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Equilibrium – the intersection of the AD and AS curves determines the economy’s equilibrium price level and equilibrium real domestic output.
Ratchet effect – is the commonly observed phenomenon that some processes can not go backwards once certain things happened. The producers observe that shifting-down AD leads to changes in equilibrium, but not in the price level.
Consumption and Saving.
Consumption and savings are opposite by nature. The term consumption denotes expenditure and by savings we understand the act of preserving money for the future needs. Again, when it comes to giving priority, consumption comes first.
Most of us are in the habit of meeting the present needs from our income. After that, if there remains anything, then only savings can be done. But in the long run, it is the savings that matters most.
Consumption savings – DL is the basic determinant of consumption and personal savings. Households can consume more than their incomes by liquidating accumulated wealth or by borrowing – C0.
Investment. Investment demand curve.
Investment – expected rate of return: businesses buy capital goods only when they expect such purchases to be profitable. The real interest rate: the financial cost of borrowing the money capital required to purchase the real capital. The curve is down sloping, reflecting an inverse relationship between the real interest rate and quantity of investment demanded.
INVESTMENT DEMAND CURVE: A graphical depiction of the negative relation between investment expenditures and the interest rate, based on the marginal efficiency of investment for different capital investment projects. This curve is derived by plotting, from high to low, the marginal efficiency of investment for all possible capital investment projects. Because firms select those projects with returns greater than the interest rate on financial capital, this marginal efficiency of investment curve traces out the investment demand curve.
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Equilibrium GDP: Expenditures – Output approach.
Multiplier effect of Investment.
Multiplier effect – the change in investment leads to a larger change in output and income. This result is called – the multiplier effect. It determines how much in equilibrium GDP.
Equilibrium GDP: Leakage – Injections.
–S=I approach. A part of Dl may be saved not consumed by households. Saving represents a leakage of spending from income – expenditures stream. Saving is what keeps consumption short of total output or GDP. Investment – a potential replacement for leak stage of saving. Equilibrium GDP- at the point where the amount households save and the amount businesses plan to invest is equal.
Recessionary Gap.
the level of equilibrium GDP is less than full-employment GDP. This is amount by which aggregate expenditures at the full-employment GDP fall short of those required to achieve the full-employment GDP.
Inflationary Gap.
is the amount by which an economy` s aggregate expenditures exceed those just necessary to achieve the full employment GDP. This effect will pull output prices. Nominal GDP will rise because of a higher price level, but real GDP will not.
Fiscal Policy: meaning, tools, goals.
Fiscal policy- is the means by which a government adjusts its levels of spending in order to monitor and influence a nation` s economy.
Tools: 1) Government spending 2) Government taxing. They are directly related to the economy` s total output, income and employment levels.
Goals (options?): 1) increase government spending- Increasing G pushes the economy out of recession. Real GDP rises;
2) Reduce taxes- AE=C+I;
C is determined by Dl.
To increase initial consumption by specific amount, government must reduce taxes by more, than that amount.
C1=Co+MPC
Tax reduction C2=Co+MPC
BUT Fiscal policy during recession or depression should create a government budget deficit – government spending in excess of tax revenues.
3) Use some combination of the two.
Multiplier effect of Taxation. Multiplier effect of Government Purchases.
32. Discretionary Fiscal Policy.
Means that the changes in taxes and government spending are at the opinion of the Federal government. There are 2 cases:
33. Cases of discretionary fiscal policy: expansionary and concretionary policy.
a) An expansionary fiscal policy - when recession occurs. The economy is experiencing recession and cyclical unemployment reducing investment spending and aggregate demand.
There are 3 main fiscal policy options:
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1) increase government spending- Increasing G pushes the economy out of recession. Real GDP rises;
2) Reduce taxes- AE=C+I;
C is determined by Dl.
To increase initial consumption by specific amount, government must reduce taxes by more, than that amount.
C1=Co+MPC
Tax reduction C2=Co+MPC
BUT Fiscal policy during recession or depression should create a government budget deficit – government spending in excess of tax revenues.
3) Use some combination of the two.
b) A concretionary fiscal policy - when demand pull inflation occurs.
Government looks to fiscal policy to control inflation.
3 options: 1)Decrease G – pull inflation is experienced as a shifting AE(AD) up. Fiscal policy is designed to stop such shifts.
2)Raise taxes;
3) Use some combination of the two.
Nondiscretionary Fiscal Policy. Built-in stabilizers.
Nondiscretionary fiscal policy – this is the policy of built-in stabilizers. Government Tax revenues change automatically over the course of the businesses cycle.
A Built-in stabilizer – is anything which increases the
government’s budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policymakers.
Problems and complications of fiscal policy.
