Unit 3: Fixing the Economy Part 1-Fiscal Policy

Real Wealth Effect

PL Increase→ Savings increase→ rGDP decreases

Interest Rate Effect

PL increase→ interest rates increase→ rGDP decrease

Net Export Effect

PL increase→ exports decrease→ rGDP decreases

AD shifters on a aggregate supply/demand graph

any change in C, I, G, or Nx

Demand pull inflation

when AD increases

Cost-push inflation

when SRAS decreases

Stagflation

PL increase and U increase

Aggregate demand

sum of all demands for all the goods and services in all final markets

AD=C+G+I+X_n

Aggregate demand formula

AD=C+G+I+X_n

Aggregate Supply

Sum of all supply of all the goods and services in all final markets

Two types of AS

Short-run aggregate supply and long-run aggregate supply.

Sloped Short-run AS

-In short run, factor cost are ____. ____ are sticky in the short run

fixed

wages

Sloped Short-run AS

-In the short run, increase in price level will ______ firms’ profits

increase

Sloped Short-run AS

-Higher profits encourage production so on the SRAS curve, rGDP ___ with price level

increases

Sloped Short-run AS

-In the short run, we have booms and busts: ___ and ____

expansions and recessions

Shifting SRAS

occurs when factor costs change, ex oil prices, wages shift, government tax policies on businesses change, or dramatic national events, weather affects production

Short-run equilibirum

Where AD and SRAS intersect illustrates the current state of the economy. Shows the current rGDP and PL.

Vertical Long-run AS

LRAS is a vertical line in the aggregate supply curve representing the full employment output of an economy, indicating that in the long run, supply is not influenced by price levels.

Shifting LRAS

Any permanent change in FOPs

3 Places an economy can be

1. Long run equilibrium: at potential, at the full employment level of output, U=NRU

2. Recessionary Gap: Below potential, below the full employment level of output, U>NRU

3. Inflationary Gap: Above potential, above the full employment level of output, U<NRU

If recessionary gap, naturally, in the long run nominal wages ___ factor costs ___ SRAS ____

decreases

decreases

increases

In inflationary gap nominal wages ___ factor costs ____ SRAS ____

increase

increase

decrease

Fiscal Policy

Government (pres and congress) power to tax and spend to stabilize an economy and it refers to government policies, like taxes, budgets, government purchases, and laws

3 tools pres and congress can use in fiscal policy

1. Change in gov spending: Impacts the G in AD

2. Change Taxes: Impacts C

3. Change transfer payments: impacts the C

Automatic stabilizers

ex) unemployment benefits, progressive tax

No need for a new policy

What is the goal of expansionary fiscal policiy

to increase aggregate demand and stimulate economic growth by

-Increasing G spending

-Lowering taxes (T)-Impacts C

-Increase transfer (TR)-Impacts C

What is the goal of contractionary fiscal policy

to decrease aggregate demand and reduce inflation by

-Decreasing G spending

-Increasing taxes (T)-Impacts C

-Decreasing transfer payments (TR)-Impacts C

Two approaches to fiscal policy

Demand-side policies and supply side policies

Demand-side policies (fiscal policy)

Policies targeted at consumers. Goal=Government stimulates demand to spur output. Focus on increasing aggregate demand through government spending and tax adjustments, aimed at stimulating economic growth.

Supply-side policies (fiscal policy)

Policies aimed at producers like firms/businesses. Goal=stimulate production to grow output, often by tax cuts, cut gov regulations, increase subsidies for businesses to increase incentives. Also known as trickle down economics

MPC=

Marginal propensity to consume

MPS=

Marginal propensity to save

MPC+MPS=

1

Government multiplier/Investment multiplier/Net Exports Multiplier=

1/MPS

Tax multiplier=

-MPCx(1/MPS)

Government multiplier is (larger/smaller) than the tax multipler

larger

Short-run phillips curve

shows the inverse relationship between inflation and unemployment in the short run, illustrating how inflation can decrease when unemployment rises.

If the economy is operating at a point left to the LRPC curve, it’s in an ___ gap

inflationary

If the economy is operating at a point to the right of the LRPC curve, it’s in a ___ gap

recessionary

Demand shocks: (slide/shift) on the SRPC

slide in the opp direction as demand shift

Supply shocks: (Slide/Shift) the SRPC

shift in the opp direction as supply

On the Phillips curve slides/shift move in the (same/opp) direction as the preceding AD/AS shift

opp