Unit 4 Presentation


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Unit 4 Presentation

  1. 1. Unit IV Learner’s Guide Aggregate Demand/Supply Investment Consumption/Saving Fiscal Policy
  2. 2. What is it?• The relationship between price level(PL) and Real Gross Domestic Product(RGDP) is inverse• Shows the amount of RGDP that the private, public, and foreign sector collectively desire to purchase at each possible PL
  3. 3. Reasons it is Downward Sloping?• Real Balances Effect• Interest Rate Effect• Foreign purchases Effect
  4. 4. Model of AD
  5. 5. Shifts in AD• Caused by changes in C(consumption), I(investment), G(government spending), Xn (net exports)• in AD= shifts to the right• in AD= shifts to the left SHIFT TO THE RIGHT SHIFT TO THE LEFT
  6. 6. What is it??• The level of RGDP that firms will produce at each PL• 2 types of AS: – Long Run (LRAS):period of time where input prices are flexible and adjust to PL – Short Run (SRAS):period of time where input prices are sticky and doesn’t adjust to PL
  7. 7. Long Run Aggregate Supply• Marks level of full employment in economy• Analogous to PPC• Measures potential output• Causes of LRAS to shift: – Increase in capital – Technology – Eco growth – Entrepreneurship – Resource availability
  8. 8. LRAS Model
  9. 9. Short Run Aggregate Supply• Shifts caused by change in input/resource prices • in resource prices= SRAS shifts left • in resource prices= SRAS shifts right • in SRAS= shifts to the right • in SRAS= shifts to the left
  10. 10. SRAS (cont’d.)• Key to understanding shifts in SRAS is per unit production cost• FORMULA: – per unit prod. cost= total input cost total output• Productivity• FORMULA: – Productivity= total output total input • More prod.= lower unit prod. cost=SRAS • Less prod.= higher unit prod. cost= SRAS
  11. 11. SRAS Model
  12. 12. Full Employment• Equilibrium exists where AD intersects SRAS and LRAS at the same point
  13. 13. Recessionary Gap• Exists when equilibrium occurs below full employment output
  14. 14. Inflationary Gap• Exists when equilibrium occurs beyond full employment output
  15. 15. Ranges/Shapes of AS• Keynesian Range: – Has a horizontal AS curve when eco is below full employment which cause AD to shift outward • RGDP , u% , PL is constant – Demand creates its own supply• Intermediate Range: – AS is in btwn Classical and Keynesian range – When occurs AS shifts outward • GDP & PL• Classical Range: – In Long Run, AS curve is vertical – Supply creates its own demand(Say’s Law)
  16. 16. Ranges/Shapes of AS Model
  17. 17. The Debate PT.1
  18. 18. The Debate PT.1(cont’d.)
  19. 19. The Debate PT.2
  20. 20. The Debate PT.2(cont’d.)
  21. 21. What is it??• Money spent or expenditures on: – New plants(factories) – Capital equipment(machinery) – Technology(hardware/software) – New homes – Inventories(goods sold by prod)
  22. 22. Expected Rates of Return• How does business make investment decisions? – Cost/benefit Analysis• How does business count the cost? – Expected Rate of Return• How does business determine the amount of investment they undertake? – Compare Expected Rate of Return to interest cost • If E.R.R > interest cost, then invest • If E.R.R < interest cost, then don’t invest
  23. 23. Real v. Nominal• Nominal: the observable rate of interest• Real: subtracts out inflation(π%) and is only known – Example- post facto• FORMULA (real int. rate (r%)): – r%= i% - π%
  24. 24. Investment Demand Curve(ID)• Shape of curve is downward sloping• Why? – When int. rates are high, fewer investments are profitable, when int. rates are low, more investments are profitable – There are few investments that yield high rates of return, and many that yield low rates of return• Shifts in ID Curve: • $ of prod • Business taxes • Tech change • Stock of capital • expectations
  25. 25. What is Consumption?• Household spending• Ability to consume is constrained by – Amt of disposable income (DI) – Propensity to save• Do household consume if DI=0? – Autonomous consumption – Dissaving• *Disposable Income : income after taxes or net income
  26. 26. What is Saving?• Household NOT spending• Ability to save is constrained by – Amt of DI – Propensity to consume• Do households save if DI=0? – NO!!• *Disposable Income: income after taxes or net income
  27. 27. APS & APC• APC= Average Propensity to Consume• APS= Average Propensity to Save• FORMULAS: – APC + APS= 1 – 1 – APC= APS – 1 – APS= APC – APC > 1: dissaving – -APS: dissaving
  28. 28. MPC & MPS• MPC= Marginal Propensity to Consume• MPS= Marginal Propensity to Save• % of every extra $ earned that is saved• FORMULAS: – MPC= ∆ C ∆DI – MPS= ∆ S ∆DI – MPS + MPC= 1 – 1 – MPC= MPS – 1- MPS= MPC
  29. 29. Determinants of C & S• Wealth• Expectations• Household debt• Taxes
  30. 30. What is it?• An initial ∆ in spending (C,I,G,Xn) causes a larger ∆ in aggregate spending or AD• Why? – Expenditures and income flow continuously which sets off a spending increase in the eco• FORMULA: – 1/ 1 – MPC OR 1/ MPS• *multipliers are (+) where there is an increase in spending and (-) when there is a decrease.
  31. 31. Tax Multiplier• When gov’t taxes, the multiplier works in reverse• Why? – Because now money is leaving the circular flow• FORMULAS: – -MPC/1 – MPC or –MPC/MPS• *if there is a tax cut, then multiplier is (+) because there is now more $ in circular flow
  32. 32. What is it?• Changes in the expenditures or tax revenues of the fed gov’t – 2 tools of fiscal policy: • Taxes: gov’t can increase or decrease taxes • Spending: gov’t can increase or decrease spending• Fiscal policy is enacted to promote our nation’s eco goals: – Full employment – Price stability – Eco growth
  33. 33. Deficits, Surpluses, and Debt• Balanced budge – Revenues= expenditures (profit) ($ spent)• budget deficit – Revenues < expenditure• Budget surplus – Revenues > expenditure• Gov’t debt – Sum of all deficits – sum of all surpluses• Gov’t must borrow $ when it runs a budget deficit• Gov’t borrows from: • Individuals (savings bonds) • Corporations • Financial institution • Foreign gov’t/ entities
  34. 34. Fiscal Policies• 2 options: – Discretionary Fiscal Policy (take action) • Expansionary Fiscal Policy (think deficit) • Contradictory Fiscal Policy (think surplus) – Nondiscretionary Fiscal Policy (take NO action)
  35. 35. Discretionary v. Automatic Fiscal Policies• Discretionary: – or gov’t spending and/or taxes in order to return the eco to FE – Involves policy makers doing fiscal policy in response to an eco problem• Automatic: – Unemployment compensation & marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation – Takes place w/o policy makers having to respond to current eco problems
  36. 36. Contradictory v. Expansionary Fiscal Polices• Contradictory: – Policy designed to decrease AD – Strategy for controlling inflation – Inflation is counted – gov’t spending – taxes• Expansionary: – Policy designed to increase AD – Strategy for increasing GDP, combating recession – Reducing unemployment – Recession is counted – gov’t spending – taxes
  37. 37. Weaknesses of Fiscal Policy• Progressive Tax System – Avg tax rate rises w/ GDP• Proportional Tax System – Avg tax rate remains constant as GDP ∆• Regressive Tax System – Avg tax rate falls w/ GDP• *the more progressive the tax sys, the greater the econ’s built in stability