Fiscal Policy

March 6, 2017

How does the Government Stabilize the Economy?

Fiscal Policy - Actions by Congress to stabilize the economy

changes in the expenditures or tax revenues of the federal government

2 tools of the Fiscal policy:

Taxes- government can increase or decrease taxes

Spending- government can increase or decrease spending

Fiscal Policy is enacted to promote our nation's economic goals: full employment, price stability, economic growth

Deficits/Budgets/Surplus

Balanced budget

Revenues = Expenditures

Budget deficit

Revenues < Expenditures

Budget surplus

Revenues > Expenditures

Government debt

Sum of all deficits - Sum of all surpluses

Government must borrow money when it runs a budget deficit

Government borrows from:

- Individuals

- Corporations

- Financial Institutions

- Foreign entities or foreign governments

Fiscal Policy Two Options

- Discretionary Fiscal Policy (action)

          -Expansionary fiscal policy - think deficit

          -Contractionary fiscal policy - think surplus

- Non-Discretionary Fiscal Policy (no action)

Three types of Taxes

1.Progressive Taxes - takes a larger percent of income from high-income groups (takes more from rich people) Ex: Current Federal Income Tax System

2. Proportional Taxes (flat rate) - takes the same percent of income from all income groups.  Ex: 20% flat income tax on all income groups

3. Regressive Taxes - takes larger percentage from low-income groups (takes more from poor people) Ex: Sales tax; any consumption tax

Contractionary Fiscal Policy

- Laws that reduce inflation, decrease GDP

(Close a Inflationary Gap)

- Decrease Government Spending

- Tax Increases

- Combinations of the Two

Expansionary Fiscal Policy

- Laws that reduce unemployment and increase GDP

(Close a Recessionary Gap)

- Increase Government Spending

- Decrease Taxes on consumers

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 policymakers

Transfer Payments

- Welfare checks

- Food Stamps

- Unemployment checks

- Corporate dividends

- Social Security

- Veteran's benefits

Consumption and Savings

February 23, 2017

Disposable Income

income after taxes or net income

DI = gross income - taxes

with disposable income, households can either:

         consume (spend money on goods and services)

         save (not spend money on goods and services)

Consumption

• household spending

• the ability to consume is constrained by:

•          the amount of DI

•          the propensity to save

Average Propensity to Consume (APC) = % DI that is spent

Saving

• household not spending

• the ability to save is constrained by:

•            the amount of DI

•           the propensity to consume

Average Propensity to Consume (APS) = % DI not spen

APS + APC = 1

APC > 1 = dissaving

APC = dissaving

Marginal Propensity to Consume (MPC)

• % of every extra dollar earned that is spent

• △C / △DI

Marginal Propensity to Save (MPS)

• % of every extra dollar that is saved

• △S / △DI

MPC + MPS = 1

Determinants of C and S

• wealth

• expectations

• household debt

• taxes

The Spending Multiplier Effect

• an initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending, or aggregate demand

Multiplier = △AD / △Spending

Multiplier = AD / △(C, Ig, G, Xn)

Why does this happen?

expenditures and income flow continuously which sets off a spending increase in the economy

The spending multiplier can be calculated from the MPC or the MPS

Multiplier = 1 / 1-MPC  or  1 / MPS

Multipliers are (+) when there is an increase in spending and (-) when there is a decrease

Calculating the Tax Multiplier

• when the government taxes, the multiplier works in reverse because now money is leaving the circular flow
• Tax multiplier = -MPC / 1-MPC  or  -MPC / MPS   (It's a negative number)

If there is a tax cut, then the multiplier is (+) because there is now more money in the circular flow

Aggregate Supply

February 21, 2017

Aggregate Supply

The level of new GDP that firms ill produce at each price level

Long run v. Short run

Long run:

            Period of time where inputs prices are completely flexible and adjust to changes in the price level

            In the long run, the level of real GDP 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 Real GDP supplied is directly related to the price level

Long Run Aggregate Supply

            The long run Aggregate supply of LRAS marks the level of full employment in the economy

Short Run Aggregate Supply

            Because input prices are sticky in the short run, the SRAS is upward sloping

Changes in SRAS

            An increase in SRAS is seen as a shift to the right to the right

            A decrease in SRAS is seen as a shift to the left. SRAS to the left

            The key to understanding shifts in SRAS is per unit cost production

PER- UNIT production cost 

Determinants of SRAS ( all of the following affect unit production cost)

            Input prices

                        Domestic resource Price

                                    Wages (75% of all business cost)

                                    Cost of Capital

                                    Raw material (commodity)

                        Foreign Resource Prices

                                    Strong $= lower foreign resources prices

                                    Weak $= higher foreign resources prices

                        Market Power

                                    Monopolies and cartels that control resources control the price of those resources

                        Increase in Resource Prices = SRAS to the left

                        Decrease in Resource price = SRAS to the right

   Productivity

              Total output / total inputs

              More productivity = Lower unit production cost= SRAS to the right         

              Lower productivity = higher unit production cost = SRAS to the left

   Legal- Institution Environment

               Taxes and Subsides

               Taxes on business increase per Unit production cost= SRAS to the left

                Subsidies to business reduce per unit production cost = SRAS to the right

   Government Regulation

              Government regulation creates a cost of compliance= SRAS to the left

              Deregulation reduces compliance cost = SRAS to the right

Interest Rates and Investments

February 21, 2017



Investment
  money spent or expenditures on
   New plants (factory)
   Capital Equipment (machinary   Technolagy   New homes   Inventories


Expected rate of returns

 How does business make investment decisions?  (cost/benefit analysis)
 How does business determine the benefits?  (expected rate of return) How does business count the cost?  (interest costs) How does business determine the amount of investment they undertake?  (compare expected rate of return to interest costs; if expected return > interest cost, then invest; if     expected return < interest cost, then don't invest)

Formula:
Real interest rate (r%) = nominal interest rate (i%) - inflation (𝝅%)

What determines cost of investment decision?
 (the real interest rate)
Shifts in Investment Demand 
cost of production
business taxestechnological changestock of capital
expectations

VIDEO BELOW WILL HELP WITH THIS LESSON

Aggregate Demand

February 16, 2017

Three reason why AD downward sloping

     Wealth Effect 
Higher prices reduce purchasing power of $      
This decreases the quantity of expenditures
 Lower price levels increase purchasing power and increase expenditures

      Interest-rate effect
As price levels increase, lenders need to charge higher interest rates to get a real return on their loan
Higher interest rates discourage consumer spending the business investments

     Foreign Trade Effect
When U.S price level rises, foreign buyers purchase fewer U.S goods and Americans buy more foreign goods
Exports fall and imports rise casing real GDP demanded to fall. ( X_n Decrease)


Shifts in Aggregate Demand
      There are two parts to a shift in AD
      change in C, I_g , G and/ X_n
           multiplier effect that produces a greater change than the original change in the 4 components

Increase in AD = AD increase
Decrease in AD= AD decrease


      
Determinant of AD
 Consumption C

 Consumer wealth( boom in the stock market

 Consumer expectations (recession)
Household indebtedness (more consumer debt)

Taxes

 Change in Investment Spending

    Real interest Rate ( price borrowing money)
    Future Business Expectations ( high expectations)
 Productivity and technology
 Business Taxes

    Change in government Spending
   War / Nationalized Health care / Decreased in defense spending

 Change on Net Exports (X-M)
   Exchange rates ( different currency)
 National Income compared to Abroad
 If a major importer has a recession

 Government Spending
 More government spending (AD to the right)
 Less government Spending (AD to the left)

VIDEO ABOVE TO TEACH OVER THE LESSON JUST DISCUSSED!!!!!