FISCAL POLICY

-Changes in expenditures or tax revenues of the federal government.

TOOLS OF FISCAL POLICY

-Taxes: government can increase or decrease taxes.

-Spending: government can increase or decrease spending.

DEFICITS, SURPLUSES AND DEBT

Balanced Budgets

-Revenues = Expenditures.

Budget Deficit

-Revenues < Expenditures.

Budget Surplus

-Revenues > Expenditures.

Government Debt

-Sum of all deficit - sum of all surpluses.

Government must borrow money and its run a budget deficit.

Government borrows money from:

-Individuals.

-Corporations.

-Financial Institutions.

-Foreign entities or government.

FISCAL POLICY TWO OPTIONS

Discretionary Fiscal Policy(action)

-Expansionary Fiscal Policy- think deficit.

-Contractionary Fiscal Policy- think surplus.

Non-Discretionary Fiscal Policy(no action)

DISCRETIONARY FISCAL POLICY

-Increasing or decreasing government spending and/or taxes in order to return the economy to full        employment.

-Discretionary policy involves policy makers doing fiscal policy in response to an economic problem.

AUTOMATIC FISCAL POLICY

-Unemployment compensation and marginal tax rates are examples of automatic policies that help    mitigate the effects of recession and inflation.

-Automatic fiscal policy takes place without policy makers having to respond to current economic  problems.

EXPANSIONARY FISCAL POLICY

-Combat a recession.

-Government spending increases.

-Taxes decreases.

CONTRACTIONAL FISCAL POLICY

-Combat inflation.

-Government spending decreases.

-Taxes increases.

TYPES OF TAXES

PROGRESSIVE TAX SYSTEM

-Average tax rate(tax revenue/ GDP) rises with GDP.

PROPORTIONAL TAX SYSTEM

-Average tax rate remains constant as GDP changes.

REGRESSIVE TAX SYSTEM

-Average tax rate falls with GDP.

AUTOMATIC OR BUILT-IN STABILIZERS

-Anything that increases the government's budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policymakers.

CONSUMPTION & SAVINGS

DISPOSABLE INCOME(DI)

-Income after taxes or net income.
-DI = gross income -taxes.
-With disposable income, households can either:
 *Consume(spend money on goods & services)
 *Save(spend money on goods &services).

CONSUMPTION

-Household spending
-The ability to consume is constrained by:
 *The amount of disposable income.
 *The propensity to save.
-Do household consume if DI=0.
 *Autonomic consumption
 *Dis saving.

SAVING

-Households not spending.
-The ability to save is constrained by:
 *The amount of disposable income.
 *The propensity of disposable income.
-Do households save if DI=0.
 *No.

APC &APS(AVERAGE TO CONSUME/SAVE)

-APC+APS = 1.
-1- APC = APS.
-1- APS = APC.
-APC >1: Dis saving.
-(-APS): Dis saving.

MPC(MARGINAL PROPENSITY TO CONSUME)

-The fraction of any change in-disposable income that is consumed.
-MPC = change in consumption/ change in disposable income.

MPS(MARGINAL PROPENSITY TO SAVE)

-The fraction of any change in disposable income that is saved.
-MPS = change in savings/ change in disposable income.

MARGINAL PROPENSITIES

-MPC +MPC =1.
 *MPC = 1- MPS.
 *MPS = 1- MPC.
-Remember, people do two things with their disposable income, consume or save it.

SPENDING MULTIPLIER EFFECTS

-An initial change in spending(C, Ig, G, Xn) causes a larger change in aggregate spending or aggregate  demand.
-Multiplier = change in AD/ change in spending.

CALCULATING SPENDING MULTIPLIER

-The spending multiplier can be calculated from the MPC or MPS.
-Multiplier = 1/1- MPC or 1/MPS.
-Multipliers are (+) when there is an increase in spending and (-) when there is a decrease.

CALCULATING TAX MULTIPLIER

-When the government taxes, the multiplier works in reverse.
-Why?
 *Because now money is leaving the circular flow.
-Tax multiplier(note: it's negative)
 *-MPC/1- MPS or -MPC/MPS.
-If there is a tax cut, then the multiplier is (+), because there is now more money in the circular flow.

REAL(r%0) VS. NOMINAL(i%)

What is the difference?

-Nominal is the observable rate of interest rate of interest. Real subtracts out inflation and is only known ex post facto.

How do you compute the real interest rate(r%)?

-r% = i% - inflation.

What then, determines the cost of an investment decision?

-The real interest rate(r%).

INVESTMENT DEMAND CURVE

What is the shape of the investment demand curve?

-Downward sloping.

Why?

-When interest rates are high, fewer investments are profitable; when interest rate are low, more investments are profitable.

SHIFTS IN INVESTMENT DEMAND(ID)

-Cost of production.

 *Lower costs shift(ID ->).
 *Higher costs shift(ID <-).

-Business taxes

 *Lower business taxes shift(ID ->).
 *Higher business taxes shift(id <-).

- Technological Change

 *New technological shifts(ID ->).
 *Lack of technological change shifts(ID <-).

-Stock of capital

 *If an economy is low on capital, then(ID ->).
 *If an economy is low on capital, then(ID <-).

-Expectations

 *Positive expectations shift(ID ->).
 *Negative expectations shift(ID ->).

LONG RUN VS SHORT RUN AGGREGATE SUPPLY

LONG RUN AGGREGATE SUPPLY (LRAS)

-Period of time where input prices are completely flexible and adjust to changes in the price level.
-In the long run, the level of real GDP supplied is independent of the price level.
-The long run aggregate supply marks the level of full employment in the economy.
-Because input prices are completely flexible in the long run, change in price level do not change firms' real  profits and therefore do not change firms' level of output. this means that the LRAS is vertical at the  economy's level of full employment.

SHORT RUN AGGREGATE SUPPLY (SRAS)

-Period of time where input prices are sticky and do not adjust to changes in the price level.
-In the short run, the level of real GDP is directly related to the price level.

CHANGES IN SRAS

-An increase in SRAS is seen as a shift to the right(SRAS ->).
-A decrease in SRAS is seen as a shift to the left(SRAS <-).
-The key to understanding shift in SRAS is per unit cost of production.
-Per unit production cost = total input cost/ total output cost.

DETERMINANTS OF SRAS

-Input prices
-Productivity
-Legal-institutional environment

INPUT PRICES

-Domestic resource prices

 *Wages(75% of all business costs).
 *Cost of capital.
 *Raw materials(commodity prices).

-Foreign resource prices

 *Market power.
 *Increase in resource price(SRAS <-).
 *Decrease in resource prices(SRAS ->).

PRODUCTIVITY

-Productivity = total output/ total input.
-More productivity = lower unit production cost(SRAS ->).
-Lower productivity = higher unit production cost(SRAS <-).

LEGAL-INSTITUTIONAL ENVIRONMENT

-Taxes and subsidies

 *Taxes($ to government) on business increase per unit production cost(SRAS <-).
 *Subsidies($ from government) to business reduce per unit production cost(SRAS ->).

-Government regulation

 *Government regulation compliance cost(SRAS <-).
 *Deregulation reduces compliance cost(SRAS ->).

FULL EMPLOYMENT

-Full employment equilibrium exists where AD intersects LRAS X SRAS at the same point.

INFLATIONARY GAP

-An inflationary gap exists when equilibrium occurs beyond full employment prices.

RECESSIONARY GAP

-A recessionary gap exists when equilibrium occurs below full employment.

AGGREGATE DEMAND

WHY IS AD DOWNWARD SLOPING?

1) Real Balance Effect: 

    -Higher price levels reduce the purchasing power of money.
    -This decreases the quantity of expenditures.
    -Lower price levels increase purchasing power and increase expenditures.

2) Interest Rate Effect:

    -When the price level increases, lenders need to charge higher interest rates to get a REAL return on their       loans.
    -Higher interest rates discourage consumer spending and business investments.

3) Foreign Trade Effect:

    -When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign       goods.
    -Exports fall and imports rise causing real GDP demanded to fall. (Xn decreases).

SHIFTERS OF AGGREGATE DEMAND

GDP= C+I+G+Xn

 There are two parts to a shift in AD:
  -A change in C, I, G AND Xn.
  -A multiplier effect that produces a greater change than the original change in the four components.
    *Increase in AD = AD ->
    *Decrease in AD = AD <-

CONSUMPTION 

Household spending is affected by;

-Consumer wealth

  *More wealth = more spending(AD shifts ->)
  *Less wealth = less spending(AD shifts <-)

-Consumer expectations

  *Positive expectations = more spending(AD shifts ->)
  *Negative expectations = less spending(AD shifts <-)

-Taxes

  *Less taxes = more spending(AD shifts ->)
   *More taxes = less spending(ad shifts <-)

GROSS PRIVATE INVESTMENT

Investment spending is sensitive to:

-The real Interest Rate

  *Lower real interest rates = more investment(AD ->)
  *Higher real interest rate = less investment(AD <-)

-Expected Returns

 *Higher expected returns = more investment(AD ->)
 *Lower expected returns = less investment(AD <-)
 *Expected returns are influenced by
   +Expectations of future profitability
   +Technology
   +Degree of excess capacity(existing stock of capital)
   +Business taxes

GOVERNMENT SPENDING

-More government spending(AD->)
-Less government spending (AD<-)

NET EXPORTS 

Net exports are sensitive to:

-Exchange rates(international value of $)

 *Strong$ = more imports and fewer exports = (AD <-)
 *Weak$ = fewer imports and more exports =(AD ->)

-Relative income

 *Strong foreign economies = more exports =(AD ->)
 *Weak foreign economies = less exports =(AD <-)