AI flash cards

AP MACRO STUDY GUIDE

TEST 1

Scarcity is a condition that comes from human wants exceeding resources able to satisfy them

Forces us to make choices among alternatives based on our incentives

Economics is the social science that studies the choices individuals, businesses, and governments make to cope with scarcity and what influences those choices

Micro: Choices of individuals and businesses and how they are affected by governments

Macro: Total effect of choices made by businesses, individuals, and governments on the economy

Goods and services are objects and actions that people value and produce to satisfy human wants

We think about what goods and services are produced, how are they produced, and who are they produced for

Self-interest: Choices best for the individual who makes them

Social interest: Choices that are the best for society

Choice is a tradeoff 

• We choose from alternatives, but whatever is chosen we could have chosen something else

• A tradeoff is an exchange; giving up one thing for another

Cost is what you must give up to get something

• Opportunity cost is the  highest value thing that you have to give up to get something

Benefit is what you gain from something

• Benefit is a gain/pleasure from something, measured by what you are willing to give up

People make rational choices by comparing benefits and costs

• Rational choice is a choice that uses the best available resources to best achieve the objective of who is making the choice

• Compare costs and benefits

• Marginal benefit > marginal cost

Most choices are how much choices made at the margin

• Marginal cost is opportunity cost for one unit increase in an activity; Marginal benefit is what you gain for one more unit of something

Choices respond to incentives

• An incentive is something that encourages or discourages an action

Consumption goods and services are g&s bought by individuals for personal enjoyment or to improve qol

Capital goods are bought by businesses to increase productivity

Consumption goods and services make up almost 80 percent of the economy

Manufacturing is about 13%; others add up to about 9%

We produce with the factors of production; Land, Labor, Capital, and Entrepreneurship

Land is natural resources such as minerals, water, air, plants, animals, farmland, and forests

Labor is the time and effort devoted to producing goods and services; human capital is the knowledge and skills obtained from education, training, and experience

Capital is tools, instruments, machines, buildings, and items that are used by businesses to produce goods and services(Not stocks and bonds)

Entrepreneurship is the human resource that organizes labor, land, capital 

Incomes come from the sale of services of factors of production

Land gets rent, labor gets wages, capital gets interest, entrepreneurship gets profit/loss

Country production structures are similar, but differences in human capital and physical capital and how large food production make the difference between countries

Advanced economies are richest

Emerging is in the middle

Developing is the lowest

OC: What must be given up to get something else

PPF: a boundary between combinations of goods and services that can and can’t be produced

PPC illustrates ppf

Considers attainable and unattainable combinations, efficient and inefficient production, and tradeoffs/free lunches

Can produce inside the frontier, but not outside

Producing on the points on the PPF is efficient(every point except G)

When we are on the PPF we have to make a tradeoff: give to get

Inside the ppf we can move anywhere we want without tradeoffs

***

Steeper the PPF the higher the opportunity cost is

When the resources of an economy increase PPF moves outwards

Absolute advantage is when a person or nation is more productive than another; takes less time to produce more goods or uses fewer inputs

Comparative advantage is the ability of someone to perform an activity or produce a good/service at a lower opportunity cost than others

You can have absolute advantage in both, but not comparative advantage

Liz should produce smoothies, Joe should produce salads due to comparative advantages

A market is an arrangement that brings buyers and sellers together

Demand is the buyers, supply is the sellers

Anything can be traded

Quantity Demanded is amount of a good/service/resource people are willing and able to buy

Law of Demand states that when other things stay the same, if the price of a good falls, quantity demanded increases, and if the price of a good rises, quantity demanded decreases

Demand is the relationship between quantity demanded and the price of a good

Law of Demand explains downward slope

Change in demand causes curve to change

TRIBE shifts demand

Tastes: Due to information or new goods, people will avoid/gravitate toward a good or buy a different good

Related Goods: Substitutes and Complements

Substitutes move in the same direction: When the price of a substitute rises, demand for a good increases, and vice versa

Complements move in opposite directions: When the price of a complement decreases, demand for the good increases, and vice versa

Income: Income moves in the same direction as demand

However for Inferior goods when income increases demand decreases

Buyers: More buyers higher demand

Expectations:

Expected Future Prices: A rise in the expected FUTURE price of a good increases current demand, and a fall leads to a decrease

Expected Income: Expected increase in future income means increase in the demand of goods

When the quantity demanded changes, there is movement along the curve

Quantity supplied is the amount of a good/serice people are willing and able to sell at a certain period at a certain price

Law of supply states if price rises, quantity supplied rises

Leads to Upward Sloping

ROTTEN shifters

Related Goods: When price of substitute goods increase, supply decreases: sub decrease, supply increase

When price of complement increases, supply of base good increases, vice versa

Other Inputs: Wages, oil, steel etc.; when their price increases supply decreases because it costs more to produce

Taxes: Taxes make it more expensive to produce and decrease supply; subsidies make it less expensive and increase production

Technology: Better technology leads to more supply

Expectations: Expecting higher future prices = more supply

Number of Firms: More sellers means more supply

Equilibrium is when the quantity supplied = quantity demanded

Price is the regulator of a market

A shortage is when quantity demanded > quantity supplied: price rises to make up for it

A surplus is when quantity supplied > quantity demanded: price falls to make up for it

Questions to consider: Does the event change demand or supply? Does it increase demand or supply? What are the new equilibrium price and quantity

TEST 2

Market price; how much something is worth, what is paid for it

GDP(Gross Domestic Product) is the market value of the final goods and services produced within a country in a given time period

It is calculated quarterly(every 3 months) and is the scorecard of a given country’s economic health

Final goods and services are goods produced for a user and not as a part of another good or service

Intermediate goods are bought by a firm to use as part of their good or service

For a good to count as part of a country’s GDP, it has to be produced in that country

Households, firms, governments, and the rest of the world buy goods and services

Consumption, investment, government spending, and net exports

Expenditure approach = Y= C + I + G + NX(X-M)

Consumption is household expenditure, investment is new capital bought by firms(NOT STOCKS AND BONDS), government spending is self-explanatory, net exports consists of goods and services sold to foreign nations, households, and firms, and imports consist of goods and services bought from foreign governments

Consumption makes up most of the expenditure

The income approach shows how households receive and save their income and pay some in taxes 

Uses and Limitations of GDP

Real GDP shows the standard of living over time, tracks the course of the business cycle, and compares the standard of living among countries

Real GDP removes inflation and accurately compares different times

Potential GDP is the value of real GDP when the factors of production(land,labor capital, and entrepreneurship) are fully employed

Real GDP fluctuates around potential GDP.

Fluctuations in the expansion of real GDP is part of the business cycle; movement of total production and economic activity

Contains expansions, peaks, recessions, and troughs

A recession is when real GDP is negative for six months or more

To compare different living standards across countries, we convert real GDP into a common currency/set of prices known as purchasing power parity

Compares country currencies with a basket of goods approach

Things excluded from GDP

Household production; cooking, cleaning, housework

Underground production; economic activity hidden from government to avoid taxes and regulations or production that is illegal

Leisure time

Environmental quality; GDP does not reflect pollution and other similar factors

Health and life expectancy and political freedom are not reflected

Income Approach

Different to expenditure

Wage income and net operating surplus

Wage income is the payment for labor services; net wages and salary + benefits such as health care, social security, and pension fund contributions

Interest rent and profit together are known as the net operating surplus

Interest is the income households receive on loans minus the interest they pay for borrowing

Rent is the payment for the use of land and other things

Profit is the profits of corporations and small businesses

Income approach is calculated with the net domestic product at factor cost; sum of wages, interest, rent, and profit

We also need to adjust from factor cost to marke prices and from net product to gross product

To convert from the value at factor costs, we add indirect taxes and subtract subsidies

Income measures net product, expenditure measures gross

To get to gross we must add depreciation(decrease in value of capital from use & obsolescence)

There is also a statistical discrepancy between expenditure and income approaches, and we subtract GDP income total from the expenditure total

GNP(Gross National Product)- market value of all the final goods and services produced anywhere in the world by the factors of production supplied by a country

GNP = GDP +  Net Factor Income from abroad

Real GDP- value of final goods and services produced in a given year expressed in the prices of the base year(adjusted for inflation)

Nominal GDP- value of final goods and services produced in a given year expressed in the prices of that same year

CPI

CPI is a measure of the average of the prices paid by urban consumers for a fixed market basket of consumer goods and services

Calculated monthly

Reference base period is 100 from 1982-1984

Three stages: selected basket, conducting monthly price survey, calculating the CPI

Basket is in the budget of an average urban household; not updated monthly and influenced by Consumer Expenditure Survey

Monthly price survey is when BLS employees check the prices of 80,000 goods and services in the basket in 30 metropolitan areas

Measures price changes, so the prices recorded must refer to the same terms

(Current period cost/over base period ) * 100

Inflation rate is the percent change in the price level from one year to the next

((Current CPI- Previous CPI)/Previous CPI)*100

Other Price Level Measures

CPI does not measure the cost of living because it does not measure all the components of living cost and some of the components are not measured exactly

CPI has potential biases

New goods; they do better than old goods they replace and cause an upwards bias

Better goods cost more than what they replace; a price rise that is a payment for improved quality is not inflation but still might be counted as that

Substitution: When the price of one good rises faster than another, more of the cheaper good will be bought

CPI does not account for this

When prices rise, discount stores are used more; CPI also doesn’t account for this

CPI is estimated to be 1.1% per year

CPI biases leads to the distortion of private contracts; wage contracts are linked to it and bias can lead to unexpected outcomes

Also causes increase in government outlays and decreases in taxes; ⅓ of outlays are tied to cpi, affected things like social security, food stamps, school lunches, etc.

Nominal vs Real

To compare dollar amounts at different dates we need to know the CPI at these dates

These adjectives apply to GDP, wage rate, and interest rate

Real GDp is nominal GDP multiplied by the ratio of a price index in a different year

GDP price index is an average of the current prices of all the goods and services included in GDP expressed as a percentage of the base years

GDP Price Index/Deflator = (Nominal GDP/Real GDP) * 100

Real GDP is calculated by multiplying the quantity of output in one year by the prices in a base year.
Wage rate is the hourly wage rate measured in current dollars

Real wage rate is average hourly wage rate compared to another reference base year

Real interest rate is just nominal interest rate- inflation rate

Unemployment

Working-age population is the total number of people aged 16+ who are not in jail, hospital, military, or another kind of institutional care

Divided into labor force and not in labor force

Most of those not in are in school or retired

Labor force = employed + unemployed

Employed: worked an hour in a paid job or 15 hours unpaid or not working but had jobs where they had a temporary absence the week before the survey

Unemployed: had no employment and were available for work the week before the survey

Both had made efforts to find employment in the precious four weeks or wanted to be recalled to a job from which they had been fired

We need to focus on the unemployment rate, employment-population ratio, and labor force participation rate

Unemployment omits the following types of labor

Marginally attached workers do not have a job, are willing/available to work, but have not made efforts to find a job in the past for weeks and have looked for work sometime in the recent past

Discouraged workers are marginally attached workers who don’t make efforts to find a job because their previous attempts were discouraging

Part time workers who want full-time work are also omitted

Full time = >=35 hours a week

Part time = <35 hours a week

Unemployment rate increases in recessions and decreases in expansions

Participation rate increased between 1960 and 1999; women participated more, men less

Measures of unemployment

U-3 is main and official, percentages of labor force

Unemployment and full unemployment

There is unemployment because the labor market is always churning

New jobs are recreated and old jobs die

Three types of unemployment: Frictional, Structural, and Cyclical

Frictional arises from people entering and leaing the labor force; it is permanent and healthy

Structural arises from changes in technology or internationall competition; changes in skills needed to perform jobs

Cyclical is essentially bad; fluctuating unemployment over the business cycle; increases during a recession, decreases during an expansion

Natural unemployment arises from frictional and structural unemployment; NOT CYCLICAL

Natural unemployment rate = 4.5-5.5%

Full employment occurs when the unemployment rate = natural unemployment rate

Age distribution of populace(young = new job seekers), pace of structural change(tech changes), real wage rate(rise = surplus of labor), unemployment benefits(increase NRU because less opportunity cost for the job search)

At full employment there is no cyclical unemployment

At the trough of the business cycle, cyclical unemployment is positive

At the peak, cyclical unemployment is negative

POTENTIAL GDP

VALUE OF REAL GDP WHEN THE ECONOMY IS AT FULL EMPLOYMENT

THEORETICAL: WORLD WHERE EVERYTHING IS PERFECT

WE PRODUCE THE GOODS THAT MAKE UP REAL GDP USING FACTORS OF PRODUCTION: LABOR, PHYSICAL CAPITAL, LAND, AND ENTREPRENEURSHIP

QUANTITY OF LABOR IS NOT FIXED; DEPENDS ON CHOICES OF PEOPLE AND BUSINESSES

REAL GDP DEPENDS ON QUANTITY OF LABOR EMPLOYED

UNEMPLOYMENT RATE FLUCTUATES AROUND THE NATURAL UNEMPLOYMENT RATE; REAL GDP FLUCTUATES AROUND POTENTIAL GDP

WHEN UNEMPLOYMENT RATE > NATURAL UNEMPLOYMENT RATE, REAL GDP < POTENTIAL GDP

WHEN UNEMPLOYMENT RATE< NATURAL UNEMPLOYMENT RATE, REAL GDP > POTENTIAL GDP

UNEMPLOYMENT RATE FLUCTUATES AROUND THE NATURAL UNEMPLOYMENT RATE; FALLS BELOW THE NATURAL RATE WHEN CYCLICAL UNEMPLOYMENT IS NEGATIVE, RISES ABOVE WHEN CYCLICAL UNEMPLOYMENT IS POSITIVE

PRODUCTION FUNCTION SHOWS THE RELATIONSHIP BETWEEN QUANTITY OF REAL GDP AND QUANTITY OF LABOR EMPLOYED WHEN OTHER INFLUENCES ON PRODUCTION REMAIN THE SAME

BOUNDARY BETWEEN ATTAINABLE AND UNATTAINABLE

DIMINISHING RETURNS; TENDENCY FOR EACH ADDITIONAL HOUR TO PRODUCE SMALLER AMOUNTS OF REAL GDP

LABOR MARKET CONSISTS OF DEMAND AND SUPPLY FOR LABOR

QUANTITY OF LABOR DEMANDED IS THE TOTAL LABORS ALL FIRMS PLAN TO HIRE IN A GIVEN TIME PERIOD AT A REAL WAGE RATE

DEMAND FOR LABOR IS THE RELATIONSHIP BETWEEN THE QUANTITY FOR LABOR DEMANDED AND REAL WAGE RATE; LOWER REAL WAGE RATE= GREATER QUANTITY OF LABOR DEMANDED; HIGHER RWR = LOWER QOL DEMANDED

FIRMS HAVE TO COMPARE THE EXTRA OUTPUT FROM AN HOUR OF LABOR W/ REAL WAGE RATE

EACH ADDITIONAL HOUR PRODUCES LESS OUTPUT

SUPPLY FOR LABOR IS THE NUMBER OF LABOR HOURS HOUSEHOLDS IN THE ECONOMY PLAN ON WORKING

QUANTITY OF LABOR SUPPLIED IS THE NUMBER OF LABOR HOURS THAT ALL HOUSEHOLDS IN THE ECONOMY PLAN TO WORK DURING A GIVEN TIME PERIOD AT A GIVEN REAL WAGE RATE

SUPPLY OF LABOR IS THE RELATIONSHIP BETWEEN THE QUANTITY OF LABOR SUPPLIED 

LOWER RWR = LOWER SOL PROVIDED; INCREASE IN RWR = INCREASE IN SOL

QUANTITY OF LABOR SUPPLIED INCREASES BECAUSE HOURS PER PERSON INCREASES AS RWR INCREASES(higher opportunity cost for leisure), HIGHER LABOR FORCE PARTICIPATION RATE(people work when rwr exceeds value of other productivie activities), AND OTHER INFLUENCES(Work-leisure depends on after-tax wage rate (wage actually received by household).Income tax rates lower supply or labor. Unemployment benefits lower the OC of job search.)

A RISE IN THE RWR ELIMINATES A SHORTAGE OF LABOR BY DECREASING THE QUANTITY DEMANDED AND INCREASING THE QUANTITY SUPPLIED

A FALL IN THE RWR ELIMINATES A SURPLUS OF LABOR BY INCREASING THE QUANTITY DEMANDED AND DECREASING THE QUANTITY SUPPLIED

WHEN THERE IS NO SHORTAGE OR SURPLUS, THE MARKET IS IN EQUILIBRIUM

FULL EMPLOYMENT IS WHEN THE QOL DEMANDED = QOL SUPPLIED

IN THIS GRAPH, RWR IS 50 AND FULL EMPLOYMENT QUANTITY OF LABOR IS 200 BILLION

EQUILIBRIUM = FULL EMPLOYMENT

IN THIS SCENARIO REAL GDP = POTENTIAL GDP

Natural Rate of Unemployment

NRU is the unemployment rate that a healthy economy will have

4.5-5.5, 4-5%

Fiscal and monetary policies are used to reach full employment

To understand the amount of frictional and structural unemployment that exists at the natural NRU, we look at job search and job rationing, causes of unemployment

Job search is looking for an acceptable vacant job; depends on demographic change, unemployment benefits, and structural change

Demographic Change: Increase in the proportion of population that’s working age and increase in the entry rate into the labor force increases the unemployment rate

Unemployment Benefits: Higher unemployment benefits = lower OC of not having a job and you get to search longer; vice versa works too

Structural change: Technological changes influence labor market flow and unemployment

Job rationing occurs when the rwr is above the full-employment equilibrium level; real wage rate might be set above the full-employment equilibrium level for three reasons

Efficiency Wage: Firm paying over market wage(full unemployment equilibrium wage rate) to induce a higher work effort

Minimum Wage: Government sets a minimum wage above the equilibrium wage rate, leading to unemployment results

Union Wage: Labor unions operate in some labor markets and agree a wage rate with employers/firms

Classical macroeconomics

Market economy gives best macroeconomic performance

Aggregate fluctuations are a natural consequence of an expanding economy with rising living standards

Government intervention hinders the ability of the market to allocate resources efficiently

Fell off in 1930s because of Great Depression and high unemployment

Suggested that Great Depression would end but provided no method

Bastiat;Ricardo;Smith;Hume

Keynesian macroeconomics

Market economy is unstable and active government intervention is needed to achieve full employment and economic growth

John Maynard Keynes

Limited consumer spending led to the GD; suggested that his policy would cure short term unemployment but increase it in the future

Came true in 1960s-1970; inflation exploded, growth slowed, unemployment increased

Recession of 2008 revived interest in Keynes ideas; juggernaut of 1900s macroeconomics

Monetarist macroeconomics

Classical view of the world is correct, but we need to account for fluctuations in the quantity of money that generate the business cycle

A slowdown in the growth rate of money causes recession;a decrease in the quantity of money aused the GD

Milton Friedman
Quantity of money plays a huge part in fluctuations

Values

VIDEO

Economists measure the health of the economy by looking at key economic indicators like GDP, the unemployment rate, the the inflation-measuring CPI.

The circular flow model shows how households, businesses, and the government interact

GDP is the dollar value of all final goods and services produced within a country in one year

There are three types of unemployment: frictional, structural, and cyclical; the economy is at full employment when there is no cyclical unemployment

Real GDP is adjusted for inflation and expressed in constant/unchanging dollars. Nominal GDP is not adjusted for inflation.

AGGREGATE DEMAND

Demand for every good and service

Quantity of real GDP demanded

Total amount of FINAL goods and services produced in a country that people, businesses, and governments and foreigners plan to buy

Expenditure approach; Y= C+I+G+Nx

Aggregate demand is the relationship between the quantity of real GDP demanded and the price level when all other influences on expenditure plans remain the same

When price rises, quantity of Real GDP demanded decreases

When the price falls, quantity of real GDP demanded increases

Sloped down because more is bought when price level falls

Also when prices increase in one country less people buy from that country

Price level changes affect the buying power of money, real interest rate, and the real price of exports and imports

When price goes up, buying power of money decreases, and quantity of real GDP demanded decreases

When prices falls money buys more and real GDP demanded increases

When price level rises, real interest rate rises

Price rise increases the amount of money people want to hold and increases demand for money

When demand increase, NIR increases

Rise in nominal interest rate = rise in real interest rate

Lower the interest rate the likely you are to buy something

Quantity of real GDP demanded decreases as real interest rate rises

Real prices of net exports

When US prices rise and other things are consistent, prices in other countries do not change

Rise in price level makes US goods more expensive than foreign goods

People spend less on US goods and more on foreign goods

When price level changes more in one country than other, exchange rate changes to neutralize the price change

Factors that shift aggregate demand: expectations about the future, state of the world economy, fiscal and monetary policy

Expectations

• Increases in expected future income increases the amount of consumption goods people buy now

• Increases in expected future inflation increases aggregate demand because people buy goods now before the prices rise

• Increase in expected future profit increases firms investing now and increases aggregate demand

World Economy

• The foreign exchange rate and foreign income influence aggregate demand.

• The foreign exchange rate is the amount of foreign currency you can buy with a U.S. dollar.

• Other things remaining the same, a rise in the foreign exchange rate decreases aggregate demand.

• Example: $1 to 100¥ exchange rate. $125 Motorola or 12,500¥ Fujitsu phone? Depends on PL!

• An increase in foreign income increases U.S. exports and increases U.S. aggregate demand. 

• A decrease in foreign income decreases U.S. exports and decreases U.S. aggregate demand.

Fiscal and Monetary Policy

• Fiscal- Actions of Congress and President

• Changing taxes, transfer payments, government spending 

• Monetary Policy- Actions of the Fed and Central Bank

• Federal Reserve influences aggregate demand; stimulus increases demand, taxes decrease

• Changing quantity of money and interest rate

Aggregate demand multiplier is an effect that magnifies change in expenditure plans and brings potential large fluctuations in aggregate demand

Increase in investment increases AD and income

Increase in income leads to an increase in consumption spending

AD increases by more than the initial increase

Quantity of real GDP supplied is the total amount of final goods and services that firms in the U.S. plan to produce

All goods and services

This depends on labor employed, capital, land, and entrepreneurship

At full employment real GDP = potential GDP; the quantity of labor demanded and the quantity of labor supplied at the equilibrium real wage rate

Quantity of labor employed fluctuates around the full employment level

Aggregate supply is the relationship between the quantity of real GDP supplied and the price level when all other influences on production plans remain the same

When the price level rises, the quantity of real GDP supplied increases(people want to sell)

Vice versa(when prices are lower, you don’t wanna sell)

Rising price indicate that businesses should expand production to meet aggregate demand

Only influence on production plans is the price level

Money wage rate and money prices of other resources

Shifters of the AS curve

Key resources/costs(oil steel labor, cost/availability of key resources)
Productivity(machinery, capital, new tech)

Size and Quality of Labor(Immigration, skilled workers, human capital)

Change in Expected price level(different from price level, wages are negotiated in response to the increase

Gov’t Action(taxes, regulations, subsidies)

AS changes when influences on production plans other than the price level changes

AS changes when potential GDP changes

Watch the money wage rates, money prices, and anything that changes potential GDP

A change in the money prices of other resources changes aggregate supply because it changes firms’ costs

Higher prices of other resources, the higher firms costs and firms want to supply less at each price level

Decreases AS

Economic Trends and Fluctuations

AS-AD Model

Basis of macroeconomics

Used to explain business cycle fluctuations in real GDP and price level with Aggregate Supply and Demand

Movements of the curve predict the effect on events on rGDP and PL

Equilibrium occurs when the quantity of real GDP supplied equals the quantity of real GDP demanded

When firms cannot meet demand, production needs to be increased and prices need to be raised

When firms can’t sell their production, they lower production and prices
Different types of equilibrium to consider

Full-Employment Equilibrium- when equilibrium real GDP = potential GDP when AD intersects AS

Recessionary gap exists when potential GDP exceeds real GDP, causing the price level to fall

Inflationary gap exists when real GDP exceeds potential GDP, causing a rising price level

When real GDP is not at potential GDP, the money wage rate gradually increases or decreases to bring full employment

In a recessionary gap, there is a surplus of labor, and firms higher new workers a a lower wage rate

Price levels fall, real GDP increase

In an inflationary gap, there is a shortage of labor, and firms raise the wage rate to attract more workers

Price level rises, real GDP decreases

Economic growth results from a growing labor force and more productivity, increasing potential GDP

Inflation results from a growing quantity of money that outpaces the growth of potential GDP

Economic growth comes to increase potential GDP(rightward shift in the vertical line)

Inflation arises from aggregate demand increasing faster than potential GDP

Real Business Cycle results from fluctuations in AS and AD

AS fluctuates because of labor productivity, changing the growth rate of potential GDP

AD fluctuations are the main source of the business cycle, because it fluctuates more than AS

Inflation also has cycles; Demand Pull and Cost-Push

Inflation that starts because of AD increasing is demand-pull inflation

Factors that increase aggregate demand lead to inflation(C+I+G+Nx), but what sustains it is a growth in the quantity of money

When quantity of money increases, AD moves to the right

When GDPr exceeds potential GDP,the money wage rate has to rises and AS move lefts 

Inflation that is a result of AS increasing is cost-push inflation(or stagflation)

Factors that shift AS(productivity, input prices, expectations of inflation, government regulation)

Sustained by growth in the quantity of money

Higher input costs decrease AS, while AD doesn’t change

When costs increase, AS curve shifts left

When GDPr is below potential GDP, the Fed increases Q of M and AD goes right

Marginal Propensity(behavior) to Consume

Can only save or spend a dollar

Aggregate expenditure is C+I+G+NX

Aggregate planned expenditure is the planned expenditure for each sector

Equal to autonomous expenditure + induced expenditure

The sum of spending plans for households, firms, governments

Autonomous expenditure is the components of aggregate expenditure that don’t change when real GDP changes

(I+G+X)(unimportant)

Investment + government expenditure + exports + components of consumption expenditure and imports not influenced by real GDP

Induced expenditure is the parts of aggregate expenditure that change when real GDP changes

(consumption-imports)(unimportant)

Consumption function is the relationship between consumption expenditure and disposable income

Disposable income = aggregate income(GDP)- net taxes

Net taxes are taxes paid to the government - transfer payments 

SAVE OR SPEND

Graph on slides to look at

Marginal propensity to consume is the fraction of a change in disposable income spent on consumption

Richer people have a lower mpc to consume since they have more money to save

***

Must be less than or equal to 1

Helps us find the effect of spending 

MPS is marginal propensity to save

Real Interest Rate and Wealth/Expected Future Income influence consumption plans(fall and rise together)

Equilibrium Expenditure

The multiplier is the amount by which a change in any component of autonomous expenditure is magnified or multiplied to determine the change that it generates equilibrium expenditure and real GDP

Aggregate Expenditure Multiplier

Increase in investment increases aggregate expenditure because it causes an increase in consumption expenditure

Multiplier determines how much aggregate expenditure increases because of another component of autonomous expenditure

Determines change in equilibrium expenditure

Multiplier = Change in equilibrium expenditure/Change in autonomous expenditure

Multiplier size depends on MPC

Higher MPC = Higher Multiplier

1/1-MPC is the mpc multiplier; also 1/MPS

Taxes decrease the multiplier, along with imports(only US expenditure affects real GDP)

Tax Multiplier = MPC Multiplier - 1

Multiplier gives momentum to the economy’s new direction

Expansion caused by increase in autonomous expenditure

Firm inventory decreases so they produce more and increase Real GDP

Test 4

Financial capital- funds firms use to buy and operate physical capital

Gross investment- total amount spent on new capital

Net investment- gross investment minus depreciation

Wealth- the value of all the things that a person owns(not earning)

Saving- the amount of income that is not paid in taxes or spent on consumption; added to wealth

Saving is the source of funds that finance investments

Loan Market: 

Businesses use loans to buy things and give credit to their customers

Households purchase more expensive items with loans

Bond Market: 

Bond- promise to pay a certain amount of money at a certain date; used by governments to raise money

Stock Market: 

Stock- ownership to profits that firm makes

A financial institution is a firm that operates on both sides of the market for financial capital; borrows and lends

Investment banks- sell and give bonds to raise money for firms and governments

Commercial banks

Government sponsored mortgage lenders- government related that buys from banks

Pension funds- used to buy stocks and bonds

Insurance companies- firms that provide compensation in accidents

Net worth is the total market value of lent-minus

A positive net worth means the institution is solvent and can keep trading

Institutions lend and borrow

Negative means the institution is insolvent and has to stop trading

The owners of an insolvent institution suffer

A firm is illiquid if it makes long term loans with borrowed funds and needs to repay more of what was borrowed than what they have available 

Can save themselves by borrowing from others

Stocks, bonds, and loans are financial assets

An interest rate is a percentage of the price of the asset

When asset price rises, interest rate falls, and vice versa

Markets and institutions allow us to
Invest in capital

Smooth Consumption Expenditures

Trade Risk

Loanable Funds

Interest rates are the price of borrowing and using money

Nominal is regular; real is adjusted for inflation

Nominal interest rate = real interest rate + expected inflation

Real interest rate = nominal interest rate- expected inflation

For loanable funds we use real interest rates

Loanable funds are funds available for borrowing or lending come from the federal reserve

Commercial banks go to fed banks to get loanable funds

Savings->deposits->loans-> lent out

Qlf = Quantity of loanable funds

Households and business demand loanable funds for consumption/investment

Although banks hold money technically we are supplying loanable funds

The demand for loanable funds is the quantity of credit wanted and needed at every real interest rate by borrowers in an economy to finance investment

High interest rates restrict how much you can borrow

We use one average interest rate called THE interest rate

Loanable funds are used for investment by businesses, private loans, government budges, and international investment/lending

Investment depends on interest rate and expected profit

Firms only invest when they expect to earn a rate of profit that exceeds the real interest rate

When interest rate rises, less profit; when IR falls, more profit

Higher IR = smaller QLF; Smaller IR = higher QLF

Different influences on expected profit can be categorized into objective(business cycle, tech change, population growth), subjective(Keynes animal spirits), and the Contagion effect

Influences of demand for loanable funds

• Decrease in expected profits shifts demand curve to the left

Supply of loanable funds; quantity of credit provided at every real IR by lenders in an economy

The quantity of loanable funds supplied is the total funds available from private saving, the gov’t budget surplus, and international borrowing during a given period

Saving is the main of supply of loanable funds

Depends on:

• Real Interest Rate

• Disposable Income (higher DI greater the MPS)

• Wealth (greater the wealth the less it will save) ***

• Expected Future Income (higher EFI the less it saves today)

• Default Risk (greater risk = higher IR = smaller supply of LF)

More saving = More supply of loanable funds

Higher RIR, greater QLF; lower RIR, smaller QLF

Supply is shifted by 

• Decrease is disposable income, moves left

• Wealth, expected future income, default risk increases

When demand for loanable funds increases, IR rises

When supply of loanable funds increases, IR falls

When govt increases deficit spending, it increases demand OR decreases supply

Real IR increases either way

Government in Loanable Funds Market

Actions that change the gov’ts budget balance influences loanable funds and real interest rate

A government budget surplus increase supply of loanable funds

Government budget surplus is added to private saving supply

An increase in the supply of loanable funds brings a lower RIR which decreases the quantity of private saving and increases the quantity of investment and quantity of loanable funds demanded

Government budget deficit increase the demand for loanable funds

Increase of demand raises RIR, increases the quantity of private saving

Higher interest rate decreases investment and the quantity of loanable funds demanded

A budget deficit causes investment to crowd out; can’t profit anymore

The tendency for a government budget deficit to raise the RIR and decrease investment is the crowding-out effect.

The Ricardo Barro Effect suggests that a government budget deficit has no effect on the RIR or investment

Works when private saving and supply of loanable funds increases to offset government budget deficit

Supply of loanable funds increases by an amount equal to the government budget deficit

Essentially stops crowding out

Basically anything can be used as money

Money is a commodity or token used as a means of payment for goods and services

Can be recognized and divided into smaller parts

Used to buy anything

Means of payment is a way to settle a debt

MONEY IS NOT A LOAN. MONEY IS USED TO PAYOFF A LOAN

Money acts as a medium of exchange, a unit of account, or a store of value

A medium of exchange is an object that is accepted in return for goods/services

Before money goods and services were directly traded for other goods and services; this is known as bartering

Bartering needs a double coincidence of wants. Money allows specialization in comparative advantage

A unit of account is an agreed upon measure for stating the prices of goods and services; opportunity costs of purchases

Store of value is any commodity or token that can be held and exchanged for goods or services

The more stable the value of a commodity/token, the better it is as a store of value or money

Values increase over time

Inflation decreases the money’s store of value

Money in the world today is called fiat money

Fiat money is objects that are money because the law makes them money

This group includes currency, deposits at bank

CURRENCY INSIDE BANKS IS NOT MONEY; would be like double counting it

M0 = Currency and bank reserves

M1 is currency by individuals and businesses, traveler’s checks, checkable deposits owned by individuals and businesses

M2 is M1 plus all types of deposits and money market funds

Something is considered money if it accepted as a means of payment

M1 is money, but some deposits aren’t a means a payment

Some of the deposits in M2 are payment

Checks, credit cards(loans), debit cards, mobile wallets are NOT money

E-Currency will be money at some point

E-cash is the electronic version of paper notes and coins; electric currency and a form of money

Money tends to lose value over time

Money today > money tomorrow 

Future value of money = X * (1+r)

Federal Reserve is at the top of the banking system

Banks and other institutions are under it that take deposits and provide services that enable people and businesses to make payments

Reserves regulate how commercial banks and other institutions work

A commercial bank is a firm licensed by the comptroller of currency in U.S. Treasury to accept deposits and make loans

Mergers decrease amount of banks

A commercial bank accepts checkable deposits, savings deposits, and time deposits

Banks want to maximize the long-term wealth of stockholders

Banks borrow from depositors and others and lend for long-term at high interest rates

Lending is risky, banks have to be prudent in how they use their depositor’s funds and balance security of returns

When banks make losses, a bank run(everyone trying to get their money) will cause a crisis

A bank divides its assets into reserves, liquid assets, securities, and loans

A bank’s reserves consist of currency in bank vaults + the balance on its reserve account

Currency in vault for depositors

The required reserve ratio is the minimum percentage that the fed requires banks to hold as reserves; 10% in this class

Reserve is like bank deposit to fed; fed is bank for a bank

Desired reserves can > required reserves when cost of borrowing reserves is high

Banks create money by making loans

Liquid assets are short term treasury bills and overnight loans to other banks

When banks have excess reserves they can lend them to other banks

The interbank loans market is called federal funds market and the interest rate on those loans is the federal funds rate

Fed policies attempt to target the federal funds rate

Securities are bonds issued by the U.S. government to banks

A bank earns an interest rate on securities but sell them quickly if it needs cash

Loans are the funds that banks provide to businesses and individuals and include outstanding credit card balances

Loans earn the bank a high interest rate, but they are risky and cannot be called in before the agreed date

Three types of thrift institutions are savings/loans associations, saving banks, and credit union

S&L is a financial institution that accepts checkable and savings deposits and makes personal, commercial, ad home purchase loans

A savings bank is financial institution that accepts saving deposits and mainly makes consumer and home-purchase loans

A credit union is a financial institution owned by a social/economic group such as a firm’s employees, that accepts saving deposits and makes mostly consumer loans

Thrift institutions hold reserves and must meet minimum reserve ratios

A money market fund is a financial institution that obtains funds by selling shares and uses these funds to buy assets such as U.S. Treasury Bills

Money market fund shares act like bank deposits

Shareholders write checks on money market fund accounts

Money multiplier can be applied to the reserve ratio; Multiplier = 1/reserve ratio

The initial deposit doesn't count for the new money produced however; was already in the money supply

Initial is subtracted from the new money produced

Federal Reserve System

The fed is the central bank of the U.S.

The central bank is a public authority that provides banking services to banks and regulates financial institutions/markets

The fed regulates the interest rate and the quantity of money to keep inflation low and sustained economic growth

12 Federal districts; each district has its own bank

Elements of the fed:

Chair of the Board of Governors

Chair is chief executive, public face, and center of power/responsibility

Board of Governors

7 members appointed by the POTUS confirmed by the Senate for 14 year terms

One board member as chair for 4 years

Regional Federal Reserve Banks

Each bank has 9 directors, 3 appointed by the Board of Governors and six elected by the commercial banks

Federal Open Market Committee

Fed’s main policy-making committee

Consists of chair, member of board of governors, president of the federal reserve bank of NY, four presidents of the other Fed Reserve Banks

Meet every six weeks

Fed has 4 main policy tools

Required reserve ratios

Banks holding a minimum percentage of deposits as reserves

DIscount rate- the interest rate at which the fed is ready to lend reserves to commercial banks

A change in the discount rate begins with a proposal to the FOMC by a reserve bank

When the FOMC agrees on a change, it proposes it to the Board of Governors

An open market operation is the purchase or sale of government securities- Treasury bills and bonds, by the New York Fed in the open market

Purchase allows banks to make more loans

Sales make it harder for banks to make loans

Extraordinary crisis measure- new tools to deal with collapses(Quantitative easing, credit easing, operation twist)

Quantitative easing is the fed creating bank reserves by conducting large scale open market purchases at a low federal funds rate; can involve buying private securities

Pumping a lot of money at once into the economy

Credit easing- the fed buying private securities or makes loans to financial institutions to stimulate lending

Operation Twist- when the fed buys long term govt securities to sell short term govt securities; lowering long term interest rates to stimulate borrowing and investment

The Fed’s normal policy tools change either the demand or supply of monetary base, which change the interest rate

Monetary base is the sum of coins, fed notes, and banks’ reserves at the Fed; the larger the monetary base, the greater the quantity of money it can support(shrinks the multiplier)

Increasing the reserve ratio, the discount rate, or selling securities lead to an increase in the interest rate

Decreasing the reserve ratio, lowering the discount rate, and purchasing securities in the open market decrease the interest rate

The amount of deposits that banks can create is limited by the monetary base, desired reserves, and desired currency holding

The monetary base is the sum of Federal Reserve notes, coins, and bank deposits at the Fed

The size of the monetary base limits the total quantity of money that the banking system can create due to desired reserves and desired currency holdings

Both depend on the quantity of money

Open market operations are used to increase the monetary base

The desired reserve ratio is the ratio of reserves to deposits that a bank wants to hold; exceeds the required reserve ratio by the amount the bank needs to be prudent

Excess reserves = actual reserves- desired reserves

When the quantity of money increases, so does the quantity of currency people want to hold

Desired currency holding increases when deposits increase; currency leaves banks when they make loans and increase deposits

The leakage of currency is called the currency drain; the ratio of currency to deposits is called the currency drain ratio

An open market operation is the purchase/sale of government securities by the Fed to influence the quantity of money

Basically printing money

When the fed buys securities in an open market operation, it pays for them with newly created bank reserves and money

When there are more reserves in banking systems, the supply on interbank loans increases, the demand for interbank loans decreases, and the federal fund rate(interest rate on loans in the interbank market) decreases

When the fed sells securities it is bought with bank reserves and money, decreasing the money supply

The Fed sets a target for the interest rate and using OMO to reach the target

When reserves increase, lending increases, increasing quantity of money

When reserves decrease, lending decreases, decreasing quantity of money

When the fed sells securities, their assets decrease by 100m, the reserves of the banking system decrease by 100m, and banks borrow in the market to meet their desired reserve ratio

An open market purchase increases bank reserves that increase the monetary base, and the increase equals the amount of the purchase

Quantity of bank reserves increases and gives banks more reserves to lend

Multiplier = 1/Reserve Ratio

Ratio of change in quantity of money to change in monetary base

Currency drain ratio: Ratio of C(Currency) to D(Deposits)

MB=(Reserves(R) + Currency(C))

Quantity of money = Deposits + Currency(D+C)

Make sure when it is a DEPOSIT you use the multiplier and subtract the initial deposit from it

Buy increases money supply, sell decrease

Real factors that are independent of the price level determine potential GDP and NRU

Investment demand and saving supply determine a RIR, population growth, human capital growth, and technological change

Money consists of currency and bank deposits

Banks create money, FEd influences QOM, determining monetary base and FFR

The effects of the Fed’s actions on the short term nominal interest rate and the long run effects of the Fed’s action are involved in the effects of money

QOM demanded is the amount of money that households and firms choose to hold

Price of money

Value of money is the value of goods and services it can buy; opportunity cost is the goods and services forgone by holding this

The benefit of holding money is the ability to make payments; more money held, the more you can buy and the higher the benefit of holding money

The opportunity cost of holding money is the interest forgone on an alternative asset; holding money instead of putting in a fund with an interest rate costs the rate multiplied by the money being held

The higher the OC of holding money, the lower the demand for money

Nominal interest is the opportunity cost of holding money; equal to RIR + expected inflation rate

RIR = Nominal IR- Inflation Rate

The higher the nominal interest rate, the smaller the quantity of money

The demand for money is the relationship between QOM demanded and the nominal interest rate

The lower the NIR, the greater the quantity of money demanded

A rise in NIR decreases quantity of real money demanded

A fall increases the quantity of money demanded

The price level- A rise in the price level brings an increase in the same amount of the quantity of money that people plan to hold because number of dollars that need to be made is proportional to price level

Real GDP; demand for money increase as real GDP increases

Increase in interest rate increases demand for money; allows people to earn more interest

Financial technology can increase the demand for money; things like transfers, ATMS, deposits, and debit cards make money easier to use

Credit cards make it easier to buy goods and services on credit

The supply of money is the relationship between the quantity of money supplied and the nominal interest rate

The quantity of money supplied is determined by what the banking system and Fed does

Money supply curve is vertical due to the quantity of money being fixed

The nominal interest rate makes the QOM demanded = QOM supplied

When bonds are bought, interest rate falls, and QOM demanded increases

When bonds are sold, interest rate rises, and  QOM demanded decreases

Interest rate and bond prices move in opposite directions

When the government issues a bond, it specifies how much interest it pays each year

Bond interest rate = Dollar amount received/bond price

When IR is above equilibrium level, quantity of money supplied exceeds quantity of money demanded

People hold too much money and interest rate needs to be lowered

When IR is below, vice versa

Fed changes QOM to change the interest rate

Increase causes interest rate to fall and supply to increase; Decrease causes interest rate to rise and supply to decrease

A change in the nominal interest rate affects borrowing and lending, investment, consumption, and spending, which affects real GDP and price level

The long run refers to the economy at full employment or when we smooth out the effects of the business cycle

When real GDP = potential GDP there is full employment, and real GDP = potential in the long run

In the short run, the interest rate adjusts to make QOM demanded = QOM supplied

Price level does the adjusting

The equilibrium in the loanable funds market determines the real interest rate in the long run

An economy with no inflation has the same NIR and RIR

The interest rate is determined by real forces in the long run

The variable that adjusts in the long run is the price of money

Law of demand applies to money; lower the price/value of money, the more money people want to hold

Value of money= 1/P

P is the price level, or the GDP price index divided by 100

The value of money is the quantity of goods and services that a unit of money will buy

When the price level increases the value of money decreases

Money market equilibrium determines long run value of money

When QOM > the long run quantity demanded, excess money can be spent

Value of money falls and prices go up

When it is less, people lower spending to increase the quantity of money they hold

PL falls and the value of money rises

When supply = demand, we are at equilibrium

Long run demand for money is determined by potential GDP and equilibrium interest rate

LRMD curve shows how the quantity of money households and firms plan to hold changes depending on the value of money

MS curve shos QOM supplied, and the price level adjusts to make the value of money = 1 and achieve long term equilibrium

When the Fed increases the quantity of money by 10%, the quantity of money lowers the IR and people want to spend more

When real GDP = potential GDP, prices start to rise

A new equilibrium is reached where PL increases at the same rate as QOM

Quantity theory of money: when real Gdp = potential GDP, an increase in the quantity of money brings an increase in the price level

Money growth brings inflation

QTM = Price level and money supply are proportional

Velocity of circulation- number of times in a year that the average dollar of money gets used to buy final goods and services

Equation of exchange: equation stating the quantity of money multiplied by velocity of circulation = price level * real GDP

M*V = P* Y

P*Y is equal to nominal GDP

With this formula, we can also rearrange to get P = (M*V)/Y

Money supply, velocity and real GDP influence the price level

If M increase P also increases

Money growth + velocity growth = inflation rate + Real GDP growth

Inflation rate = Money growth + velocity growth - real GDP growth

Inflation rate increases slowly and temporarily increases the real GDP growth rate

Velocity speeds up as IR increases

Faster inflation rate reduces potential GDP and slows real GDP growth

Money growth rate works in the opposite way

In the long run and other things remaining the same, a change in the growth rate of the quantity of money brings an equal change in the inflation rate

Hyperinflation is when the inflation rate exceeds 50% a month; happens when money grows massively

Inflation is costly 

Tax costs- government gets revenue from inflation, and inflation is a tax

The income tax of nominal interest rates separates before tax interest and after tax interest rate

Fall in after tax rate weakens incentive to save and lend

RIse in before tax rate weakens incentive to borrow and invest

Inflation increases the nominal interest rate, and because income taxes are paid, the true income tax rate rises with inflation

Higher inflation rate = higher true income tax rate

Higher tax rate = higher interest rate paid by borrowers

With a fall in saving and investment, GDP growth slows

Shoe leather costs arise from an increase in the velocity of circulation of money and an increase in the amount of running around that people do to try avoiding losses

When money loses value at a rapid anticipated rate it is not a good store of value

Incomes are paid and spent immediately

Money is our measure of value; we make decisions based on the marginal benefits and costs

Borrowers and lenders agree on the terms of money

Inflation make the value of money changes and messes up the measure of value

Leads to confusion

A high inflation rate leads to uncertainty about the long-term inflation rate

Uncertainty makes it difficult to plan for the long-term and reduces investment and slows economic growth

People want to avoid the losses from inflation

Gains and losses happen because of unpredictable changes in the value of money

No specialization 

Cost of inflation depends on the rate and predictability

Higher inflation and more unpredictable = greater cost

Reserve market

Banks dont actually hold reserves

After 2008 they started holding more reserves; ample reserves given to the fed for earning interest

Weird graph

Federal budget is annual statement of the tax revenues, outlays, and the surplus/deficit of the U.S. government

Finances the activities of the federal government and achieves macroeconomic objectives

Fiscal policy is the use of the federal budget to acheive the macroecnomic objectives of high and sustained economic growth and full employment

President and Congrss decide budget and develop fiscal policy annually

Fiscal year begins on October 1 and ends September 30

Budget balance = tax revenues- outlays(or revenue- spending)

Balanced budget is 0

Surplus is positive, deficit is negative

Government borrows to finance a deficit and repays debt for a surplus

The outstanding debt that rises from past budget deficits is national debt

Debt at end of year = Debt at end of previous year + Budget deficit of current yar

Tax revenues consists of personal income taxes(big)(taxes paid on wages, salaries, and interest), Social Security taxes(taxes paid by workers and employers to fund SS benefits), corporate income taxes(small)(paid by corporations on their profits), and indirect taxes; sales, customs, excises

Us has been piling debt for past 40 years and will continue to

Age distribution is a big part

Social Security obligations are adding up to the debt

Fiscal imbalance; the present value of the government’s commitments to pay future benefits minus the present value of its future tax revenues

A present value is an amount of money that will earn interest to grow and equal a required future amount

Basically true debt of gov’t

To meet these obligations, the government can choose any combination of raising income taxes, raising social security taxes, cutting social security benefits, and cutting other federal government spending

A fiscal imbalance has to be corrected at some point

Generational imbalance is the division of the fiscal imbalance between the current and future generations

Current generation is before 1988; future is after

Classical, keynesian, monetarist macroeconomic

The theories of these people have had flaws exposed

Problems in Keynesian economics

Fiscal policy changes outlays or tax revenues due to government spending

A change in any item in gov’t budget changes aggregate demand

Reponse to the state of the economy or a result of new spending/tax decisions by Congress

Automatic fiscal policy- fiscal policy action initiated by the economy

Discretionary fiscal policy- fiscal policy action initiated by an act of Congress

Automatic fiscal policy is a consequence of tax revenues and outlays fluctuating with real GDP

Automatic stabilizers stablize real GDP

Induced taxes; taxes that vary with real GDP; more real Gdp = more tax revenue

Needs-tested spending is spending on programs that entitle suitably qualified people and businesses to receive benefits; benefits that vary with need and with the state of the economy(like unemployment)

Both of these decrease the multiplier effects of change in autonomous expenditure and moderate both expansions and recessions make real GDP more stable

An automatic stimulus happens when government tax revenues fall and outlays increase in a recession; budget provides automatic stimulus that shrinks the gap

And vice versa

Fluctuations in the government budget balance over the business cycle create a need to distinguish between cyclical and structural balance

Recession: Revenue down, spending up

Peak: Revenue up, spending down

A structural surplus/deficit is the budget balance occurring if the economy was at full employment

A cyclical surplus/deficit is the budget balance that arises because tax revenues and outlays are not at full employment levels

Structure balance + cyclical balance = budget balance

Discretionary fiscal policy can take the form of a change in outlays or tax revenue

A change in any items in the government budget changes aggregate demand with a multiplier effect

Gov’t expenditure multiplier is the effect of a change in government expenditure on g&s on aggregate demand

Increase in aggregate expenditure increases aggregate demand and increases real GDp and increases consumption expenditure, increasing aggregate demand more

The tax multiplier is the effect of a change in taxes on aggregate demand

Decrease in taxes increases disposable income increases c and aggregate demand, making employment and real GDP increase; consumption continues to decrease

Spending multiplier - 1

Both increase aggregate demand with a multiplier effect

The transfer payment multiplier is the effect of a change in transfer payments on aggregate demand

Multiplier is like tax multiplier opposite direction

An increase in transfer payments increases disposable income, increases consumption expenditure

Employment and real GDP increase and consumption increases more

Balanced budget multiplier is the effect on aggregate demand of a simultaneous change in government expenditure and taxes that leave the budget balance unchanged

Budget is positive

The government can pursue a fiscal stimulus by increasing government expenditure on goods and services(buying new equipment, building roads, bombing the midle east), increasng transfer payments(more robust social services or welfare), cutting taxes(lowering taxes, eliminated taxes, reducing income generators)

Combining all 3

Fiscal stimulus is limited by the amount of time it takes Congress to pass laws

Most of the federal budget can’t be used for discretional fiscal policy

Estimating potential GDP is difficult

Econoic forecasting; some policies need time to be effective

Contractionary is for inflation, expansionary is for recession