Macroeconomics Chapter 7-12

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The Business Cycle
Gives us insight on our economy
Economic Boom
5% or greater increase
Economic Bust
When the economy shrinks by 5%
Law of demand
Quantity of a good demanded at a given time period increases as its price fall
Classical economic school of thought
Adam Smith- “Wealth of Nations” –economy affects life
Classical Economic School of Thought
1. Flexible Prices- should be able to charge whatever you want
2. Flexible Wages- pay people whatever you want
3. Says Law- Supply creates demand
4. Popular Economic school of thought- prior to the 1930’s
5. Naturally Unstable- The economy is naturally unstable
Keynesian Economic School of Thought
John Maynard Keynes
1. The economy is constantly in motion
2. The government intervention was good
The Great Depression- October 25, 1929
1. Steady decline in output
2. Real GDP- 30% decrease in 1929-1933
3. 1934- some economic growth
4. 1936-37- got worse
5. 1939- had the same real GDP as it did in 1929
6. Per capita was less in 1929
World War 2- December 7, 1994
1. Increase in market demand
2. Marketed the end of the depression
3. 19% incredible in the GDP by 1942
4. Full employment
When the economy slows down for two or more consecutive quarters–results in unemployment
G.I. Bill
Designed to help people who fought in the war to go on and get a college education
1. Post WW2 Recession- lasted 8 months long 4.3%
2. Lasted 16 months 12.3% unemployment rate
Macroeconomic Determinants
1. Internal Marker Forces- businesses within our economy
2. External Shocks- when something on the outside of our economy shakes up or disrupts the economy (not all shocks are good or bad)
Policy Levers
Taxes, government spending
Macroeconomy Outcomes
1. Output- should produce from year to year
2. Jobs- should be able to get a job
3. Prices- should be able to purchase goods and services at affordable prices
4. Growth- diversification/ want to have a variety for the consumer
5. International balances we want to be able to trade with other countries and we want want them to be able to trade with us
Internal shocks
When something from within our economy shakes things up
External shocks
When something happens on the outside of our economy
Aggregate Demand
The total quantity of output that’s demanded at different prices and different times
Aggregate Supply
The some total of output that producers are willing and able to supply at different places and at different times
Potential Problems with Macro equilibrium
1. Undesirability- When the equilibrium price or output level may not satisfy our economic goals
2. Instability- Even if the equilibrium is what you want, it may not last long
Short Run
Quick fix
Long Run
More permanent fix
Fiscal Policy
When the government spends money in the economy
Monetary Policy
using money and credit controls to ultra the economy
Supply Side Economic Policy
the use of tax insentives and other mechanisms to increase the ability and willingness to increase goods and services
Components of Aggregate Demand
1. Consumption- Expentagers on final good and services by consumers
2. Investment- Upgrading existing equipment or buying new equipment
3. Government Spending- Anytime the government spends money in the economy
4. Net Exports- Exports-Imports
Disposable Income
The money that we have left over after we pay our taxes
The portion of our disposable income that is not spent
Average Propensity to Consume
The portion of total disposable income that is spent on consumer goods and services
Formula for Average Propensity to Consume
Total Consumption/Total Disposable Income
Marginal Propensity to Consume
The fraction of each additional dollar of disposable income that is spent on consumption
Formula for Marginal Propensity to Consume
Change in Consumption/Change in Disposable Income
Marginal Propensity to Save
The fraction of each additional dollar of disposable income that is not spent on consumption
Formula for Marginal Propensity to Save
Wealth Effects
change in consumer spending that is caused by a change in the own value of owned assets
Non-Income Terminates of Consumption
things that affect what we consume and how
Non-Income Terminates of Consumption
1. Expectations- if we think some is going to do something special we may buy something for them as well
2. Wealth Effects- If you have more money, the less careful you are going to be with it or how you spend
3. Credit- How carried away you will get with spending
4. Taxes- What we owe the government
Total Consumption=
Autonomous Consumption + Income – Dependent Consumption
Consumption Function
The mathematical relationship that indicates the rate of desired consumer spending at various income levels
Consumption expentagers in excess of disposable income
Types of Inflation
1. Demand Poll Inflation- When the cost of goods or services go up because people are in demand of them.
2. Cost Push Inflation- When the costs go of factors of production goes up so do the prices
Product Market
Where finished good are bought
Factor Market
Where we get our factors of production
Income that is not spent directly on domestic output but instead diverted from circular flow
Types of Leakages
1. Savings- if you choose to save some of your money
2. Imports- If you are buying something from another country it takes away from our country
3. Household Taxes- When you have to give money to the government you’re not spending it
4. Business Taxes- If businesses are paying taxes they are not spending money in the economy
5. Business Savings- If a business decides not to spend money but sets it aside
when there is addition of money to the circular flow
Declines of Income
1. Undesired Inventory- Merchandise that you have in stock that people no longer want anymore
2. Falling Output Prices- Pay top dollar for something and the price goes down, bought it when it was expensive, but now it is cheap.
Marginal Propensity to Consume
The fraction of each additional dollar of disposable income spent on consumption
Formula for Marginal Propensity to Consume
Change in total consumption/change in disposable income
The multiple by which an initial change in spending will alter total expentager after an infinite number of spending cyclicles
1/1- M.P.C.
Total change in spending=
Multiplier X Initial Change in Aggregate Spending
Macro equilibrium According to Keynes
1. Produce cut output when output exceeds demand- if people aren’t demanding something don’t produce it
2. Resulting Loss of Income- causes a decline in consumer demand- the less income people make the less people will demand
3. Declines in Consumer- spending will lead to further cut backs of production and more lost income
When there is an increase in the average prices we pay for
Short Run Inflation
A brief period of inflation
Long Run Inflation
Long period of inflation
Fiscal Policy
When the government spends or doesn’t spend money in the economy to alter the economy (uses its own personal spending to affect the economy. If the government wants to speed up or slow down the economy)
Fiscal Policy/ Ways the Government can Alter the Economy
1. Purchase more is less goods- people are more likely to spend money in the economy
2. Raises or Lowers Taxes- If the government increases taxes you will have less disposable income, less demand slows down the economy
3. Change The Level of Income Transfers- Social security or welfare benefits increase people will still be spending more money
Determinants of Fiscal Policy
1. Internal Market Forces- What is happening within out economy
2. External Shocks- When something on the outside of our economy shakes things up
3. Policy Tools
Outcomes of Fiscal Policy
1. Increase in Output
2. Jobs- People should be able to find work
3. Prices- Should be able to buy goods and services
4. Growth- More diverse/ more variety
5. International Balances- Want things to go well with our trade partner
Fiscal Stimulus
Tax cuts or government spending increases
Desired Fiscal Stimulus
How much do we want to speed the government up?
Short Fall
Amount of additional aggregate demand you will need to achieve full employment
Desired Fiscal Stimulus=
Aggregate Demand and Short Fall/ Multiplier
Effects of Tax Cuts
1. More Consumption- can spend more on goods and services
2. More Income
3. More Savings- may have extra money you can put away
Desired Tax Cuts=
Desired Fiscal Stimulus/ M.P.C.
Fiscal Restraints
Take the form of tax increases or spending cuts
Desired Fiscal Restraints=
Excess Aggregate Demand / Multiplier
Desired Increase in Taxes=
Desired Fiscal Restraint / Marginal Propensity to Consume
Crowding Out
A reduction in private sector borrowing as a result of increases in government borrowing
Deficit Spending
the use of borrowed money to finance government expentagers that exceed tax revenue.
Is it okay to operate a Deficit?
Budget Deficit
The amount by which the government exceeds its tax revenue
Budget Surplus
When your revenue is greater than your expentagers
Fiscal Year (F.Y.)
A 12 month period that we use for accounting purposes
Discretionary Fiscal Spending-
The elements of the federal budget that are not determined by legislative or executive decisions
Discretionary Funding
Accounts for about 20% each yr.
-80% determined by things years ago from our government
Fiscal Restraints
Something like a tax increase or spending cut, used by the government if the government wants to slow down the economy
Fiscal Stimulus
A tax cut or spending increase
– if we want to speed the economy up
Automatic Stabilizer
Federal expentagers that automatically respond to counter cyclical changes in national income
Example: Unemployment Compensation
When The GDP Decreases by 1%
1. Government Spending Increases- increases through unemployment compensation, welfare, social security– costs about $2 Billion for the government.
2. Government Tax Revenue Declines- about $38 Billion in decreases
2. Deficit Increases- by $15 Billion– shrinks because there is not enough spending occurring
Cyclical Deficit
The portion of the budget balance that is attributed to short run changes in the economy
Total Budget Balance=
Cyclical Balance + Structural Balance
Structural Deficit=
Federal Revenue At Full – Expentagers at full employment under fiscal or budgetary conditions
Crowding Out
Reduction in private sector borrowing caused by an increase in government borrowing
Crowding In
An increase in private sector borrowing cause by decreases in government borrowing
Uses for Budget Surplus
1. Spending it on goods and services- government can buy more stuff
2. Cut Taxes- Reduce taxes people are being charged for
3. Increases- Income transfers
4. Can be used to pay of old debt
National Debt
The accumulation of debt by the national government
An obligation to make future payment of debt
Anything having exchange value in the market place or wealth
Name The Two Kinds of Debt
1. Internal Debt- The U.S. gov. debt that is help by U.S. households and institutions
2. External Debt- The U.S. gov. debt that is held by foreign households and institutions
The issuance of new debt in payment or previous debt
Debt Service
The interest that is required to be paid each year on outstanding debt
debt- charged 6% on loan, what you have to pay each year
Deficit Ceiling
An explicit legislated limit on the size of the budget deficit– when the legislature tells the president that he cannot spend this amount
Debt Ceiling
An explicit legislative limit on the amount of outstanding national debt
Categories: Macroeconomics