Unit 3 blog

Feb-18-16

Aggregate supply 

-level of real GDP (GDPr) that firms will produce at each price level (PL)

Long run 

-period of time where input prices are completely flexible and adjust to changes in 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 agregate supply or LSAS marks the level of full employment in the economy (analogous to PPC)

-because input prices are completely flexible in the long run changes in price level do not change firms real profits and therefore do not change firms level of output this means that the LRAS. 

-An increase in SRAS is shift to right 

- decrease is shift to left

- per-unit production cost= total input cost/ total output

-determinants of SRAS 

1. Input prices

-domestic resource prices

 -wages(75%)

 -cost of capital 

 -raw material (commodity)

-foreign resource prices

-market power

-increase in resource prices=SRAS shift to left

-Decrease in resource prices=SRAS shift to right 

2. Productivity = total output/ total inputs 

- more productive you are=lower production cost= shift to right of SRAS

-lower productivity=higher unit production cost=SRAS to left

3. Legal-institutional 

Legal-Institutional Environment 

-taxes and subsidies 

 -taxes ($ of gov) on buissness increase per unit production cost=SRAS TO LEFT

-Subsidies ($from gov.) to buissness reduce per unit production cost= SRAS to right

-Government Regulation 

 -government regulation creates a cost of compliance=SRAS TO LEFT

 -Deregulation reduces compliance cost=SRAS to right

Nominal wages- amount of money received by a worker per unit of time 

-real wages- amounts of goods and services a worker can purchase with their nominal wage. 

-sticky wages-nominal wage level that is set according to an initial price level and it does not vary due to labor contracts or other restrictions 

what is an Investment 

- money spent on fine things such as:

- New plants(factories)

- Capital equipment (machinery)

- Technology (hardware and software)

- New homes

- Inventories (goods sold by producers)

Expected rates of return

-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 cost

-how does business determine the amount of investment they undertake

- compare expected rate of return to interest cost

- If expected return is greater than interest cost then invest

- If expected return is less than interest cost then do not invest 

Real vs Nominal rate

-what's the difference?

- nominal is the observable rate of interest. Real subtract out inflation (pi%) and is only known ex post facto. 

How do you compute the real interest rate (r%)

- r%=i%-pi%

What then, determines the cost of an investment decision

- the real interest rate (r%)

-what is the shape of the investment demand curve?

- downward sloping 

-why

- when interest rates are high fewer investments are profitable; when interest rates are low, more investment are profitable. 

Shifts investment demand m(ID)

-cost of production 

- lower cost shift ID to right 

- Higher cost shift ID to left

-business taxes 

- lower business taxes shift ID to right

- Higher business taxes shift ID to left 

-  

Disposable income (DI)

-income after taxes or net income

2 choices with disposable income,households can either 

-consume(spend)

-save(not spend money)

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

-households don't spend 

-the ability to save is constrained b

- amount of disposable income

- The propensity to consume 

-do households save if DI=0?

- no

Apc =average propensity to consume

Aps-average propensity to save

-apc +aps =1

-1-apc=aps

-1-aps=apc

-apc>1 =dissaving

Mpc=marginal propensity to consume 

-mpc=change in consumption/change in disposable income

Mps=marginal propensity to save

-mps=change in savings/Change in disposable income

-mpc+mps=1

-mpc=1-mps

-mps=1-mpc

People either spend or save with their income. 

-spending multiplier effect 

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

- Multiplier=change in AD/change in spending 

- Multiplier=1/1-mpc or 1/mps

- Multipliers are positive when there is an increase in spending and negative when there is a decrease 

Tax multiplier 

-when gov. Taxes the multiplier works in reverse because money is leaving the circular flow

- tax multiplier =-mpc/1-mpc or -mpc/mps

- Negatives!!

- If there is a tax cut then the multiplier is positive because there is now more money in the circular flow.

 Feb.29.16

-Fiscal policy 

- changes in the expenditures or tax revenues of the federal government 

-2 tools of fiscal policy 

- taxes- government can increase or decrease taxes 

- Spending-government can increase or decrease taxes

Deficits, surplus, and debt

-balanced budget is  revenues=expenditures

-budget deficit is revenues<expenditures 

-budget surplus is revenues>expenditures

Government debt is sum of all deficit- 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)

-discretionary 

- 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 

-Automatic 

- unemployment compensation and marginal tax rate 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 

- combat recession 

- Increase gov. Spending

- Decrease taxes

Contactionary fiscal policy

- combat inflation 

- Decrease government spending

- Increase taxes 

Automatic or built in stabilizers 

-anything that increase the governments budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policy makers 

-progressive tax system

- average tax rate rises with GDP

-proportional tax rate

- average tax rate remains constant as GDP changes

-regressive tax system

- average tax rate falls with GDP.