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Keynesian Economics
macroeconomic generalization
led to the conclusion that a capitalistic economy is characterized by macroeconomic instability
says that fiscal and monetary policy can be used to promote full employment, price level stability, and economic growth
consumption schedule
a schedule showing the amounts households will spend at different levels of disposable income
saving schedule
a schedule showing the amounts households will save at different levels of disposable income
marginal propensity to consume (MPC)
the fraction of any change in disposable income spent for consumer goods
equal to the change in consumption divided by the change in disposable income
marginal propensity to save (MPS)
the fraction of any change in disposable income not spent for consumer goods (in other words: saved)
equal to the change in savings divided by the change in disposable income
investment demand curve (loanable funds market)
a curve that shows the amount of investment (loanable funds) demanded by an economy at a series of real interest rates
equilibrium GDP
the point at which aggregate supply equals aggregate demand
planned investment
the amount that a firm plans or intends to invest
impacted by interest rates
actual investment
the amount that a firm does invest
equal to planned investment + unplanned investment
spending multiplier
the number by which a change in any component of aggregate demand must be multiplied to find the resulting changes in the equilibrium GDP
calculated as 1/MPS or 1/(1-MPC)
net exports
exports - imports
aggregate demand
a schedule or curve, which shows the total quantity of goods and services demanded (purchased) at different price levels
wealth effect (real balances effect)
the tendency for increases in the price level to lower the real value or purchasing power of consumer assets, effecting a reduction in consumer spending
a fall in aggregate price level increases the purchasing power, so consumption increases
discretionary fiscal policy
deliberate changes in taxes (tax rates) and government spending by congress to promote full employment, price stability, and economic growth
expansionary fiscal policy
an increase in government expenditures for goods and services
a decreases in net taxes
or a combination of the two
for the purpose of increasing aggregate demand and expanding real output to stabilize economy
contractionary fiscal policy
a decrease in government expenditures for goods and services
an increase in net taxes
or a combination of the two
for the purpose of reducing inflation
budget defecit
amount by which the government’s expenditures exceed its revenues (mostly taxes) each fiscal year
cyclical defecit
budget deficit that is caused by recession conditions bringing in lower tax revenues
budget surplus
amount by which government revenues (mostly taxes) exceed its expenditures each fiscal year
built in / automatic stabilizer
a mechanism that:
increases deficit or reduces surplus during a recession
decreases deficit or increases surplus during during an expansionary period
WITHOUT action from fiscal policymakers
ex. tax system: the more money we make a society, the more the government’s revenues increase
progressive tax system
system of taxation where the average tax rate of an individual raises as their income increases
proportional tax system
system of taxation where the average tax rate of an individual remains constant as their income rises or falls
regressive tax system
system of taxation where the average tax rate of an individual falls as their income rises or vice versa
net export effect
the idea that the impact of the change in fiscal or monetary policy will be strengthened or weakened by the subsequent change in net exports
supply-side fiscal policy
fiscal policy emphasizing control of the aggregate supply curve through changes in production costs
interest rate effect
the tendency for increases in the price level to increase the demand for money, raise interest rates, and as a result, reduce total spending in the economy
(opposite is true for decreases in price level)
foreign purchases effect
the inverse relationship between the net exports of an economy, and its price level relative to foreign price levels.
if our PL decreases, AD increases
if our PL increases, AD decreases
determinants of aggregate demand
factors which include:
input prices
productivity
the legal-institutional environment
nominal wages
that can shift the aggregate supply curve when they change
productivity
a measure of average output, or of real output per unit of input
ex. productivity of labor may be found by dividing the real output by the hours of work
equilibrium price level
the price level at which the aggregate demand curve intersects the aggregate supply curve
equilibrium GDP
the real domestic output at which the aggregate demand curve intersects the aggregate supply curve
the GDP at which the total quantity of final goods and services purchased (aggregate expenditures) is equal to the total quantity of final goods and services produced (real domestic output)
tax multiplier
= - MPC / MPS
because income is reduced by saving any new income or changes in taxes or transfers, we cannot use the spending multiplier because it must be reduced by the amount saved
balanced budget multiplier
measures the change in aggregate production caused by government taxation and spending changes.
always equal to 1 because in a balanced budget, total anticipated revenues and total anticipated expenditures are equal.
sticky wages
refers to a situation in which employers are slow to change wage rates in the face of a surplus or a shortage of workers
capital inflow
net inflow of funds into a country
rate of return
the profit earned on a project expressed as a percentage of its cost
nominal wage
the dollar amount of the wage paid (not adjusted for inflation)
potential output (full-employment output)
the level of Real GDP the economy would produce if all prices, including nominal wages, were sticky and there there is only structural and frictional unemployment present
AD-AS model
a model in which the aggregate supply curve and the aggregate demand curve are used together to analyze economic fluctuations
supply shock
an event that shifts the short-run aggregate supply curve
cause the quantity supplied to change rapidly
ex. a natural disaster that disrupts the production process or supply chain
demand shock
an event that shifts the short-run aggregate demand curve
an unexpected event that dramatically changes demand for a product/products
ex. a global pandemic
stagflation
the combination of inflation and falling aggregate output
worst of both worlds
caused by SRAS decrease
long-run macroeconomic equilibrium
when the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curve
recessionary gap
when aggregate output is below potential output
point INSIDE LRAS or PPC
inflationary gap
when aggregate output is above potential output
point outside LRAS or PPC
classical economics
belief that
supply creates its own demand
wages and prices are fully flexible
an economy will always be at or move towards full employment output (on LRAS or PPC)
short-run phillips curve
graph that shows the negative relationship between the unemployment rate and inflation rate
increase in unemployment = decrease in inflation (vice versa)
decrease in unemployment = increase in inflation (vice versa)
long-run phillips curve
graph that shows that there is no relationship between the unemployment rate and the inflation rate
vertical line is equal to structural plus frictional unemployment
Note 
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