Macroeconomics Review Draw a PPF for guns and butter and show the following concepts: - opportunity cost - actual output - potential output - point of efficiency - point of inefficiency - unattainable point Also draw a PPF to represent GROWTH with and without DEVELOPMENT.
Macroeconomics Review All else equal The social science that deals with the production, distribution, and consumption of goods and services
What does ceteris paribus mean?
Why is economics a social science?
Define microeconomics and macroeconomics.
Micro: the branch of economics that studies the economy of consumers or households or individual firms Macro: the study of economics in terms of whole systems, especially with reference to general levels of output and income and to the
People have been unemployed for so long that they are willing to work below the minimum wage, but businesses cannot hire them because of the minimum wage law.
What type of unemployment is this, and represent it with a graph.
Also, what could a government do to eliminate this type of unemployment?
Distribution of Income Evaluating Taxes and Income Re-Distribution The Laffer Curve: Illustrates the supply-siders' view that higher taxes could lead to lower tax revenue ·Originally sketched on a napkin by Arthur Laffer to help a reporter understand his theory. ·Shows that 100% tax rate, nothing would get produced so there's ZERO tax revenue. ·As the marginal tax rate declines, there is more of an incentive for firms to produce and workers to seek employment since they now get to keep more of their income. As a result, lower taxes cause incomes and tax revenue to rise. ·At some point, further decreases in taxes will cause tax revenue to decline as firms and workers keep more and more of their income. ·At 0% taxes, clearly tax revenue = $0 Read and discuss the following articles on supply-side economics: Blog post: "Hey, what are you Laffing at? The relationship between tax rate and tax revenue" Blog post: "Supply - side economists: lower taxes, more growth, more tax revenue!"
Inflation and Unemployment the Phillips Curve (HL only) Graphing the inflation/unemployment relationship: the Phillips Curve ·In the short-run, there is an inverse relationship between the price level and the unemployment rate ·When AD is weak, unemployment will increase and there is downward pressure on prices. ·When AD is strong, unemployment falls and there is upward pressure on prices as the economy approached full-employment. ·When economy is at equlibrium, UE will be stable at the Natural Rate of Unemployment Inflation (ΔPL) 8% Pfe 2% PC 2% 8% NRU Unemployment
Inflation and Unemployment the Phillips Curve (HL) AD/AS and the Phillips Curve: Assume the economy is at full employment, with an inflation rate of 3% and an unemployment rate of 5% (NRU). The economy is at point A on its Phillips Curve. When aggregate demand increases, price levels rise, output increases, causing unemployment to fall, and the country moves from point A to point B on the PC. When AD falls, there is downward pressure on the price level and the fall in output means fewer workers are needed. Inflation falls and unemployment increases, moving from point A to C on the PC. In the short-run, there is a trade-off between unemployment and inflation! ASlr ASsr PL Inflation (ΔPL) B Pb 5% A Pa 3% AD1 C Pc 1% AD1 PC AD read GDP 4% 6% Yfe Y1 NRU Unemployment Inflation increases as Unemployment decreases!
Inflation and Unemployment the Phillips Curve (HL) Question: What could cause the PC to shift out from PC to PC1 ? In other words, what could cause an increase in both unemployment AND inflation? Answer: Stagflation ·A leftward shift of the SR Aggregate Supply curve will cause both unemployment and inflation to increase simultaneously. ·The Phillips Curve will shift to the right ·The economy will experience UE greater than the NRU and higher than desired rates of inflation. Inflation (ΔPL) I1 Ife PC1 PC Factors that could cause stagflation: ·sharp increases in fuel costs ·rising food prices ·weak currency Unemployment NRU >NRU
Inflation and Unemployment the Phillips Curve (HL) AD/AS and the Phillips Curve: Assume the economy starts at full employment. When aggregate supply decreases, price levels rise and output falls causing unemployment to increase. When AS falls, there are upward pressures on the price level and on unemployment. This is shown in an outward shift of the Phillips Curve, and known as STAGFLATION (stagnant grown combined with inflation) ASsr1 ASlr ASsr PL Inflation (ΔPL) B Pb I1 A Ife Pa AD1 PC1 PC read GDP Yfe Y1 >NRU NRU Unemployment
Inflation and Unemployment the Phillips Curve - SR to LR (HL) What happens to the Phillips Curve when there is an increase in spending and AD shifts out? ·Unemployment will decrease below NRU, ·Price level will increase Phillips Curve moves from A to B ·With rising inflation, workers will begin demanding higher wages. ·Wages are a resource cost, so when they increase AS will shift to the left ·Leftward shift of AS restores full-employment output ·Higher resource costs cause the price level to increase Phillips Curve moves from B to C If AD increases again, the process will repeat itself: Rising prices lead to higher wages which leads to AS shifting in, UE returning to NRU, and price level increasing ever higher D E P2 C Inflation (ΔPL) P1 B Pfe A PC2 PC1 PC NRU <NRU Unemployment
Inflation and Unemployment the Long-run Phillips Curve the Long-run Phillips Curve: In the long-run, there is NO tradeoff between inflation and unemployment. PClr Understanding the LR PC: As AD increases, UE will decrease in the short-run, when wages are fixed. In the log-run, wages and other resource costs are variable, and will adjust to the higher price level, causing AS to shift left Output will always return to the full-employment level, and unemployment to the NRU. Consequently, in the long-run, there is no tradeoff between unemployment and inflation! P2 Inflation (ΔPL) P1 Pfe PC2 PC1 PC NRU <NRU Unemployment The Long-run Phillips Curve is vertical at the Natural Rate of Unemployment.
Inflation and Unemployment Evaluating the Phillips Curve Does unemployment always return to the NRU (or Non-accelerating inflation rate of unemployment: NAIRU)? The neo-classical economists led by MiltionFriedmen argued that there was no long-run tradeoff between unemployment and inflation. Just as the long-run AS curve is vertical at full-employment GDP, the Phillips Curve is correspondingly vertical at the NAIRU (NRU). Is an economy's unemployment doomed to always return to some set level?NO! The implication of the LR PC is not that UE will always be at the same NRU, rather that demand-side policies are ineffective at decreasing UE in the long-run. SUPPLY-SIDE policies, however, can lower the UE in the long-run. More productive, lower cost resources will shift LRAS out, and the LR PC to the left.
Inflation and Unemployment Evaluating the Phillips Curve Supply-side expansion and the Phillips Curve: Expansionary supply-side policies lead to a more productive workforce, more efficient resources, and lower costs to firms and an outward shift of the LRAS, which is consistent with a lower natural rate of unemployment. An outward shift of LRAS results in a leftward shift of the LRPC. ASlr1 ASlr PClr PClr1 ASsr PL ASsr1 Inflation (ΔPL) P1 P2 AD Yfe Y1 read GDP (employment) NRU NRU1 Unemployment
Macroeconomics Review During a recession, most governments will rely on fiscal policy to some extent and increase government spending. But how much should they spend?
Macroeconomic Models Spending Multiplier (HL only) The Spending Multiplier: Any increase in spending in the economy (C, I, G, Xn) will multiply itself through further rounds of new spending, resulting in a larger increase in GDP than the initial change in spending. The size of the spending multiplier depends on society's Marginal Propensity to Consume Marginal Propensity to Consume:The proportion of any change in income used to consume domestically produced output MPC = ∆Consumption / ∆Income Marginal Propensity to Save:The proportion of any change in income saved, used to pay off debts, or to purchase imports MPS= 1-MPC MPC + MPS = 1 1 1 or Spending Multiplier = MPS 1 - MPC
Macroeconomic Models Spending Multiplier (HL only) Example of the spending multiplier effect: The Swiss government wishes to stimulate spending in the economy. To do so, it increases government spending on infrastructure projects by SFR 10b Assume Swiss household tend to spend 40% of new income on Swiss goods and services, while 60% goes towards savings, debt repayment and purchase of imports Price level 1 = 1.67 Multiplier = .6 An initial change in spending of SFR 10b will result in an increase in Switzerland's GDP of SFR 16.7b AD1 G increases Aggregate Demand real Output or Income (Y) Blog posts: "The Multiplier Effect"
Demand and Supply-Side Policies the Crowding-out Effect Crowding-out effect:when a deficit-financed increase in government spending drives up interest rates, thereby directing productive resources away from the private sector towards the public sector Question: How do governments get money to finance their budgets if they lower taxes at the same time that they increase spending (expansionary fiscal policy)? Answer:they borrow from the public by issuing new government bonds BOND (definition):The general term for a long-term loan in which a borrower agrees to pay a lender an interest rate (usually fixed) over the length of the loan and then repay the principal at the date of maturity. Bond maturities are usually 10 years or more, with 30 years quite common. Bonds are used by corporations and federal, state, and local governments to raise funds. (source: www.amosweb.com/)
Demand and Supply-Side Policies the Crowding-out Effect What causes crowding out? ·When the government issues new bonds to finance its budget deficits, the supply of bonds increases in the bond market, lowering the bond price and increasing the interest rates on bonds ·The higher return on government bonds directs savings away from commercial banks, decreasing the supply of loanable funds for the private sector to invest with, driving up commercial interest rates ·The increase in borrowing by the government may lead to a decline in private investment, thus "crowding-out" private enterprise in the economy ·Crowding-out can also refer to the re-allocation of physical resources (labor, land and capital) away from the private sector towards the public sector as the government embarks on projects requiring large inputs of productive resources.
Demand and Supply-Side Policies the Crowding-out Effect Crowding-out effect:Graphical representation Interpretation: The government's "transaction demand" for money increases as it must finance its budget deficit, shifting money demand out, driving up interest rates Two ways to illustrate crowding-out: ·The impact on the Money Market Crowding-out in the Money Market Money Market Investment Demand S Private investment is "crowded-out" due to increased government borrowing Interest rate 7% Interest rate 5% D2 DI Dmoney Q2 Q1 Q1 Quantity of Investment Quantity of money
Demand and Supply-Side Policies Monetary Policy (IB and AP) The Money Market: an introduction Supply of money: Money supply is established by the Central Bank, it is perfectly inelastic since it is based on policy goals ·Money supply can increase: If a central bank wishes to lower interest rates, it can increase the supply of money in the economy by buying bonds from the public ·Money supply can decrease:If a central bank wishes to increase interest rates, it can decrease the supply of money in the economy by selling bonds to the public Expansionary Monetary Policy Contractoinary Monetary Policy S S1 S S1 Interest rate Interest rate 6% 5% 5% 4% Dmoney Dmoney Q2 Q1 Q1 Q2 Quantity of money Quantity of money
Demand and Supply-Side Policies Monetary Policy Expansionary Monetary Policy - how it works: Excess reserves, money supply checkable deposits and bank reserves GDP, employment, price level CB buys bonds from public and banks Interest rates C, I AD Central Bank Central Bank buys bonds from banks, injecting liquidity to excess reserves Central Bank buys bonds from public, increasing amount of checkable deposits $ $ $ $ $ B $ B B $ B $ $ B B B B $ $ $ $ the Public Commercial Banks Contractionary Monetary Policy - how it works: Excess reserves, money supply checkable deposits and bank reserves GDP, employment, price level CB sells bonds to public and banks Interest rates C, I AD