Economics: Growth, Fiscal Policy, and Aggregate Models

GDP per capita

Measures output per person, accounting for population size, making it a better indicator of living standards than total GDP.

Rule of 70

A formula (70 ÷ growth rate) used to estimate how long it takes for a variable like GDP to double.

Labor Force Participation and Growth

A rise in labor force participation boosts GDP per capita temporarily but doesn't create long-term growth without productivity gains.

Three Sources of Productivity Growth

1) Physical capital growth, 2) Human capital (education, skills), 3) Technological progress.

Decreasing Returns to Factors

Adding more capital yields smaller increases in output; sustained growth needs technology and efficiency improvements.

Government Role in Long-Run Growth

The government promotes growth through investment in education, infrastructure, technology, and stable institutions.

Convergence Hypothesis

Poorer nations grow faster than richer ones over time, assuming similar access to technology and institutions.

Regional Growth Differences

East Asia: rapid growth via investment and education; Latin America: inequality and instability; Africa: low investment and infrastructure.

Mainstream vs Ecological Economics on Sustainability

Mainstream assumes markets and innovation solve sustainability; ecological economists emphasize environmental limits and active regulation.

Multiplier

Measures how a change in autonomous spending causes a larger change in GDP; formula = 1 / (1 - MPC).

Autonomous vs Induced Spending

Autonomous spending is independent of income; induced spending changes with income levels.

Marginal Propensity to Consume (MPC)

The fraction of additional income that is spent; helps determine the size of the multiplier.

Consumption Function

C = A + MPC(Yd); where A = autonomous consumption, Yd = disposable income. Changing A shifts the line; changing MPC changes its slope.

Movements vs Shifts in the Consumption Function

Movement: change in income; Shift: change in wealth, expectations, taxes, or interest rates.

Aggregate Expenditure (AE)

AE = C + I(planned) + G (+ NX); represents total planned spending in the economy.

Equilibrium GDP (Y*)

Occurs where AE = output; shows equilibrium between planned spending and actual production.

Shifts in AE and New Equilibrium

When AE shifts, the new equilibrium GDP (Y*) can be found using the multiplier effect.

Keynesian Cross vs AD-AS Models

Keynesian Cross focuses on spending-driven equilibrium; AD-AS links output and price level for full macro analysis.

Deriving AD Curve from Keynesian Cross

As prices rise, real wealth and spending fall, reducing equilibrium output—creating a downward-sloping AD curve.

Shifts in Aggregate Demand (AD)

Caused by changes in expectations, wealth, fiscal or monetary policy, or foreign demand.

Short-Run Aggregate Supply (SRAS)

Upward sloping because prices rise faster than wages, encouraging higher production.

Shifts in SRAS

Caused by changes in input costs, productivity, taxes/subsidies, or supply shocks.

Long-Run Aggregate Supply (LRAS)

Vertical because long-run output depends on resources and technology, not price; shifts with potential GDP growth.

Demand and Supply Shocks

Demand shocks shift AD (spending changes); supply shocks shift SRAS (production cost changes).

Automatic Stabilizers

Built-in fiscal mechanisms (like taxes and unemployment benefits) that counteract economic fluctuations automatically.

MMT Job Guarantee as Stabilizer

Provides jobs automatically during downturns, expanding in recessions and shrinking in booms.

Advantage of Automatic Stabilizers

They act quickly without requiring new legislation or policy changes.

Discretionary Fiscal Policy

Government changes in spending or taxes designed to manage aggregate demand.

Multiplier and Fiscal Policy

The multiplier shows how spending or tax changes impact total output.

Different Multiplier Effects by Policy Type

Spending has a direct impact; taxes affect output indirectly through disposable income.

Net Taxes Multiplier

Equal to -MPC / (1 - MPC); measures how tax changes affect GDP.

Expansionary vs Contractionary Fiscal Policy

Expansionary increases AD (used in recessions); contractionary decreases AD (used to fight inflation).

Problems with Discretionary Fiscal Policy

Includes time lags, forecasting errors, political issues, and risk of crowding out private investment.