2/11/15
Ø
Aggregate Demand (AD)
·
Shows the amount of Real GDP that the private,
public and foreign sector collectively desire to purchase at each possible
price level
·
The relationship between the price level and the
level of Real GDP is inverse.
·
Looking at output. Once price level goes up the
quantity goes down and once price goes down quantity goes up. Inverse
relationships.
Ø
Aggregated Demand Graph
Ø Three reasons AD is downward sloping
-
Real-balances Effect
-
When the price level is high households and
businesses cannot afford to purchase as much output.
-
When the price level is low households and
businesses can afford to purchase more output.
-
Interest- Rate Effect
-
A higher price- level increases the interest
rate which tends to discourage investment
A lower price- level decreases the
interest rate which tends to encourage investment
-
Foreign Purchases Effect
A higher price- level increases the demand for relatively cheaper imports
-
A lower price-level increases the foreign demand
for relatively cheaper U.S. exports.
Ø
Shift AD
·
There are two parts to a shift in AD:
-
A change in C, Ig, G, and /or Xn
-
A multiplier effect that produces a greater
change than the original change in the 4 components.
- Increase in AD=AD right
-
Decrease in AD=AD left
Ø
Consumption
·
Household spending is affected by:
-
Consumer wealth
o
More wealth=more spending (AD shifts right)
o
Less wealth=less spending (AD shifts left)
-
Consumer expectations
o
Positive expectations = more spending (AD shifts
right)
o
Negative expectations = less spending (AD shifts
left)
-
House hold indebtedness
o
Less debt = more spending (AD shifts right)
o
More debt = less spending (AD shifts left)
-
Taxes
o
Less taxes = more spending (AD shifts right)
o
More taxes = less spending (AD shifts left)
Ø
Gross Private Investment
·
Investment Spending is sensitive to:
-
The real Interest Rate
o
Lower Real interest Rate = more investment (AD
right)
o
Higher Real interest Rate = less investment (AD
left)
-
Expected Returns
o
Higher Expected Returns =More Investment (AD
right)
o
Lower Expected Returns = Less investment (AD
left)
o
Expected Returns are influenced by
-
Expectations of future profitability
-
Technology
-
Degree of Excess Capacity (Existing Stock of
Capital)
-
Business Taxes
Ø
Government Spending
·
More Government Spending (AD right)
·
Less Government Spending (AD left)
Ø
Net Exports
·
Net Exports are sensitive to:
-
Exchange Rates (International value of $)
o
Strong $ = More imports and fewer Exports = (AD
left)
o
Weak $ = Fewer Imports and More Exports = (AD right)
-
Relative Income
o
Strong Foreign Economies = More exports = (AD
right)
o
Weak Foreign Economies = Less Exports = (AD
left)
2/12/15
Ø
Aggregate Supply
·
The level of Real GDP (GDP R) that firms will
produce at each Price Level (PL)
Ø
Long-Run v. Short-Run
·
Long- Run
-
Period of time where input prices are completely
flexible and adjust to changes in the price-level
-
In the long-run the level of RGDP supplied is
independent of the price-level
·
Short-Run
-
Period of time where input prices are sticky and
do not adjust to changes in the price level
-
In the short-run, the level of RGDP supplied is
directly related to the price-level
Ø
Long-Run AS (LRAS)
·
The Long-Run Aggregate Supply or LRAS marks the
level of full employment in the economy (analogous to PPC)
·
Price are completely flexible in the long-run,
changes in price-level do not change firms’ real profits and therefore do not
change firms’ level of output. This means that the LRAS is vertical at the
economy level of full employment.
-
*Long-run is vertical at full employment
Ø
Long Run AS graph
Ø
Short-Run Aggregate Supply (SRAS) Upward sloping
Input prices are
sticky in the short run, the SRAS is upward sloping. This reflects the
fact that in the short-run, increases in the price-level increase firm’s
profits and create incentives to increase output.
Ø
Short run Aggregate Supply Graph
Ø
Changes in SRAS
·
An increase in SRAS is seen as a shift to the
right. SRAS right
·
A decrease in SRAS is seen as a shift to the
left. SRAS left
·
The key to understanding shifts in SRAS is per
unit cost of production
·
Per-unit production cost
= total input cost/ total output cost
Ø
Change in SRAS( increase)
Ø
Change in SRAS (Decrease
Ø
Determinants of SRAS (all of the following
affect unit production cost)
·
Input
prices
-
Domestic Resource Prices
o
In wages, Raw materials,
o
Pay cost of capital
-
Foreign Resource Prices
o
Value of the dollar is it weak or strong?
o
Strong $ = Lower foreign resource prices
o
Weak $ = higher foreign resource prices
-
Market Power
o
Monopolies and cartels that control resources
control the price of those resources. (OPEC)
-
Increases in Resource Prices = SRAS left
-
Decreases in Resource prices = SRAS right
·
Productivity
o
Total output/total inputs
o
More productivity = lower unit production cost =
SRAS right
o
Lower productivity = higher unit production cost
= SRAS left
·
Legal-
institutional Environment
o
Taxes and Subsidies
-
Taxes ($ to gov’t) on business increase per unit
production cost =SRAS left
-
Subsidies ($ from gov’t) to business reduce per
unit production cost = SRAS right
o
Government Regulation
-
Government regulation creates a cost of
compliance = SRAS left (side regulations in businesses)
-
Deregulation reduces compliance costs = SRAS
right (Deregulated airline, paid the same cost. Different destination, but
later on cheap ticket, price of fair changed)
2/17/15
Ø
Full Employment
·
Full Employment equilibrium exists where AD
intersects SRAS & LRAS at the Same point.
Ø
Recessionary Gap
·
A recessionary gap exists when equilibrium
occurs below full employment output
o
AD Shifts to the left which decreases
Ø
Inflationary gap
·
An inflationary gap exists when equilibrium
occurs beyond full employment output.
o
When there is an inflationary gap AD to the
right increasing
Ø
Investment Demand
·
What is investment?
o
Money Spent or expenditures on:
-
New plants (factories)
-
Capital equipment (machinery)
-
Technology (hardware & software)
-
New Homes
-
Inventories (goods sold by producers)
Ø
Expected Rates of Return
·
How does business make investment decisions?
o
Cost/Benefit Analysis (red, if business 3 years
you good)
·
How does business determine the benefits?
o
Expected Rate of Return
·
How does business count the cost?
o
Interest costs
·
How does business determine the amount of
investment they undertake?
o
Compare expected rate of return to interest cost
-
If expected return > interest cost, then
invest
-
If expected return < interest cost, then do
not invest
Ø
Real (r %) v. Nominal (i %)
·
What’s the difference?
o
Nominal is the observable rate of interest. Real
subtracts out inflation (π%) and is only
known ex post factor
·
How do you compute the real interest rate (r %)?
o
r % = i % - π% (inflation rate) π is inflation
·
What then, determines the cost of an investment
decision?
o
The real interest rate (r %)
Ø
Investment Demand Curve (ID)
·
What is the shape of the investment demand
curve?
o
Downward sloping
·
Why?
o
When interest rates are high, fewer investments
are profitable; when interest rates are low, more investments are profitable.
(High, fewer buyers, low, more buyers)
-
Changes in r% cause changes in Ig. Factors other
than r% may shift the entire ID curve
2/18/15
Ø
Shifts in Investment Demand (ID)
·
Cost of production
·
Lower costs shift ID right
·
Higher Costs shift ID left
Ø
Business Taxes
·
Lower business taxes ID right
·
Higher business taxes ID left
Ø
Technological Change
·
New technology shifts ID right
·
Lack of technological change shifts ID left
Ø
Stock of Capital
·
If an economy is low on capital, then ID right
·
If an economy has more capital, then ID left
Ø
Expectations
·
Positive expectations shift right
·
Negative goes left
Ø
Long-run AS
- Always vertical at full employment, it
represents a point on an economy production possibilities curve
- Long-run AS Does not
change as the price level change.
- Change long-run AS same as the PPC curve outward
- Only shifts: Change of resources, change in
technology, and economic growth
2/25/15
Ø
Fiscal Policy
·
Changes in the expenditures a tax revenue of the
federal government
·
2 Tools of fiscal policy:
o
Taxes government can increase or decrease taxes
o
Spending- government can increase or decrease
spending
Ø
Deficits, Surpluses, and debt
·
Balanced budget
o
Revenues=Expenditures
·
Budget deficit
o
Revenues < Expenditures
·
Budget Surplus
o
Revenues > Expenditures
·
Government Debt
o
Sum of all deficits – Sum of all surpluses
o
Government must borrow money when it runs a
budget deficit
·
Government borrows from:
o
Individuals
o
Corporations
o
Financial Institutions
o
Foreign entities or foreign governments
·
Fiscal Policy Two Options
o
Discretionary Fiscal Policy (action)
o
Expansionary fiscal policy – think deficit
o
Contractionary fiscal policy- think surplus
o
Non- discretionary fiscal policy (no action)
Ø
Discretionary v. Automatic Fiscal Policies
·
Discretionary- Increasing or decreasing Government
Spending and/ or Taxes in order to return the economy to full employment.
Discretionary policy involves policy makers doing fiscal policy in response to
an economic problem
·
Automatic- Unemployment compensation &
marginal tax rates are examples of automatic policies that help mitigate the effects
of recession and inflation. Automatic fiscal policy takes place without policy
makers having to respond to current economic problems.
Ø
Contractionary vs. Expansionary Fiscal Policy
·
Contractionary fiscal policy- policy designed to
decrease aggregate demand
-
Strategy for controlling inflation
·
Expansionary fiscal policy- policy designed to
increase aggregate demand
-
Strategy for increasing GDP, combating a
recession, & reducing unemployment.
-
Increase government spending (G up)
-
Decrease taxes (T down)
·
Contractionary fiscal policy
-
Decrease government spending
-
Increase Taxes
-
RECESSION TO INFLATION OR TO INFLATION TO
RECESSION
Ø
Automatic or Built-In Stabilizers
-
Anything that increases the government’s budget
deficit during a recession and increases its budget surplus during inflation without
requiring explicit action by policy.
·
Automatic Stabilizers (Food stamps etc.) Fiscal
is run by congress.
o
Transfer Payments
-
Welfare checks
-
Food stamps
-
Unemployment checks
o
Nondiscretionary Fiscal Policy ( Automatic
Stabilizers)
-
Corporate Dividends
-
Social Security
-
Veteran’s Benefits
Ø
Tax System
·
Progressive Tax System
o
Average tax rate (tax revenue/GDP) rises with
GDP
·
Proportional Tax System
o
Average tax rate remains constant as GDP changes
·
Regressive Tax System
o Average tax rate falls with GDP
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Three Economic Schools
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Classical
|
Keynesian
|
Monetary
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Ø Adam
Smith
Ø John
B. Say
Ø David
Ricardo
Ø Alfred
Martial
-
Competition is good
-
Adam smith made the invisible hand “don’t need
government help for business”
-
Says-Law
o Supply
creates its own demand
o Determines
output
-
In the LR the economy would balance at full employment
o The
economy is always close or at full employment
- AS=AD
o At
full employment equilibrium
-
Triple effect down effect
o Halves
and halves not
-
Savings (leakage) =investment (injection)
o Savings
increase with interest rate
-
Prices and wages are flexible downward
-
Lassies fair
|
Ø John
Maynad Caynes
-
Competition is flawed
-
Ad is key not AS
o Ad
determines its own output and demand creates its own supply
-
Leaks cause constant recessions
-
Savings cause recessions
-
Savers and investors save and invest for
different reasons savings are inverse to the interest rate.
-
Ratchet and sticky wages saves law
-
Prices and wages are flexible downward
-
So there is no mechanism is able for full
employment in the LR we’re all dead
-
The economy is not always close to or at full
employment
-
Government Intervention
-
Fiscal policy
o Add
stabilizers
o Expansionary
and Conpansionary
|
Ø Alen
Greenspan
Ø Ben
Bernanke
- Fine tuning is needed
-
Voters won’t allow contractionary options
-
Congress can’t time policy options
-
Institute easy money and tightly money
-
Change required reserve if need
-
Buy and sell bonds through open market
operations
-
Use interest rates to change the discount rate
and the federal fund rate.
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