Learn all that you need to know that was discussed in Unit 4!!

2. Unit IV Learner’s Guide
Aggregate Demand/Supply
Investment
Consumption/Saving
Fiscal Policy

4. 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

5. Reasons it is Downward Sloping?
• Real Balances Effect
• Interest Rate Effect
• Foreign purchases Effect

6. Model of AD

7. 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

9. 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

10. 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

11. LRAS Model

12. 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

13. 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

14. SRAS Model

16. Full Employment
• Equilibrium exists where AD intersects SRAS
and LRAS at the same point

17. Recessionary Gap
• Exists when equilibrium occurs below full
employment output

18. Inflationary Gap
• Exists when equilibrium occurs beyond full
employment output

19. 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)

20. Ranges/Shapes of AS Model

22. The Debate PT.1

23. The Debate PT.1(cont’d.)

24. The Debate PT.2

25. The Debate PT.2(cont’d.)

27. What is it??
• Money spent or expenditures on:
– New plants(factories)
– Capital equipment(machinery)
– Technology(hardware/software)
– New homes
– Inventories(goods sold by prod)

28. 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

29. 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%

30. 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

32. 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

33. 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

34. 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

35. 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

36. Determinants of C & S
• Wealth
• Expectations
• Household debt
• Taxes

38. 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.

39. 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

41. 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

42. 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

43. 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)

44. 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

45. 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

46. 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