Christina Hernandez

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Chapters 9-12

• Christina Hernandez
• Kate Peadan
• Mary Miller

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Chapter 9Basic Macroeconomic Relationships
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Simplifications

• The economy is closed.
• The role of government is ignored.
• All savings take place in households.
• Depreciation and net foreign exchange are zero.
• The economy has excess capacity and unemployment

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Disposable Income

• Taxes
• Savings
• Consumption
• DICS

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The Consumption Schedule

• The consumption schedule gives the relationship
  between consumption and income
• circular flow diagram
• consumption expenditure
• Total income that one doesnt spend is considered
  saved. The 45 degree line shows where
  consumption equals income.
• The vertical distance between the 45 degree line
  and the consumption function is income saved at
  that level.

• Break-even income is that level of income where
  households spend all their income and savings is
  zero.

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Propensity
?C
Consumption
MPC
APC
?DI
Disposable Income
Savings
?S
MPS
APS
Disposable Income
?DI

• APS APC 1

• MPSMPC 1

MPC and MPS are the slopes of consumption and
savings schedules
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Nonincome Determinants of Consumption and Saving

• Wealth
• Expectations
• Real Interest Rates
• Taxation
• Household Debt

If r is less than the real interest rate (r lt i),
then the firm loses on the investment. If r is
greater than the real interest rate (r gt i), the
firm makes extra profits.
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The Investment Demand Curve

• shows the relationship between desired investment
  and the interest rate. Businesses borrow money to
  invest. As the real interest rate increases,
  profitable investment opportunities decline, and
  businesses reduce the level of investment.
• Shifts of the Investment Demand Curve
• -Acquisition, Maintenance, and Operating Costs
• -Business Taxes
• -Technological Change
• -Stock of Capital Goods on Hand
• -Expectations

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Instability in Investment

• Durability
• Irregularity of Innovation
• Variability of Profits
• Variability of Expectations

Change in real GDP
Multiplier
Initial change in spending
1
1
Multiplier
Multiplier
MPC
1-MPS
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Questions for Ch. 9

• 1. If the interest rate rises
• a) investment spending will decrease
• b) the investment demand curve will shift upward
• c) the investment demand curve will shift to the
  left
• d) the investment demand curve will shift to the
  right
• 2. If Margy's MPC is .9, this means that she will
  
• a) spend 90 cents out of every additional dollar
  of disposable income
• b) spend 90 of her total disposable income
• c) spend all her disposable income when her
  disposable income is 9000
• d) save 10 of her total disposable income

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More Questions

• 3. The multiplier is equal to all of the
  following except
• a) 1 / (1 - MPC)
• b) 1 / (APC - 1)
• c) 1 / (MPS)
• d) change in real GDP / initial change in
  spending
• 4. The multiplier process suggests that
• a) any initial drop in the price level causes a
  proportionately larger increase in consumption
  spending
• b) any initial increase in disposable income
  causes a larger increase in investment spending
• c) any initial increase in the interest rate will
  cause a larger increase in the money supply
• d) any initial increase in aggregate expenditures
  will cause a larger increase in GDP

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Answers

• 1. A
• 2. A
• 3. B
• 4. D

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Chapter 11Aggregate Demand and Aggregate Supply
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AD

• Aggregate demand is a schedule of curve that
  shows the amounts of real output that buyers
  collectively desire to purchase at each possible
  price level. The relationship between price
  level and the amount of real GDP demanded is
  inverse
• A decrease in aggregate demand leads to a
  recession and cyclical unemployment
• Determinants of AD
• 1. Change in Consumer Spending
• 2. Change in Investment Spending
• 3. Change in Government Spending
• 4. Change in Net Export Spending
• The AD curve slopes down because
• Real-Balances Effect
• Interest-Rate Effect
• Foreign Purchases Effect

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AS

• Aggregate supply is a schedule or curve showing
  the level of real domestic output that firms will
  produce at each price level.
• In the long run, AS is determined by availability
  of resources and technology. Changes in price
  level cannot alter the amount of real GDP
  produced
• Determinants of Aggregate Supply
• 1. Input Prices
• 2. Domestic Resource Prices
• 3. Prices of Imported Resources
• 4. Market Power
• 5. Productivity
• 6. Legal-Institutional Environment
• Business Taxes and Subsidies
• Government Regulation

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AD and AS Together

• equilibrium price level and amount of real output
  
• Demand-Pull Inflation price level is pulled up
  as a result of increased aggregate demand
• Why Resource Prices and Output Prices dont
  Readily Decline
• 1. Wage contracts
• 2. Morale, Effort, and Productivity
• 3. Minimum Wage
• 4. Menu Costs
• 5. Fear of Price Wars
• Cost- Push Inflation occurs when some external
  event outside the country raises costs across the
  economy

AS
PRICE LEVEL
AD
REAL GDP
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Questions for Ch. 11

• 1. If aggregate demand and aggregate supply both
  decrease
• a) real GDP and the price level will both fall
• b) real GDP will fall and the price level will
  decrease
• c) the price level will fall but real GDP may
  either increase or decrease
• d) real GDP will fall but the price level may or
  may not increase
• 2. An increase in the price level will
• a) increase net exports
• b) reduce the value of household debt and
  increase investment
• c) increase production costs and reduce aggregate
  supply
• d) reduce the purchasing power of household
  wealth and reduce consumption

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More Ch. 11 Questions

• 3. The short-run aggregate supply curve
• a) assumes that wages and salaries fully match
  any change in the price level
• b) is vertical at the full-employment level of
  output
• c) shows the amount of real output supplied at
  various price levels
• d) becomes increasingly flatter as output expands
  
• 4. Other things equal, depreciation of the dollar
  will
• a) increase U.S. aggregate demand by increasing
  net exports
• b) decrease U.S. aggregate demand by reducing net
  exports
• c) increase U.S. aggregate supply by increasing
  the price of exported resources
• d) increase U.S. aggregate supply by reducing the
  price of imported resources

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Answers

• 1. D
• 2. D
• 3. C
• 4. A

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Chapter 12 Fiscal Policy
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Fiscal Policy

• The Employment Act of1946with the pressure of
  rising unemployment, the government passed this
  act, allowing the Federal government to use all
  practicable means, consistent with the market
  system, to promote the goals of fiscal policy
  (listed below)
• This act also established the Council of Economic
  Advisors (CEA) to assist and advise the president
  on economic matters and the Joint Economic
  Committee (JEC) of Congress
• Fiscal policy consists of deliberate changes in
  government spending and tax collections designed
  to achieve these goals
• 1. Full employment
• 2. Price Stability
• 3. Encourage economic growth

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Types of Fiscal Policy

• Discretionary active fiscal policy
• Nondiscretionary automatic
• Expansionary in order to foster growth during a
  recession the Executive Branch has these options
  to shift the AD curve rightward
• 1. Increase government spending
• 2. reduce taxes
• 3. some combination of the two
• Contractionary in order to halt demand-pull
  inflation the Executive Branch has these options
  to shift the AD curve leftward
• Reductions in government spending
• Tax increases
• Some combination of the two

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Tax Revenues

• U.S. net tax revenues (meaning tax revenues less
  transfers and subsidies) vary directly with GDP
  meaning they increase during expansions and
  decrease during recessions
• This means there is a build in stability in the
  tax system
• Transfer payments (negative taxes) include
  unemployment compensation, welfare, etc.
  Transfers decrease during expansions, vice versa.
• Taxes reduce spending and AD
• The average tax rate tax revenue/GDP

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Types of Tax Systems

• Progressive tax system the average tax rate
  rises with GDP
• Proportional tax system the average tax rate
  remains constant as GDP rises
• Regressive tax system the average tax rate falls
  as GDP rises
• The more progressive the tax system, the greater
  the economys built-in stability

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Problems with Fiscal Policy

• Recognition lag the time between the beginning
  of recession or inflation and the awareness that
  it is actually happening
• Administrative lag the time between when the
  government recognizes the need for fiscal action
  and the time the action is taken (example
  recession after 9/11)
• Operational lag the time between when the fiscal
  action is taken and the time that action affects
  the economy

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More Fiscal Policy Problems

• The Net Export Effect the effect an interest
  rate increase would have on a nations net
  exports
• If the interest rate rises, the U.S. will attract
  foreign financial capital, appreciating the U.S.
  dollar
• Since the dollar is more expensive, U.S. exports
  will likely decline and Americans will buy more
  imports with their more valuable dollar

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The Crowding-Out Effect

• The crowding-out effect an expansionary fiscal
  policy (deficit spending) may increase the
  interest rate because of government borrowing and
  reduce private spending, weakening or canceling
  the stimulus of expansionary policy

AS
After the governments intended shift to AD1, the
borrowing needed to finance the spending
increases the interest rate and crowds out some
investment spending, decreasing AD to AD2
PRICE LEVEL
AD1
AD2
AD
REAL GDP
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Questions about Ch. 12

• If the government wishes to increase the level of
  real GDP it reduces
• a) taxes
• b) its purchase of goods/services
• c) Transfer payments
• d) Budget deficit
• 2. With a proportional tax system, as the level
  of income increases in an economy, the average
  tax rate will
• a) Increase
• b) Decrease
• c) Remain the same
• d) Indeterminate

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More Questions

• 3. The crowding-out effect of an expansionary
  (deficit) fiscal policy is the result of
  government borrowing in the money market which
• a) increases interest rates and net investment
  spending in the economy
• b) increases interest rates and decreases net
  investment spending
• c) decreases interest rates and increases net
  investment spending
• d) decreases interest rates and net investment
  spending
• 4. The length of time involved for the fiscal
  action taken by Congress to affect output,
  employment, or the price level is referred to as
  the
• a) Administrative lag
• b) Operational lag
• c) Recognition lag
• d) Fiscal lag
• 5. The effectiveness of an expansionary fiscal
  policy will be reduced if
• a) borrowing increases interest rates and crowds
  out private investment
• b) the dollar depreciates because of an
  increased outflow of currency
• c) the price level falls
• d) stock prices rise

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• Answers
• 1. A
• 2. C
• 3. B
• 4. B
• 5. A