Macroeconomics Exam 3 MSU (Gonzales)

Average prosperities

APC+APS=1

Consumption and savings

Primarly determined by DI (Disposable Income). Direct relationship

consumption schedule

a schedule showing the amounts households plan to spend for consumer goods at different levels of disposable income

saving schedule

DI (disposable income) - C (consumption)

Dissaving can occur

average prosperity to consume (APC)

Fraction of total income consumed

Average prosperity to save (APS)

Fraction of total income saved

APC

consumption/income

APS

saving/income

APC+APS=

1

marginal propensity to consume (MPC)

Proportion of a change in income consumed

Marginal propensity to save (MPS)

Proportion of a change in income saved

MPC

change in consumption/change in income

MPS

change in savings/change in income

MPC+MPS=

1

Nonincome determinants of consumption and saving

Amount of disposable income is the main determinant. Other determinants: walth, borrowing, expectations, real interest rates

Interest-rate-investment relationship

Expected rate of return

The real interest rate

Investment demand curve

Shifts of investment demand

Acquisition, maintenance, and operating costs

Business taxes

Technological change

Stock of capital goods on hand

Planned inventory changes

Expectations

Gross investment expenditures as a percentage of GDP

varies widely by nation. These differences, of course can change from year to year

Instability of investment

Variability of expectations

durability

irregularity of innovation

variability of profits

The multiplier effect

A change in spending changes real GDP more than the initial change in spending

Multiplier formula

change in real GDP/ initial change in spending

Change in GDP formula

multiplier x initial change in spending

Multiplier and MPC

directly related: large MPC results in larger increases in spending

Multiplier and MPS

inversely related: large MPS results in smaller spending

Multiplier (MPC) formula

1/ 1-MPC

Multiplier (MPS) formula

1/ MPS

Actual Multiplier Effect

actual multiplier is lower than the cost assumes

consumers buy imported products

Households pay income taxes

Inflation

Multiplier may be 0

Squaring the economy

Humorous small town example of the multiplier

One person in town decides not to buy a product

Creates a ripple effect of people not spending, following the first decision

Ultimately the entire town experiences an economic downturn

Aggregate Demand

Real GDP desired at each price level

Inverse relationship

Real balance effect

Interest effect

Foreign purchases effect

Real balance effect

The change in expenditures resulting from a change in the real value of money balances when the price level changes, all other things held constant; also called the wealth effect.

Interest effect

at a low price level, people will have more money than they want and will try to acquire less liquid assets, increasing the supply of savings; this decreases interest rates and causes people to borrow more; one of the reasons aggregate demand slopes downward

Foreign purchases effect

The inverse relationship between the net exports of an economy and its price level relative to foreign price levels.

Change in aggregate demand

Determinants of aggregate demand

Shifts factor affecting C, I, G, Xn

2 components involved

Change in one of the

determinants

Multiplier effect

C, I, G, Xn

The things that make up GDP

C=Consumer Spending

I=Investments, when businesses put money back into their own businesses

G=Government Spending

Xn= Net Exports (Exports (X)-Imports (M))

consumer spending

Consumer wealth

Household borrowing

Consumer expectations

Personal taxes

consumer wealth

total dollar value of all assets owned by consumers in the economy less the dollar value of their liabilities

household borrowing

Consumers can increase their consumption spending by borrowing

consumer expectations

Your expectations for the future can affect your buying habits today.

Personal taxes

Taxes paid by individuals on their income

Investment spending

Real interest rates

Expected returns

Expectations about future business

Technology

Degree of excess capacity

Business taxes

Government spending

Government spending increases:

Aggregate demand increases (as long as interest rates and tax rates do not change)

More transportation projects

Government spending decreases:

Aggregate demand decreases

Less military spending

net exports spending

National income abroad

Exchange rated:

Dollar depreciation

Dollar appreciation

dollar appreciation

decrease in number of dollars per unit of foreign currency

dollar depreciation

Increase in the number of dollars per unit of foreign currency

Aggregate supply

total real output produced at each price level

Relationship depends on time horizon:

Immediate short run

Short run

Long run

Changes in aggregate supply

Determinants of aggregate supply:

Shift factors

Collectively position the AS curve

Changes raise or lower per-unit production costs

input prices

Domestic resource prices:

Labor

Capital

Land

Prices of imported resources:

Imported oil

exchange rates

Productivity

Real output per unit of input:

Increases in productivity reduce costs

Decreases in productivity increase costs

Productivity formula

total output/total input

per-unit production cost formula

total input cost/ total output

Legal-Institutional Environment

Legal changes alter per-unit costs of output:

Taxes and subsidies

Extent of government regulation

Decreases in AD: Recession

Prices are downwardly inflexible:

Fear of price wars

Menu costs

Wage contracts

Efficiency wages

Minimum wage law

Stimulus and the Great Recession

Housing collapse triggers bank failure and leads to recession

Federal Reserve intervenes:

Lowers short-term interest rates

Federal Government begins largest peacetime program of spending

GDP growth has been disappointing

High debt load due to low interest rates

High rate saving

Unequal impact

Price increases rather than output gains

Fiscal policy

Deliberate changes in: government spending, taxes

Designed to: achieve full-employment, control inflation, encourage economic growth

expansionary fiscal policy

Used during a recession: increases government spending, decreases taxes, combination of both, create a deficit

Contractionary fiscal policy

Use during demand-pull inflation: decreases government spending, increases taxes, combination of both, creates a surplus

To expand size of government

if recession, then increase government spending. If inflation, then increase taxes

To reduce size of government:

if recession, then decrease taxes. If inflation, decrease government spending

Build-in stability

Automatic stabilizers: taxes vary directly with GDP, transfer vary inversely with GDP

Reduces severity of business fluctuations

Tax progressivity: Progressive tax system, proportional tax system, regressive tax system

progressive tax system

a tax whose average tax rate increases as the taxpayer's income increases and decreases as the taxpayer's income decreases

proportional tax system

a tax whose average tax rate remains constant as the taxpayer's income increases or decreases

regressive tax system

a tax whose average tax rate decreases as the taxpayer's income increases and increases as the taxpayer's income decreases

Neutral fiscal policy

when changes to government spending and taxation leave the overall budget surplus or deficit unchanged and have no effect on aggregate demand.

cyclically adjusted budget

The estimated annual budget deficit or surplus that would occur under existing tax rates and government spending levels if the the economy were to operate at its full-employment level of GDP for a year; the full-employment budget deficit or surplus.

The Great Recession

Financial market problems began in 2007. Credit market freeze. Pessimism spreads to the overall economy. Recession officially began December 2007 and lasted 18 months

Problems, Criticisms, and Complications

Problems of timing: recognition lag, administrative lag, operational lag

Political business cycles

Future policy reversals

Off-setting state and local finance

Crowding-out effect

recognition lag

The time it takes for policy makers to recognize the existence of a boom or a slump.

administrative lag

lag between the time the need for fiscal action is recognized and the time action is taken

operational lag

the time it takes for the full impact of a government program or tax change to have its effect on the economy

political business cycle

results when politicians use macroeconomic policy to serve political ends

crowding-out effect

the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending

Current Thinking on Fiscal Policy

Let the Federal Reserve handle short-term fluctuations

Fiscal policy should be evaluated in terms of long-term effects

Use tax cuts to enhance work effort, investment, and innovation

Use government spending on public capital projects

The U.S. Public Debt

$16.4 trillion in 2012 - the accumulation of years of federal deficit and surpluses

Owed to the holder of U.S. securities: treasury bills, treasury notes, treasury bonds, U.S. saving bonds

Interest charges on debt: Largest burden of the debt, 2.3% GDP in 2012

False Concerns: Bankruptcy- refinancing, taxation

Burdening future generations

Treasury Bills

short-term government securities issued at a discount from face value and returning the face amount at maturity

Treasury Notes

United States government obligation with a maturity of 2 to 10 years

Treasury Bonds

Bonds issued by the federal government, sometimes referred to as government bonds.

U.S. Savings Bond

a discount bond issued by the federal government that pays a guaranteed minimum rate of interest

Subjective issues

income distribution

Incentives

Foreign-owned public debt

Crowding-out effect revisited: future generations, public investment