consumption, government spending, investment spending, and exports) by the spending multiplier to get the change in real GDP
36
3.2 v2: What are expenditures?
spendings
Aggregate expenditures = Aggregate spending
37
3.2 v3: What does the Tax / Transfer Multiplier quantify? What is the formula? What does the negative sign indicate?
The Tax multiplier quantifies the change in AD that results from the initial change in Taxes or transfer payments.
Tax multiplier
= - (MPC / 1 - MPC) = - (MPC / MPS)
Transfer multiplier
= (MPC / 1 - MPC) = MPC / MPS
The negative sign in the tax Multiplier is used to represent the inverse relationship between AD and changes in Tax.
38
3.2 v3: How do you apply the Tax / Transfer multiplier to a change in taxes or to a change in transfer?
To a change taxes:
Total AD = Initial change in taxes * Tax multiplier
To a change in transfers:
Total AD = Initial change in transfers * Transfer multiplier
39
3.2 v3: What is a difference between the spending multiplier and the tax multiplier? What does the Spending multiplier - the Tax multiplier equal?
The spending multiplier is always greater than than the tax multiplier.
The spending multiplier minus the tax multiplier will equal 1.
40
3.2 v3: If the government wanted to increasing spending by 100 billion they must raise taxes by 100 billion.
If MPC is 0.75 will there be any impact of Real GDP / AD if the 100 billion spending is offset by the 100 billion tax increase?
State:
- Spending multiplier
- Tax multiplier
- Increase and decrease in AD
- Net increase in AD
- Two reasons why there will be real impact on real GDP
1 / (1 - 0.75) = 1 / 0.25 = 4
100b * 4 = 400b in AD
- (0.75 / (1 - 0.75)) = - (0.75 / 0.25) = -3
100b * -3 = -300b in AD
400b - 300b = 100b net increase in AD
There will be impact on real GDP because the spending multiplier is greater than the tax multiplier.
There will be impact on real GDP because government spending is autonomous expenditure meaning it affects the G in C, I, G, and Xn while a changes in taxes is not.
41
3.3 v1: What are input costs?
The term refers to the prices paid by firms to purchase the inputs in production (Factors of production).
42
3.3 v1: What does it mean to fix a input price and what are some examples?
To fix a input price is to lock the input price so that neither the buyer or seller can change the price.
Some examples are:
Multi-year labor contracts for employees
Annual leases for retails space
Monthly agreements for commodity prices
43
3.3 v1: What does the short run refer to?
It refers to the time period in which at least one input price is fixed. The short-run is not a length of time but rather how long it takes for inputs prices to catch up with changes in the price level.
44
3.3 v1: What does it mean when a input price is sticky?
When wage and other input prices lag behind price changes, input prices are referred to as sticky.
45
3.3 v1: What is aggregate supply
The quantity of aggregate output supplied in an economy.
46
3.3 v1: What does the upwards sloping SRAS curve represent?
The short-run aggregate supply. It depicts the relationship between the price level and the quantity of aggregate output supplied (QAS) in the short run.
47
3.3 v1: What is the relationship between Aggregate price level and the quantity of aggregate output supplied? Why does it happen?
When price level rises QAS rise as well.
This is because when input prices are sticky an increase in price level results in higher profits for the firm which incentivises them to produce more. The opposite happens when price levels decrease and wages are sticky.
Profit = Aggregate Price level - Aggregate input costs
48
3.3 v1: What happens to the SRAS curve when Price levels change?
When price levels increase there will be movement up and to the right of the SRAS curve. When price levels decrease there will be movement down and to the left of the SRAS curve.
49
3.3 v1: What is the short-run trade off between inflation and the unemployment rate?
When price levels rise, QAS rises causing the Unemployment rate to fall. When price levels falls, QAS falls causing the unemployment rate to go up.
This happens because in order to produce more output, firms must hire more workers. When output falls firms must lay off workers.
50
3.3 v2: What happens to the SRAS curve when Input costs change?
A change in input costs will lead to a shift in the SRAS curve
51
3.3 v2: What non-price level determinants shift the SRAS curve to the right? Give examples.
Anything that makes it easier or cheaper to produce goods or services. This includes
Decreases in input costs
- Commodity prices
- Wages
Increase in productivity
- Technological advances
Government policy
- Deregulation
- Increase Subsidies
52
3.3 v2: What non- price level determinants shift the SRAS curve to the left?
Anything making it harder or more expensive to produce goods and services will shift the curve to the left. This includes:
Increases in input costs
- Commodity prices
- Wages
Destruction of resources
- Natural disasters
Government policy
- Increased regulation
- Business tax, tax on production
53
3.3 v2: How do inflationary expectations of firms effect the SRAS curve?
If firms expect the price level to fall they will increase production in the short run increasing QAS shifting the curve to the right.
If firms expect price level to rise they will decrease production in the short run decreasing QAS shifting the curve to the left.
54
3.3 v2: How are wages and income different?
A wage is someone's income however wages represent a input cost to the employer while income is what's going to the workers.
55
3.4 v1: What is the long-run?
A period of time in which all input prices are variable.
It is characterized by fully-flexible wages and input prices.
Producers have no incentive to change the level of output because input prices change in response to changes in the price level
56
3.4 v1: What does the horizontal AS curve connecting to the bottom of the SRAS curve represent.
It represents how when output levels are so low (recessionary levels of output), input prices are so sticky that because there are so many resources that are underemployed, that producers can respond to increases in aggregate demand with increases in output without any upward pressure on input prices.
57
3.4 v1: What is the LRAS curve
Long-run aggregate supply curve:
the level of output produced when the economy is operating at maximum employment.
LRAS = Potential output = full employment levels of output (Yf)
The LRAS curve is represented by a vertical line at the level of output the economy produces at a natural rate of unemployment.
58
3.4 v1: What is QASyf
It stands for the quantity of aggregate output supplied when the economy is at full employment.
It means the maximum productive quantity of the economy.
It also also known as potential output
59
3.4 v2: What does LRAS represent?
The value of output produced by a combination of consumer goods and capital goods on an economy's PPC.
LRAS = potential output = Full-employment levels of output
60
3.4 v2: What happens to the the rate of unemployment when the output point is on the PPC.
What happens to the rate of unemployment in the long run?
At a point on a PPC the Rate of unemployment (Ur) = the natural rate of unemployment (NRU)
In the long run the rate of unemployment (Ur) = the natural rate of unemployment (NRU); LRAS is vertical at Yf
61
3.4 v2: What do changes in the price level cause in the short-run?
Changes in output and employment
62
3.4 v2: What happens to potential output (LRAS) when the price level changes?
Nothing as potential output is independent of price level
63
3.4 v2: If a economy is on the PPC what does it mean for employment and production of goods?
It means the economy is producing a combination of consumer and capital goods on the PPC.
Whenthe economy is on the PPC is also means the economy is operating at full employment which means the rate of unemployment = the natural rate of unemployment.
64
3.4 v2: What does Yf represent?
It represents the value of output (Real GDP in dollars) that is comprised of the consumer and capital goods being produced.
Yf = potential output
65
3.5 v1: What is a correctly labelled AD/AS model graph following the A.C.E model?
Correctly labelled:
- Axes: Price level and real GDP on the vertical and horizontal
- Curves: A downwards sloping AD curve and upwards sloping SRAS curve.
- Equilibrium points: labelled equilibrium price level (PLe) on the vertical and equilibrium real GDP (Ye) on the horizontal.
66
3.5 v1: What is a surplus in the AD/AS model and how do producers respond do it?
A surplus is when the price level is higher than equilibrium price level causing QAD < QSRAS (quantity of aggregate output supplied).
In response to a surplus, producer will decrease the price level decreasing the QSRAS and increasing the QAD until the two are equal.
67
3.5 v1: What is a shortage in the AD/AS model and how do producers respond do it?
A shortage is when the price level is lower than equilibrium price level causing QAD > QAS (quantity of aggregate output supplied).
In response to a shortage, producer will increase the price level decreasing the QAD and increasing the QRAS until the two are equal.
68
3.5 v1: What is long-run equilibrium?
When current output is equal to potential output, an economy is in the long-run equilibrium.
This also causes the rate of unemployment to be equal to the natural rate of unemployment.
69
3.5 v1: What is potential output represented by?
Potential output is represented by the vertical LRAS curve labelled as Yf at the bottom.
70
3.5 v2: What is an output gap?
When changing economic conditions cause situations where current output is not equal to potential output.
71
3.5 v2: What is the systematic approach to graphing recessionary gap.
1. Find current output (Yc) where AD = SRAS. Label the PL and current output equilibrium.
2. Place the LRAS curve labelled as Yf ahead of equilibrium ( ahead of Yc) to indicate Potential output (Yf) is greater than current output (Yc)
72
3.5 v2: What is the systematic approach to graphing inflationary gap.
1. Find current output (Yc) where AD = SRAS. Label the PL and current output equilibrium.
2. Place the LRAS curve labelled as Yf behind equilibrium ( behind of Yc) to indicate Potential output (Yf) is is less than current output (Yc)
73
3.5 v2: What is a recessionary gap.
An output gap.
Recessionary gap is when the economy's current output is less then its potential output. Yc < Yf. This causes the rate of unemployment to be greater than the natural rate of unemployment. Ur > NRU
74
3.5 v2: What is a inflationary gap.
An output gap.
A inflationary gap is when the economy's current output is greater than potential output. Yc > Yf. this causes the rate of unemployment to be less than the natural rate of unemployment. Ur < NRU
75
3.6 v1: What are negative aggregate demand shocks?
Negative AD shocks include anything that decrease C, I, G, or Xn. Decreases price level and output shifting the curve to the bottom left. Also increases unemployment.
76
3.6 v1: What are the 3 questions you ask when proposed with a scenario that affects AD or SRAS?
1. Which curve will this impact (AD or SRAS)
2. Which direction will the curve shift (left or right)
3. How are the two variables of the curve willbe affected (inflation and employment)
77
3.6 v1: In a scenario that impacts AD, what are the two impacts and variables that are affected?
The impacts are either negative of positive shocks that affects inflation and employment.
78
3.6 v1: What are positive aggregate demand shocks
Positive AD shocks include anything that increases C, I, G, or Xn. Increases price level and output (Ye) shifting the curve to the top right. also decreases unemployment.
79
3.6 v1: What is the natural rate of unemployment
The minimum rate of unemployment an economy can sustain without increasing inflation.
80
3.6 v2: What are the shifters of the SRAS curve?
- Input prices
- Wages
- Inflationary expectations
- Technology
81
3.6 v2: what are positive short-run aggregate supply shocks and how does it affect the SRAS curve?
Anything that will shift the SRAS curve to the right.
This means there will be a decrease in price level (PLe to PL2) and an increase in output (Ye to Y2). decrease in price level means inflation decreases and an increase in output means unemployment decreases.
82
3.6 v2: What is a negative short-run aggregate supply shock and how does it affect the SRAS curve?
Anything that will shift the SRAS curve to the left.
This means there will be a increase in price level (PLe to PL2) and an decrease in output (Ye to Y2). Increase in price level means a increase in inflation and an decrease in output means a increase in unemployment
83
3.6 v3: What is Demand-Pull inflation and what are some things that cause it?
Inflation caused by an increase in AD. Some things that increase AD are:
- Increase in Positive AD shocks
- Increase in C, I, G, or Xn
84
3.6 v3: what is Cost-Push inflation and what are some things that cause it.
Inflation caused by a decrease in SRAS. Some decreases of SRAS are:
- Increases in input costs, resource cost, wages, or a reduction in technology
- Natural disaster that destroy resources
85
3.6 v3: What does demand-pull inflation look like on a graph?
A shift of the AD curve to the right. This increases equilibrium price level (inflation) and output
86
3.6 v3: What does a cost-push inflation look like on a graph.
A shift of the SRAS curve to the left. This increases the equilibrium price level (inflation) and decreases output.
87
3.7 v1: What is the classical theory of economics?
The theory that all prices and wages are completely flexible. This means there would be a completely vertical aggregate supply (AS) curve.
88
3.7 v1: What is long-run self-adjustment?
How businesses and workers adjust their price and wage expectations based on the economic conditions they are facing.
89
3.7 v1: What is the short-run and long-run aggregate supply curve used in in modern economic approach?
They are used in the modern economic approach to combine various economic theories and simplify the AD/AS model.
90
3.7 v1: In self adjustment scenarios, does the LRAS move?
No, LRAS only moves when there are changes to land, labor, capital, or technology.
91
3.7 v1: Where does an economy start and how does it relate to expectations of price and wages?
An economy can start in long-run equilibrium, a recessionary gap, or an inflationary gap.
When in the an output gap, the businesses and workers of the economy will self-adjust to the gaps. This looks like SRAS shifting left or right to match equilibrium depending on the gap.
92
3.7 v1: What are 3 some language terms surrounding Long-run self-adjustment problems?
- Long-run Self-Adjustment
- No policy action taken (Economy will self-adjust)
- Automatically adjust (How the economy goes back to equilibrium)
93
3.7 v2: What is a economy's output when in a recessionary gap
The economy is operating at an output below full capacity when in a recessionary gap.
94
3.7 v2: When is a recessionary gap the economy is operating at an output below full capacity.
How do businesses adjust?
Overtime, businesses that are not selling that many goods and services will adjust their price expectations downward. This means they will lower prices on goods and services to sell more.
95
3.7 v2: When in a recessionary gap the economy is operating at an output below full capacity.
How do workers adjust?
Overtime, workers who are actively searching for work will adjust their wage expectations downward. This means they will take on lower paying jobs in order to get work.
96
3.7 v2: When both businesses and workers adjust to the recessionary gap, what happens the to the SRAS curve?
When both workers and businesses adjust to the gap, SRAS curve increases meaning a decrease in inflation (PL falls) and a decrease in unemployment (output rises)
97
3.7 v3: What is a economy's output when in a inflationary gap
The economy is operating at a output beyond capacity when in a inflationary gap meaning the economy is producing more then it can sustain
98
3.7 v3 When is a inflationary gap the economy is operating at an output beyond full capacity.
How do workers adjust?
When in a inflationary gap, workers are working more because of increased output so workers will adjust their wage expectations upward because they expect to be worth more.
99
3.7 v3 When is a inflationary gap the economy is operating at an output beyond full capacity.
How do businesses adjust?
When in a inflationary gap, Businesses will notice a higher demand for their goods and services so businesses will adjust their price expectations upward because the current price level is unsustainable.
100
3.7 v3: When both businesses and workers adjust to the inflationary gap, what happens the to the SRAS curve?
When both businesses and workers adjust to the gap, SRAS will decrease meaning a increase in inflation (PL rises) and a increase in unemployment (output falls).
101
3.8 v1: How does the government implement the Fiscal policy?
The Fiscal policy is implemented by the government to intervene when the economy overheats or underperforms.
The goal is to attempt to bring the economy to full employment.
102
3.8 v1: What Fiscal policy is used during a recessionary gap. What does the policy entail?
The expansionary Fiscal policy is used when the economy is in a recessionary gap.
It involves:
A increase in government spending which has a direct impact on AD. This has a larger magnitude of change due to its direct effect
Taxes are cut or decreased which has a indirect impact of AD. This has a smaller magnitude of change due to its indirect effect
103
3.8 v1: What Fiscal policy is used during a inflationary gap. What does the policy entail?
The Contractionary Fiscal policy is used when the economy is in a inflationary gap.
It involves:
A decrease in government spending which has a direct impact on AD. This has a larger magnitude of change because of the direct effect.
Taxes are increased which has a indirect impact of AD. This has a smaller magnitude of change because of the indirect effect.
104
3.8 v2: How is the Expansionary fiscal policy used to fix a recessionary gap?
The government can increase their spending or decrease taxes. This increases AD causing PL to rise and Output to rise until the AD curve is at equilibrium.
105
3.8 v2: How is the Contractionary fiscal policy used to fix a inflationary gap?
The government can decrease government spending or increase taxes. This decreases AD causing PL and Output to fall until the AD curve is at equilibrium.
106
3.8 v2: What is the economy's condition when in a recessionary gap
When in a recessionary gap:
- Unemployment is growing
- Prices are falling
- Productivity (output) is falling
107
3.8 v2: What is the economy's condition when in a inflationary gap?
When in a inflationary gap:
- Unemployment is low
- Prices are rising
- Productivity is rising too fast for firms to keep up
108
3.8 v3: If government increases expenditures / spending on goods and services and increases taxation by the same amount, what will happen to AD?
AD will increase because government spending has increased. Some of the increase in AD will be offset by the increase in taxation but there will still be a net increase in AD. The Increase in government spending outweighs the increase in taxation.
109
3.8 v3: Spending multiplier = 1 / MPS
Tax multiplier = -MPC / MPS
If this is true then how much greater is the spending multiplier than the tax multiplier?
The spending multiplier will always be 1 greater than the tax multiplier
110
3.8 v3: Assume an economy at full employment has a government that wants to decrease spending by 50 billion and does not want to decrease inflation in the short run. how much should taxes change and Why
There would need to be a decrease in taxes by more than 50 billion. Since the spending multiplier has a larger impact than the tax multiplier the government would need to decrease taxes by more than what they a want decrease in spending.
111
3.8 v3: If an economy is in recessionary gap of 12 billion, how much will the government increase spending if the MPC is 0.75
The Spending multiplier = 1 / MPS. Since the MPC is 0.75 we know the MPS is 0.25. 1 0.25 = 4 so the spending multiplier = 4. 12 / 4 = 3. So, if the government wanted to close the recessionary gap of 12 billion, they would have to spend 3 billion.
112
3.8 v3: If an economy is in recessionary gap of 12 billion, how much will the government decrease taxes if the MPC is 0.75
The tax multiplier = -MPC / MPS. Since we know the MPC is 0.75, we know the MPS is 0.25. -0.75 / 0.25 = -3 so the tax multiplier = -3. 12 / -3 = -4 So, if the government wanted to close the recessionary gap of 12 they would have to cut taxes by 4 billion.
113
3.9 v1: What are automatic stabilizers and some examples?
Policies that have already passed in congress to deal with economic issues in the previous generation.
some examples of automatic stabilizers are:
- Income taxes
- Transfer payments (unemployment insurance)
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3.9 v1: How do automatic stabilizers work?
The stabilizers are not discretionary. The stabilizers start working automatically without any deliberation or legistration
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3.9 v1: If an economy is experiencing a regression, what are some examples of automatic stabilizers that will work like the expansionary fiscal policy?
Unemployment insurance is an example. The unemployed can apply for unemployment insurance to continue looking for work without the government passing new legislation.
Another examples is Temporary assistance. Temporary assistance like the TANF program in the US automatically starts to provide assistance to those hurt the most by a recession.
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3.9 v1: If an economy is experiencing a expansion, what are some examples of automatic stabilizers that will work like the contractionary fiscal policy?
When an economy is experiencing a expansion peoples will have more disposable income but they will also be paying more taxes. This also applies to businesses which are growing, investing and spending more during an expansion.
Examples of the automatic stabilizers that work like the contractionary fiscal policy are:
- Income taxes
- Corporate taxes
- Decreases in unemployment insurance
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3.9 v1: How do automatic stabilizers affect the business cycle in an inflationary and recessionary gap? How do the automatic stabilizers act like their respective fiscal policies?
During a recessionary gap automatic stabilizers will flatten the downward peaks to LR GDP in the business cycle model. The automatic stabilizers provides support to those in low income.
During a inflationary gap the automatic stabilizers will flatten the upward peaks to LR GDP in the business cycle model. The automatic stabilizers tax people and businesses more money as they have more disposible income
Automatic stabilizers work as both fiscal policies because they help reduce effects of the output gap.
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3.9 v2: If a person who is unemployed receives unemployment insurance (a form of transfer payment) for might the person spend that money and how will it affect the economy?
The assumption is that the person will spend the insurance on goods and services. However, this doesn't always happen and they will sometimes spend it on debts and taxes. If the money is not spent of consumption (goods and services) then the economy can not get out of the recessionary gap.
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3.9 v2: What is a assumption for individuals who receive transfer payments?
The person that received the transfer payments is always assumed to spend it on goods and services thereby increasing consumption.
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3.9 v2: Imagine that a economy with a balanced budget in long-run equilibrium has a decrease in business investment. If no policy action is taken, how might the fall in business investment affect government transfer payments in the US?
A fall is business investment leads to a decrease in aggregate demand. The decrease in aggregate demand means output decreases increasing unemployment. The increase in unemployment means more people will be applying for unemployment insurance increasing transfer payments in the US.
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3.9 v2: How do transfer payments help bring the economy out of a recession?
Transfer payments give the unemployed money which they are assumed to spend of goods and services. The increase of purchased goods and services means increased consumption. the increase in consumption increases AD shifting the AD curve back to Long-run equilibrium.
