Studied by 6 people
Study Guide
Interest Rate Effect
Decline in price level means lower interest rates that can increase certain levels of spending
As IR goes up, investments go down
AD shifts left
Real Balance Effect
Price level falls, the purchasing power of existing financial balances rises
As purchasing power goes up, AD will shift right
Foreign Purchase Effect
Domestic prices go down, our good is cheaper compared to foreign goods
As exports increase we will sell more to the world and AD will shift right
What way does the AD curve shift with expansionary (contractionary) Fiscal Policy?
AD curve shifts to the right with expansionary fiscal policy
AD curve shifts to the left with contractionary policy
According to the foreign purchase effect, if price levels rise (lower) in the US relative to other countries what happens to NX?
It increases
Know the determinants of Aggregate Demand and how if they change they would cause AD to shift
Determinants: C, I, G, Xn
Consumer spending, changes in interest rates or expected returns, gov spending, and changes in national income changes abroad
What is the money multiplier, how do you calculate it? If given numbers can you find the total amount of economic activity created given an injection of a certain amount.
Example - MPC = 0.75 and we inject 5 billion…AD would shift right by…
Definition: A change in spending changes real GDP more than the initial change in spending - when money is re-spent in the economy, how many times it is re-spent
MM = 1/(1-MPC)
Ex: = 4, so the MM would be 4. If 5 billion injected then GDP would go up to 20 billion
What are the 3 periods of time for Aggregate Supply and what is fixed or flexible in each one
Immediate Short run - both input and output prices are fixed - straight horizontal line
Short Run - input prices fixed, output flexible - bowing sloping supply, next 3-6 months
Long Run - Both are flexible and can vary - straight up and down one, 1-3 years
What are some ways that AS in the short run will shift left or right?
Anything that will cause firms to not have the ability to produce more or cause them to produce more.
Taxes, input costs changing, wars, government regulations
As input prices go up, supply less
Input prices go down, so supply is more
Increase corporation taxes - less money has for inputs so less outputs
What does productivity measure and how is it important to the AS curve?
Productivity measures how much can you make, and how fast and how good = measures real output per unit of input
Increases in productivity reduce costs and decreases in productivity increase costs therefore they are important to the AS curve
Productivity affects supply
How do personal and business taxes effect AD and AS?
Inversely, as taxes go up we spend less and firms have less cash flow to buy inputs
Also works the other way around
As corporations taxes go up, they have less money to use - businesses, buying less so producing less so AD would shift to the left
How is AD and AS possible effected with changes in the exchange rate (value of the dollar compared to other countries)
As the dollar gets weaker, our goods are cheaper relative than before and we will export more and AD will shift to the right, AKA increase
Dollar Depreciation -> AD increases
Dollar Appreciation -> AD decreases
Graphically how do we show demand-pull inflation or cost-push inflation?
o Demand-Pull- A shift in the AD graph to the right
o Cost-Push- A shift in AS to the left
Graphically how do we know/show a recession?
When you are to the LEFT of your long run aggregate supply and long run output
A leftward shift in Aggregate Supply when the price level is downwardly inflexible
Can you graphically give a situation to show how the AS/AD model would adjust?
i.e. graphically how would the graph change if the government issued everyone over the age of 18 a $1,400 stimulus check
Shift demand to the right, so this increases consumption, and causing the GDP to go up, causing AD to go right.
Discretionary fiscal policy vs. Nondiscretionary fiscal policy
Discretionary - Sledgehammer, when Congress has to vote on changes in taxation or changes in government spending (ex. stimulus package/check or tax cuts)
Nondiscretionary - Laws already in place that nudge GDP get back to long run output (ex. unemployment insurance, SNAP, WIC)
Why are prices downward inflexible?
Menu Costs - costs to reprint the menus (not going to lower or raise the prices because of recession)
Wage Contract - Norwood is on contract with OU, so even if something happens with the economy, the wage he gets is constant
Consumer Behavior - We freak out or we buy a lot depending on what is happening with the economy (If prices are low we will buy more)
What are some automatic stabilizers? What do they do?
Taxes, Welfare, Unemployment insurance…
Taxes very directly with GDP and transfers vary inversely with GDP
There are laws that are already in place to help nudge the economy back to long run output.
What business cycle phases go with each fiscal policy?
o During an expansion business cycle there should be contraction fiscal policy
o During a recessionary business cycle there should be a expansionary fiscal policy.
What is one major drawback with fiscal policy?
It is run by people that need to get elected to keep their jobs
What are the main tools of fiscal policy?
Taxes
Government Spending
What is a budget deficit, how does it happen, and how is it different than the national debt?
Budget Deficit: the year to year debt that the US government incurs
Budget Deficit is caused by more Expansionary Fiscal Policy NOT being offset by Contractionary Fiscal Policy
National Debt: Summation of all the yearly debts that we have incurred
What is the crowding effect?
It is when Expansionary Fiscal Policy is used and it raises interest rates that then crowds out private investments from happening
What is the biggest variable that affects your personal spending?
income/disposable income
Holding all else equal when income goes up what happens to savings and consumption?
They also go up
When you save money you give up _______ money. In regards to the consumption schedule and saving schedule if you start to spend more how does your saving schedule shift? (remember it works vis versa)
Spending
Takes longer to save for later
If personal taxes increase (decrease) what happens to your level of consumption and savings?
It goes down if there’s an increase because you lose more of you income to taxes.. so less to spend and less to save
How is the marginal propensity to consume calculated?
MPC = It is the Change in Consumption divided by the Change in Income
MPS = Change in Savings divided by the Change in Income
Income 200, Consumption 220
New Income 220 and Consumption is 230
MPC = (230-220)/(200-220) = 10/20 = .5 = MPC
What is dissavings?
When you spend more than you make
If you DI is $500 and consumption is $450 do you have Dissavings?
No you do not
If you DI is $500 and consumption is $550 do you have dissavings?
Yes you do
What cause the investment demand curve to shift from the left or the right?
Hint changes in interest rates will NOT cause a shift but it will cause a slide along it.
Anything that will cause firms to not have the ability to produce more or cause them to produce more
Taxes, input costs changing, wars, government regulations
What helped John Maynard Keynes come up with the aggregate expenditures model?
After the great depression he proposed this model
Referring to the Aggregate Expenditures Model as we added more parts of GDP to the model it would shift ____ or ____ depending on if the new component was positive or negative.
Left or right
What makes GDP goes up and down…
allows AD to shift right or left
Good Test Question: Marginal Propensity is 0.9%, inject 100, Multiplier is 10
1000 is the answer
What does MPC + MPS equal?
1
Government Spending increases, what happens?
Aggregate Demand increases (as long as interest rates and tax rates do not change)
More transportation projects
Government spending decreases, what happens?
Aggregate Demand decreases
Less military spending
Input Prices
Domestic Resource Prices
Labor - increase or decrease in labor force
Capital - machinery
Land - the land you sit on or the strip mall
Prices of imported resources:
Imported oil - needed for almost all firms
Exchange rates - input parts from overseas
Productivity
Real output per unit of input
Increases in productivity reduce costs
Decreases in productivity increase costs
Productivity = total output/total inputs
Per-unit production cost = total input cost/total output
Fiscal Policy is designed to:
Achieve full-employment
Control Inflation
Encourage economic growth
Expansionary Fiscal Policy
Use during a recession
Increase gov spending
Decrease taxes
Combination of both
Create a deficit
Contractionary Fiscal Policy
Use during demand-pull inflation
Decrease government spending
Increase taxes
Combination of both
Create a budget surplus
Tax Progressivity
Progressive tax system
Proportional tax system
Regressive tax system
Problems of Timing - Fiscal Policy
Recognition Lag - recognize when to react
Administrative Lag - congress is voting and passing
Operational Lag - we voted, stimulus check, go
Other problems with Fiscal Policy
Political Considerations
Future policy reversals
Offsetting state and local finance
Crowding-out effect
What is owed to the holders of U.S. securities?
Treasury Bills
Treasury notes
Treasury bonds
U.S. Savings bonds
What components are involved in Aggregate demand?
Change in one of the determinants
Multiplier
Changes in Aggregate Demand
Dashed lines - initial effect
Solid lines - after the multiplier takes effect
Main driver of consumption
Disposable Income
Consumer Wealth
Difference between household assets (homes and stocks and bonds) and liabilities (loans and credit cards) - literally disposable income
Household borrowing
Borrow money now, spend now
Expected returns
The expected profit you will get from your investment
National Income Abroad
Higher foreign income → AD increases
Lower foreign income → AD decreases
Aggregate Supply in the Immediate Short Run Graph
Straight horizontal lone
Flat, input is fixed, output is fixed
Aggregate Supply Curve Short Run Graph
Bowed a little
Next 3-6 months of the production of goods and services in our economy
Never leave out services
Output is fixed
Blip if something changed like if there is a shortage of wheat
Aggregate Supply in the Long Run
Straight vertical line
For this to ever shift there has to be a permanent change to the economy like if we allowed more immigrants in, more workers mean more output, etc.
Changes in Aggregate Supply
An increase is a shift to the right and a decrease is a shift to the left
Pandemic - we saw a decrease
One we marry agg supply and demand we can see all these changes
Note
Flashcard