econ unit 8

initial assumptions of AE model

1. No G

2. No Xn

3. No business savings

4. No depreciation

5. GDP = NI = PI = DI

6. No inflation

Determinants of C + S

1. DI (primary) (move along curve)

2. wealth effect: increased wealth leads to increased C and decr S

3. future expectations: if expect price to incr, incr C now and decr S, and if expect income to incr, incr C now and decr S

4. real interest rates: if interest rates go up, C goes down and S goes up

5. taxation: taxes decrease C and S

6. HH debt: if more debt, incr C (paay off debt) and decr S

Determinants of ID

1. real interest rate (primary) (move along curve)

2. acquisition, maintenance, and operating costs: higher costs shift ID left

3. business taxes: incr taxes shift ID left

4. tech change: incr tech change shift ID right

5. stock of capital goods: incr stock shifts ID left

6. expectations: optimistic shifts ID right

7. also, political climate, foreign affairs, population growth, and consumer tastes

why planned investment is unstable

1. durability of capital - people choose when to replace or patch up

2. variability of expectations

3. irregularity of innovation

determinants of Xn

1. prosperity abroad: foreigners good fortune means Xn incr

2. tariffs: tariffs on foreign goods means Xn incr (ceteris paribus)

3. exchange rates: when value of US dollar decr, Xn incr

changes in initial assumptions when adding G

1. DI = PI - taxes

2. horizontal axis represents GDP now

3. taxes occur

Actual multiplier

1 over the fraction of change in income not spent on domestic output

(less than multiplier effect)

limitations of AE model

1. GDP can’t exceed Yf

2. price levels don’t change

3. ignores premature d-pull inflation

4. c-push inflation

causes of downsloping AD

1. real balances effect: incr in PL means every asset is relatively worth less, so less purchasing power, so less C and less GDP

2. interest rate effect: when PL incr, demand for money incr so interest rate incr which decr C and Ig so decr GDP

3. foreign purchases effect: incr in PL means foreigners buy less of our goods and we buy more of their so decr Xn and decr GDP

determinants of AD

C: wealth, expectations, HH borrowing, taxes

Ig: interest rates, expected returns, tech

Xn: national income abroad, exchange rates

Ratchet effect causes

min wage: not allowed to cut wages

union contracts: not allowed to cut wages

morale: if they cut wages, workers will be sad

menu costs: firms want to wait and see if price drops will last because no point doing all the associated stuff with decreasing price if it goes back up

price wars: firms don’t want to drop prices for fear of starting a price war

counter arguments to ratchet effect

decreased power of price unions:

past wage cuts:

foreign competition will lower prices:

determinants of SRAS

domestic resources: increased supply of resources decreases resources costs so SRAS shifts right

foreign resources: increased price of foreign resources shifts SRAS left

market power of resource sellers: more market power means higher resource price which shifts SRAS left

productivity: decreased productivity increases PUPC which shifts SRAS left

business taxes: shifts SRAS left bc higher input costs

regulation: costly to comply so shift SRAS left

shocks + effect on economy

pos demand: incr in GDP and PL (partially offset)

neg demand: decr in GDP, no change in PL

pos supply: incr in GDP, hardly any PL change

neg supply: decr in GDP, incr in PL

ranges effects on multiplier

1 - full effect of multiplier

2 - partially offset

3 - completely offset

discretionary fiscal policy definition

government policy actions that are approved by acts of Congress

problems w discretionary fiscal policy

1. recognition - at least 6 months of trend

2. administration - bills not passed easily

3. implementation - it takes a while for the spending to actually result in benefit

4. political business cycle - politicians will mess w cycle to be reelected

5. state/local being procyclical means they counteract the fed

6. inflationary pressures

7. crowding out - incr G means value of dollar goes up so interest rate goes up and Ig decr

8. temp tax cuts lead to decr C bc ppl just pay off debts but permanent actually incr C

9. incr RGDP means incr imports and decr exports cuz consumption goes up and incr PL means decr X

national debt types

SR - t bills

MR - t notes

LR - t bonds

US Savings bonds

federal budget philosophies

1. balanced budget: T should equal G

2. cyclically balanced budget: budget balances over bus cycle so combination of discr FP and auto stabilizers

3. functional finance: econ stability over budget considerations

national debt breakdown

nom GDP = 27.5 trillion

nom GDP/cap = 86,000

deficit = 1.8 trillion (8% up)

Debt = 35.5 trillion

fed reserve and gov agencies own 52% of debt

private owns 48% of debt

concerns about national debt

fake

• us will go bankrupt - debt is relative to what is earned, debt believed to be manageable, US securities are in strong demand

• we burden future generations - debt owed to ourselves so its chill

Real

• interest income + income inequality - richer people own the securities and get the interest

• work incentives - higher taxes decr innovation and will to work

• foreign owned US securities - interest to foreigners is a leakage

• crowding out: lower Ig leaves future generations w less capital and lower standard of living