UNIT 3: Fiscal Policy

(2/29/16)
                                   

Fiscal Policy: - Changes in the expenditures or tax revenues of the federal government.
                       *2 tools of fiscal policy:
                         - Taxes ~ gov. can increase or decrease taxes.
                         - Spending ~ gov. can increase or decrease spending.

Deficits, Surpluses, & Debt:
-Balanced Budget: Revenues = Expenditures
-Budget Deficit: Revenues < Expenditures
-Budget Surplus: Revenues > Expenditures
-Gov, Debt: Sum of all deficits - Sum of all surpluses

*Government must borrow money when it runs a budget deficit.
Gov. borrows from:
-Individuals
-Corporations
-Financial Institutions
-Foreign Entities or Foreign Governments

Fiscal Policy Two Options:~Discretionary Fiscal Policy (action)
-Expansion fiscal policy - think deficit
-Contractionary fiscal policy - think surplus
-Non-Discretionary Fiscal Policy (NO ACTION)

1) Discretionary Fiscal Policy: 
-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.

2) Automatic Fiscal Policy:
- 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.

Expansionary Fiscal Policy: (easy)
                                                - combat a recession
                                                - increase in government spending
                                                - decrease in taxes
Contractionary Fiscal Policy: (tight)
                                                  - combat inflation
                                                  - decrease in government spending
                                                  - increase in taxes

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.
EX./unemployment compensation, SS, welfare, Medicaid/Medicare, VA benefits

*Progressive Tax System
-Average tax rate (tax revenue/GDP) rises w/ GDP

*Proportional Tax System
-Average tax rate revenues constant as GDP changes

*Regressive Tax System
-Average tax rate falls w/ GDP

UNIT 3: Consumption & Savings

(2/25/16)                                        

Disposable Income (DI): - The income after taxes on net income.
                                           DI = Gross Income - Taxes
                                           - Options: spend or save
                           2 Choices: With disposable income, households can either...
                                           - Consume (spend money on goods & services)
                                           - Save (not spend money on goods & services)

Consumption: - Household spending
                         - The ability to consume is constrained by...
                           *the amount of disposable income
                           *the propensity to save
                         - Do households consume if DI = 0?
                           *Autonomous consumption
                           *Dissaving

Saving: - Household NOT spending
              - The ability to save is constrained by...
               *the amount of disposable income
               *the propensity to consume
              - Do households save if DI = 0?
               *NO

APC & APS
APC + APS = 1
1 - APC = APS
1 - APS = APC

APC > 1 = Dissaving
-APS = Dissaving


Marginal Propensity to Consume (MPC):
- The fraction of any change in disposable income that is consumed.
MPC = Change in Consumption/Change in Disposable Income

Marginal Propensity to Save (MPS):
- The fraction of any change in disposable income that is saved.
MPS = Change in Savings/Change in Disposable Income


Marginal Propensities:
MPC + MPS = 1
MPC = 1 - MPS
MPS = 1 - MPC

The Spending Multiplier Effect:
- An initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending, or aggregate demand (AD).

Multiplier = Change in AD/Change in Spending

Multiplier = Change in AD/Change in C, Ig, G, Xn

-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.
-Why? Because now money is leaving the circular flow.

Tax Multiplier (it's negative) = -MPC/1-MPC or -MPC/MPS

- If there is a tax cut then the multiplier is (+) because there is now more $ in the circular flow.

UNIT 3: Classical v. Keynesian

 (2/24/16)

CLASSICAL V. KEYNESIAN

Classical: - Competition good
                 - Invisible hand (gov/economy can regulate itself)
                 - Economy balanced at full employment
                 - Economy always close to or at full employment
                 - Support the trickle down effect (help rich first, everyone else 2nd)


Keynesian: - Competition flawed

                    - AD is the key not AS
                    - Leaks & savings cause recessions
                    - Ratchet effects and sticky wages block Say's Law
                    - In the Long-run, we are dead

UNIT 3: SRAS

(2/22/16 - 2/23/16)                       

NOTES ON SRAS 

Nominal Wages: the amount of $ received by a WORKER per unit of TIME. (Paid hourly)
                           - what you make.

Real Wages: the amount of goods & services a worker can purchase with their nominal wages.
                     - the purchasing power of nominal wages.
                     - how far you can go with your money.

Sticky Wages: the nominal wage level that is set according to an initial price level and does not vary
                        due to labor contracts or other restrictions.

Keynesian = Recession: Price Fixed, Wages Fixed, Employment Level Flexible
                   Intermediate: Price Flexible, Wages Fixed, Employment Level Flexible
Classical = Inflation: Price Flexible, Wages Flexible, Employment Level Fixed 
             
What is Investment?
-Money spent or expenditures on:
New plants (factories)
Capital equipment (machinery)
Technology (hardware & software)
New homes
Inventories (goods sold by producers)

Expected Rates of Return:
How do businesses 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 cost
*If expected return > interest cost, then INVEST
*If expected return < interest cost, DO NOT invest

Real (r%) v. Nominal (i%)
What's the difference?
- Nominal is the observable rate of interest. Real subtracts out inflation (π%) and is only known
ex post facto.

Real Interest Rate:
r% = i% - π%
What determines cost of an investment decision?
- the real interest rate (r%) 

Investment Demand Curve (ID)
- Downward sloping 
- Why? - When investment rates are high, fewer investments are profitable; when interest rates are low, more investments are profitable. 

Shifts in Investment Demand (ID)
Cost of Production:
- Lower costs shift ID --->
- Higher costs shift ID <---
Business Taxes: 
- Lower business taxes shift ID --->
- Higher business taxes shift ID <---
Technological Change: 
- New technology shift ID --->
- Lack of technological change shifts ID <---
Stock of Capital:
- If an economy is low on capital, then ID --->
Expectations:
- Positive expectations shift ID --->
- Negative expectations shift ID <---

UNIT 3: Aggregate Supply

(2/19/16 - 2/22/16)
                                   

Aggregate Supply: The level of Real GDP that firms will produce at each price level.

                  Long-Run                                          v.                                      Short Run                  
- period of time where input prices are                         - period of time where input prices
completely flexible & adjust to changes                      are sticky and do not adjust to changes
in the price level.                                                          in the price level.

- in the long-run, the level of Real GDP                       - in the short-run, the level of Real GDP
supplied is independent of the price level.                   supplied is directly related to the price level.


Long-Run Aggregate Supply (LRAS):- The Long-Run Aggregate Supply or LRAS marks the level of full employment in the economy
(analogous to the PPC)
- Because input prices are completely flexible in the long-run, changes in price-level do not change
firms real profits & therefore, do not change firms level of output.
- Means LRAS is vertical at the economy's level of full employment.
Changes in SRAS (Short-Run):
- An increase in SRAS in seen as a shift to the right. (SRAS --->)
- A decrease in SRAS is seen as a shift to the left. (SRAS <---)
- The key to understanding shifts in SRAS is per unit cost of production.

Per unit production cost =  total input cost / total output
Determinants of SRAS (all of the following affect unit production cost):
1.) Input Prices
2.) Productivity
3.) Legal-Institution Enviroment

1.) Input Prices: - Domestic Resource Prices - Wages (75% of all business costs)
                                             - Cost of capital
                                             - Raw Materials (commodity prices)
- Foreign Resource Prices - Strong $ = lower foreign resource prices
                                           - Weak $ = higher foreign resource prices
- Market Power
- Increase in Resource Prices = SRAS <---
- Decrease in Resource Prices = SRAS --->

2.) Productivity = total output / total inputs
- More productivity = lower unit production cost = SRAS --->
- Lower productivity = higher unit production cost = SRAS <---

3.) Legal-Institutional Environment:
Taxes & Subsidies...
- taxes ($ to government) on business increase per unit production cost = SRAS <---
- subsidies ($ from government) to business reduce per unit production cost = SRAS --->
Government Regulation...
- Gov regulation creates a cost of compliance = SRAS <---
- Deregulation reduces compliance costs = SRAS --->

                                   

Full Employment:

-Full employment equilibrium exists where AD intersects SRAS & LRAS at the same point.

Recessionary Gap:
- Recessionary gap exists when equilibrium occurs below full employment output.



Inflationary Gap:
- Inflationary gap exists when equilibrium occurs beyond full employment output.

UNIT 3 Intro: Aggregate Demand

(2/18/16)

Aggregate Demand: demand by consumers, businesses, government, and foreign countries.
                               - focus on Price Level and Real GDP.
                               - Changes in price level cause a move along the curve.
                               - AD = C + I + G + Xn

Why is AD Downward Sloping?
1.) Real-Balance Effect - Higher price levels reduce the purchasing power of money.
                                       - This decreases the quantity of expenditures.
                                       - Lower price levels increase purchasing power and increase expenditures.
                                       - EX./ inflation erodes purchasing power in $50,000 in bank.

2.) Interest-Rate Effect - When the price level increases, lenders need to change higher interest rates
                                        to get a REAL return on their loans.
                                      - Higher interest rates discourage consumer spending & business investment.
                                      - EX./ Interest rate increases from 5% to 25%, less likely to get loans to
                                        improve business.

3.) Foreign Trade Effect - When U.S price level rises, foreign buyers purchase fewer U.S goods &
                                          Americans buy more foreign goods.
                                        - Exports fall & imports rise causing real GDP demanded to fall.
                                          (Xn decreases)

*Shifters of AD: GDP = C + I + G + Xn

Shifts in AD:
- There are two parts to a shift in AD:
1) A change in C, Ig, G, and/or Xn.
2) A multiplier effect that produces a greater change than the original change in the 4 components.

*Increases in AD = AD ---> (shift right)
*Decreases in AD = AD <--- (shift left)

Determinants of AD:
1.) Consumption: Household spending is affected by...
                             Consumer Wealth:
                             - more wealth = more spending (AD --->)
                             - less wealth = less spending (AD <---)
                             Consumer Expectations:
                             - positive expectations = more spending (AD --->)
                             - negative expectations = less spending (AD <---)
                             Household indebtedness:
                             - less debt = more spending (AD --->)
                             - more debt = less spending (AD <---)
                             Taxes:
                             - less taxes = more spending (AD --->)
                             - more taxes = less spending (AD <---)

2.) Gross Private Investment: Investment spending is sensitive to...
                                                The Real Interest Rate:
                                                - lower = more investment (AD --->)
                                                - higher = less investment (AD <---)
                                                 Expected Returns:
                                                - higher = more investment (AD --->)
                                                - lower = less investment (AD <---)
                                                 Expected Returns influenced by:
                                                - Expectations of future profitability
                                                - Technology
                                                - Business Taxes
                                                - Desire of Excess Capacity (Existing stock of capital)

3.) Government Spending: - More gov. spending (AD --->)
                                            - Less gov. spending (AD <---)

4.) Net Exports: Net Exports are sensitive to...
                           Exchange Rates (International value of $):
                           - strong $ = more imports & fewer exports (AD <---)
                           - weak $ = fewer imports & more exports (AD --->)
                           Relative Income:
                           - strong foreign economics = more exports (AD --->)
                           - weak foreign economics = less exports (AD <---)

                                     

UNIT 2 Economics Notes

(1/26/16)

THE CIRCULAR FLOW DIAGRAM 

Circular Flow Diagram: Represents the transactions in an economy.

Product Market: The place where households sell resources and businesses buy resources.

                           - Ex/: Goods and services

Factor/Resource Market: Holds factors of production- land, labor, capital, and entrepreneurship.
                                   - The place where households sell resources & businesses buy resources.
                                   - Firms purchased are rent land & higher workers

Firms: -An organization that produces goods and services for sale.

            -sell finished products to households.

Household: - A person or group of people that share their income.

                   -Sell their factors of production to businesses.

(1/27/16) - (1/28/16)

GDP

Gross Domestic Product (GDP): Market product of all final goods and services produced within a country's borders within a given year.

Gross National Product (GNP): The total value of all final goods and services by citizens of that country on its land/foreign land.

What's not included in GDP?

1. Intermediate goods (goods that require further processing before they are ready for final use.)

2. Used/Second hand goods  (avoid double counting)

3. Purely financial transaction (stocks and bonds)

4. Illegal Activities (Drugs)

5. Unreported business activity (unreported tips)

6. Transfer payments -Public (SS, welfare, VA)

                                     -Private (scholarships)

7. Non-Market Activity -volunteer work

                                         -babysitting

                                         -any work that you perform yourself.

                                         -producing own source of labor.

What's Included in GDP?

1. C - Personal Consumption Expenditures (wages, salaries)

2. Ig - Gross Private Domestic Investment: - New Factory equipment

                                                                      - Factory equipment maintenance

                                                                      - Construction of housing

                                                                      - Unsold inventory (of products built in a year)

3. G - Government Spending

4. Xn - Net Exports (exports - imports)

(1/29/16)

2 Ways of Calculating GDP:

1. Expenditure Approach: Add up all of the spending on final goods and services
                                             produced in a given year.
Formula: GDP = C + Ig + G + Xn (exports - imports)

2. Income Approach: Add up all of the income that resulted from selling all final
                                    goods and services produced in a given year.

Formula: GDP = W (wages) + R (rents) + I (interest) + P (profits) + Statistical Adjustments

* Statistical Adjustments include 1.) Indirect business taxes
                                                      2.) Depreciation (Consumption of fixed capital)
                                                      3.) Net foreign factor payment

National Income:
- Compensation of Employees: wages, salaries, fringe benefits, SS contributions,
                                                   health pension plans.
- Rents: Income of property owners.
- Interest: Income that is paid by someone to the owner of a loan.
- Corporate Profits: Income of a stockholder in a corporation.
- Proprietors Income: Income of a sole proprietor (entrepreneur) or from a partnership.

                                                                                                     

FORMULAS:

Budget Surplus(-)/Deficit(+) =

Gov. purchases of goods/services + Gov. transfer payments - Gov. tax/fee collection

Trade Surplus(+)/Deficit(-) =

Exports - Imports

National Income =

Compensation of employees + Rents + Interest + Corporate Profits + Proprietors Income

                                                                            OR

GDP - Indirect business taxes - Depreciation - Net foreign factor payment

Disposable Personal Income =

National Income - Personal Household taxes + Gov. transfer payments

(2/1/16)

MORE FORMULAS:

Net Domestic Product (NDP) = GDP - Depreciation
Net National Product (NNP) = GNP - Depreciation
GNP = GDP + Net Foreign Factor Payment

-Nominal GDP: The value of output produced in current prices.

                         - CAN increase from year to year if either output or prices increase.

                         - Formula: P(price) x Q(quantity)

-Real GDP: The value of output produced in constant or base year (earliest year) prices.

                  - Adjusted for inflation

                  - CAN increase from year to year ONLY if output increases.

                  - Formula: P(base yr price) x Q(current year quantity)

               

* If we want to measure ECONOMIC GROWTH we use Real GDP.

* If we want to measure INFLATION (increase in prices) we use Nominal GDP.

EX./

                              Q in 2015      Q in 2016     P in 2015     P in 2016                 

Pizzas                         5                    6                  $10              $15

CDs                            4                    5                  $15              $20

Stereos                       2                    4                  $600            $550

Automobiles              1                    1                 $10,000       $12,000

Real GDP in 2015: $11,310  

                     2016: $12,535  

Nominal GDP in 2015: $11,310  

                            2016: $14,390  

- GDP Deflator (price index): - price index used to adjust from Nominal to real.  
                                                   - Formula: Nominal GDP/Real GDP x 100    
                                                   -In the base yr, GDP Deflator will ALWAYS = 100.
                                                   - Years after the base yr, GDP Deflator is > 100.
                                                   - Years before the base yr, GDP Deflator is < 100.

- Consumer Price Index (CPI): - The most commonly used measurement for inflation.
                                                     - Measures the cost of a market basket of goods for a
                                                       typical Urban American Family.
Formula: Cost of a market basket of goods in a given yr/Cost of a market basket of goods in base yr x 100
- Inflation: (Price Index in yr. 2 - Price Index in yr. 1)/Price Index in yr. 1 x 100
                                               

(2/2/16)
REAL INTEREST RATE V. NOMINAL INTEREST RATE

Real Interest Rate: The % increase in purchasing power, the borrower MUST pay the lender a loan.
                             - IS adjusted for inflation.
                             - Unanticipated Inflation (not expected)
                             - Formula: Real Interest Rate = Nominal interest rate - Inflation

Nominal Interest Rate: The % increase in money, the borrower MUST pay the lender for a loan.
                                      - NOT adjusted for inflation.
                                      - Anticipated Inflation (expected)
                                     * Fisher effect: Nominal Interest Rate = Expected interest rate + Inflation premium

Hurt by Inflation          |          Helped by Inflation
1) Savers                                 1) Debtors (owe $)
2) Creditors/Lenders
3) Those who are on a
    fixed income.
    - elderly
    - welfare
    - medicaid
    - retired

* COLA (Cost Of Living Adjustment) - gives automatic wage increases when inflation occurs.


(2/4/16)

Unemployment: failure to use available resources particularly labor
                           to produce desired goods and services.
                           - NOT THE SAME as underemployment 

Labor Force: - Above 16 yrs. of age.
                      - Able: willing to work
                      - Employed + Unemployed

NOT in Labor Force:  
1) Military 
2) Students
3) Retired
4) Disabled
5) Homemakers (stay @ home parent)
6) Ppl in mental institutions
7) Jail/ Prison
8) Those not seeking a job

Unemployment Rate: 4 to 5% 
                                 - Formula: # of unemployed/(# of employed + # of unemployed) x 100

TYPES OF UNEMPLOYMENT:

1) Frictional unemployment: - searching for a job.
                                               - temporarily unemployed or in between jobs.
                                               - Ppl in this have TRANSFERABLE SKILLS.
                                               - Unavoidable
                                               - Ex./ better opportunity, high school/college graduate

2) Structural unemployment: - Changes in the structure of the labor force which
                                                  makes some skills and jobs obsolete.
                                                - They DO NOT have transferable skills.
                                                - Unavoidable
                                                - Ex./ Nasa workers (specifically trained to build spaceships)

3) Seasonal unemployment: - Depends upon the time of the year & nature of the job.
                                              - Ex./ bus drivers~only work when school in session
                                                        life guards~only summer time
                                                        contractors~only when weather is pleasant

4) Cyclical unemployment: - Results from economic downturns such as a RECESSION.
                                             - As demand for goods/services falls, demand for labor ALSO falls
                                               and workers are LAID OFF.

* Frictional + Structural = Natural Rate of Unemployment
* Full employment = NO cyclical unemployment

(2/5/16)

GDP Gap: The amount by which actual GDP falls short of potential GDP.

Okun's Law: For every 1% in which actual unemployment rate exceeds the NRU,
                       a GDP gap of about 2% exists.
                       EX./ In 2012, the unemployment rate for Mexico was 7.4%, the NRU
                               for Mexico is 6%, GDP Gap = 7.4 - 6 = 1.4 (x2) = 2.8% loss of potential GDP.

Rule of 70: Used to determine how many years it takes for a value to double
                   given a particular annual growth rate.
                   EX./ If you put &20,000 in the bank & it earns a yearly interest of 7%,
                            how many years will it take for your income to double? 70/7 = 10 yrs.