Fiscal Policy (last unit of Unit III)

Fiscal Policy- changes in the expenditures or tax revenues of the federal government.
           
       2 tools of fiscal policy
          1. Taxes- government can increase or decrease spending.
          2. Spending- government can increase or decrease spending.


Deficits, Surplus, and Deficit
- balanced budget
        +revenues= expenditures
            (it has been 16 years since we have had one)
- budget deficit
        +revenues < expenditure
-budget surplus
    +revenues > expenditures
- government debt
     +sum of all deficits - sum of all surpluses
-deficits
     +government must borrow money when it runs a budget deficit
      +government borrows from:
           1. individuals
           2. corporations
           3. financial institutions
           4. foreign entities of foreign government


Fiscal Policy Two Options
   - discretionary fiscal policy (action)
          +expansionary fiscal policy (think deficit)
           +contraction fiscal policy (think surplus)
          +Non- Discretionary fiscal policy (no actions)


Discretionary VS. Automatic Fiscal Policies

Discretionary-
      +Increasing or decreasing governments 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.


CAN NOT HAPPEN AT THE SAME TIME


Automatic-
    +unemployment compensation and marginal tax rates are examples of automatic polices that help militate 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) VS. Contraction Fiscal Policy (tight)
* combat a recession                                      *combat inflation

*increase government spending                     * decrease government spending
decreases taxes                                                    increase 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 expect action by policy makers.
     EX. transfer payments, social security, Medicare, medicate, unemployment, VA benefits

Tax Structures
- progressive tax system
      +average tax rate rises with GDP

EQUATION:             tax revenue
                                ------------------
                                       GDP
-proportional tax system
     +average tax rate remains constant as GDP changes

-regressive tax system
    +average tax rate falls with GDP

Here is a link below that can explain further in depth about consumption and spending ! Hope you all enjoy it ! :)
https://www.youtube.com/watch?v=vj7XExwChwI

Consumption and Savings 
   -disposable Income (DI)
   -income after taxes or net income
   - DI=gross income - taxes

2 choices
-with disposable income, households can either
          +consume (spend money on goods and services)
          +save (not spend money on goods and services



Consumption

 -household spending
-the ability to consume is constrained by
   +the amount of disposable income
    +the propensity to save
-do households consume DI= 0
   +autonomous consumption
   +dis saving

Saving
-household NOT spending
-the ability to save is constrained by
  +the amount of disposable income
   +the propensity to consume
-do house holds save if DI= 0?
     +NO


APC and APS

APC= Average Propensity to Consume
APS= Average Propensity to Save


ALWAYS =1

*APC + APS = 1

* 1 - APS= APC

*APC> 1 (dis saving)

* -APC (dis saving)


Marginal Propensity to consume (MPC)

-the fraction of any change in disposable income that is consumed

EQUATION: Change in Consumption
                     --------------------------------
                    Change in Disposable Income

MPC= ΔC
          -------
            ΔDI

Marginal Propensity to Save (MPS)
-the fraction of any change indisposable income that is saved

EQUATION: Change in Savings
                   -----------------------------           
             Change in disposable income


MPS= ΔS
        -------
         ΔDI

Marginal Propensity


ALWAYS = 1

* MPC + MPS= 1

*MPC = 1 - MPS

*MPS = 1 - MPC

***********remember, people do two things with their disposable income, they consume it or save it*******

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

EQUATION: Change in AD
                 -----------------------
               Change in spending

Multiplier= ΔAD
              ---------------
             ΔC, Ig, G, or Xn

Calculating the Spending Multiplier

-the spending multiplier can be calculated from the MPC or MPS 

Multiplier= 1                              1
               --------             OR      -----
                1 - MPC                  MPS

-multipliers are positive (+) when there is an increase in spending, a negative (-) is when there is a decrease.


Calculating the Tax Multiplier

-when the government taxes, the multiplier works in reverse
              +because now money is leaving the circular flow


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



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

More about Classical VS. Keynesian

Classical                                                                        Keynesian
- competition is good the invisible hand                    -competition is flawed
(economy will fix itself)                                             -AD is the key not AS
-economy will balance at full employment                   -in saving cause recession leaves
-believed in the trical down effect                                   -ratchet effects and sticky wages block
-economy is always close to or at                                         Say's Law
full employment                                                               - in the long run we are all dead

Classical VS. Keynesian Debate

Topic                          Classical                         Keynesian
Modern followers             - Adam Smith                                                -J.M Keynes
                                           -J.B Say
                                          -David Ricardo
                                         -Alfred Marshall
----------------------------------------------------------------------------------------------------------------------
Say's Law                    -supply creates its own demand           -depression refuit Say's Law
                                      -production= income= spending         -demand creates its own supply
                                     -under spending is unlikely                  -under spending persist
                                     -whatever output that is production                                                                                                                 will be demanded
-----------------------------------------------------------------------------------------------------------------------
Savings and                     -Savings=Investment Income               Saving does not equal investment
 Investments                  Savings(leakage)=investment                   Different Motivations
                                                                  (injection)                 Savings                Motivations
                                                                                                  -future needs          -interest rates
                                                                                                  -precaution           -rate of profit
                                                                                                                                 expectations
                                                                                                   -habit
                                                                                                   -income level
                                                                      1965                     -interest rate
-------------------------------------------------------------------------------------------------------------------------
Lonable Funds Market                                                                          -investment from savings, cash,
                                                                                                                 checking accounts
Ig=gross investment                                                                               -lending creates money which
r=real interest rate                                                                                     causes supply of money to
sm= supply of money                                                                                increase (-->sm ^)
                                                                                                                   -inflation and unemployment
                                                                                                                          are unstable
------------------------------------------------------------------------------------------------------------------------
Wage/price flexibility            -prices and wages are                          -prices and wages are  inflexible
                                                    flexible downward                        downward(ratchet effect)
-----------------------------------------------------------------------------------------------------------------------
Supply Curve                               -vertical line                                 -horizontal line
-----------------------------------------------------------------------------------------------------------------------
Output and Employment               -AS determines output and                -AD determines output and                                                                      employment                                                            employment
--------------------------------------------------------------------------------------------------------------------------
Unemployment                              -rarely exists due to wage/             -usually exists with
                                                         price flexibility                                        +external (war)
s=saving                                         -cause:external (war)                                  +internal
i=investment                                                                                                           (s does not equal i)
-------------------------------------------------------------------------------------------------------------------------
Aggregate Demand (AD)              -AD determines the price               -AD changes due to the
                                                           level                                           determinate
                                                           -AD reasonably stabled if         -AD is unstable even if money
                                                         money supply is stabled             supply is stabled due to                                                                                                                                  fluctuation
                                                                                                                in investment spending
-----------------------------------------------------------------------------------------------------------------------
Basic equation                             MV=PQ (1965-1972)                       C+Ig+g+Xn=GDP
                                                                                                                (1973-present)
------------------------------------------------------------------------------------------------------------------------
Role of Government                    -monitory rules                                      -believed in fiscal policy
                                                     -maintain a steady money supply         (tax and spend)
                                                    -Laiz Fairs is best                           -believe in an active government
                                                   -economy is self regulating                  -economy is not self regulating
-------------------------------------------------------------------------------------------------------------------------
Inflation                                   -caused by too much money                -caused by too much demand
% Change in PL^
--------------------------------------------------------------------------------------------------------------------------
How long the short                 -short time                                                 -very long time
run is
-----------------------------------------------------------------------------------------------------------------------
Emphasis Today                          -microeconomics                                          -macroeconomics
















                                                         

Interest Rates and Investment Demand

What is investment?
-money spent or expenditures on:
     +New Plants factories)
     + Capital equipment (machinery)
     +Technology hardware and software)
     +New homes
     +inventories goods sold by procedures)



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 costs

How does business determine the amount of investment they undertake?
  -compare expected rate of return to interest cost  
           +if expected >interest cost, then invest
           +if expected return < interest costs, then do not invest



Real Interest Rate (r%) Vs. Nominal Interest Rate (i%)

Whats the difference?
- nominal is the observable rate of interest. real subtracts out inflation (π%) an is only known as post factor.
r%= real interest rates
i%= nominal interest rates
π%= inflation rates
EQUATION:    r% = i% - π%

What determines the cost of an investment decision?
- the real interest rate (r%)

Investment Demand Curve (ID)

What is the shape of investment demand curve?
-downward sloping
Why?
- when interest 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 shifts ID --->
    +lack of technological change shifts ID <---
-stock of capital
     +if economy is low on capital, ID --->
    +if economy has much capital, ID <---
-expectations
     +positive expectations shift ID --->
     +negative expectations shift ID <---

Nominal Wage- amount of money received by a worker per unit of time (by hour, clocking in)

Real Wages- amount of goods and services a worker can purchase with their nominal wage (purchasing power of your nominal wage)

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

Aggregate Supply

Aggregate Supply- the level of Real GDP (GDPR) that firms will produce at each price level (PL)
                                        +long run and short run

Long Run
-period of time where input prices are completely flexible and adjust to changes in the price level
-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
-level of Real GDP supplied directly related to the price level

Long Run Aggregate Supply (LRAS):
- LRAS 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, does not change firms' level of out put. which means that the LRAS is vertical at the economy's level of full employment.



Short Run Aggregate Supply (SRAS)
-An increase in SRAS is seen as a shift to the right (SRAS ---->)

- A decrease in SRAS shifts to the left (SRAS <------)

- Key to understanding shifts in SRAS is per unit cost of production.

EQUATION: 

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

Determinate of SRAS :
(ALL AFFECTS UNIT PRODUCTION COST)
1. Input prices
2. Productivity
3. Legal - institutional enviroment


Input Prices
-domestic resource prices
           +wages 75% of all business costs)
             + cost of capital
                  + raw materials (community prices)
Foreign resource Price

Market Power



Increases in resources price= SRAS <---------

Decrease in resource price= SRAS --------->



Productivity

EQUATION:     productivity= total output
                                                  ----------------
                                                   total input

More productivity= lower unit production cost= SRAS ---->

Lower productivity= higher unit production cost= SRAS <----


Legal Institutional Environment
-Taxes and subsides
    + taxes ($ to government) on business increase per unit production cost = SRAS <---
    +subsides ($ from government) to business reduce per unit production cost= SRAS ---->

- Government Regulation
    + creates a cost of compliance= SRAS <---
    +deregulation reduces compliance costs= SRAS --->

Friday 2/5/16 Notes

GDP Gap: the amount by which actual GDP falls short of potential GDP.
Okun's Law: for every 1% that the actual unemployment rat6e in which the actual unemployment excludes the actual rate at unemployment. A GDP gap of about 2%.
***************IMPORTANT EXAMPLE-  In 2012 the unemployment rate for Mexico was 7.4% and the NRU was 6%******************

Rule of 70: It is used to determine how many years it will take for a value to double given a particular annual growth rate.
If you put $20,000 in the bank and it earns year interest of 7% how many years will it take your income  to double.

70 divided
-------------
interest rate

In the problem above you would do 70/ 7 which will give you 10%


************ALWAYS DIVIDE BY 70****************

Unemployment- failure to use available resources particularly labor to produce desired goods and services.
*Example: people now working

Underemployment-  Examples: * When a school has so much talent but we don't use it
                                                   * Working less than 12 hours a week

Labor Force- above 16 years of age and those who are able and willing to work
                               (employ + unemployed)
                                 -equation above makes up the labor force

Not in labor force- Military (majority time in other countries), students, retired people, disabled. home makers (stay at home mother/ father), mental home institutes, jail/prison, those who are not looking for a job

Unemployment rate- 4-5%= full employment or Natural Rate of Unemployment (NRU)
* having a percentage under 4% is great

How to calculate the unemployment rate: 

                                                 # of unemployed
                             --------------------------------------------- x 100
                                # of employed + # of unemployed

  Types of unemployment

Frictional: those who are searching for a job, they are temporally unemployed or in between jobs, transferable skills but not working.

                   *Examples- college and high school graduates, people that were laid off 

Structural: change in structure of the labor force made some skills obsolete, these people have no transferable skills and their jobs may never come back. Must learn new skills to get a new job.

                *Example- NASA employee getting laid off

Seasonal: due to the time of year and the nature of the job 

                *Examples-school bus drivers, life guards, Santa Clause and Easter bunny impersonator,                        construction workers

Cyclical: unemployment that results in economic down turn such as recession as demand falls for goods and services, demand for labor falls and workers are laid off.

             -full employment means there is no cyclical unemployment

Equation:  Frictional + Structural= Natural Rate                                                                                           of Unemployment (NRU)

GDP Deflation- price index used to adjust from nominal to real GDP

equation:    Nominal GDP
                 ------------------- x 100 = GDP Deflation
                   Real GDP

- BASE =  Nominal and Real GDP

- in the base year the GDP defoliator equals to 100

- years after base year GDP defoliator is greater than 100

- years before the base year GDP defoliator is less than 100


Consumer Price Index ( CPI ) - most commonly used measurement of inflation

- measures the market basket of goods for a typical urban American family

equation:  Price of a market basket of goods in the current year price
               ------------------------------------------------------------------------ x 100
                 Price of the market basket of goods in the base year price


Inflation:

equation:   Price index in  year 2 - price index in year 1
                 -------------------------------------------------------- x 100
                                     Price index in year 1




REAL INTEREST RATES 
- percentage increase in purchasing power that the borrower must pay the lender for a loan.

equation:    Nominal interest rate - inflation

(answer is usually under 10)

-unanticipated inflation (not expected)

- adjusted for inflation


                                                                    VS

NOMINAL INTEREST RATES
- percentage increase in money the borrower must pay the lender for a loan

equation:       Nominal interest rate = expected interest rate + inflation premium

- Anticipated inflation
     * fisher effect

- not adjusted for inflation





                                                  UNANTICIPATED INFLATION
Hurt by inflation


1. Savers
2. Creditors/ lender ( people you owe)
3. People who are on a fixed income (welfare, elderly, retire, medicare, medicate)

Hurt by inflation

1. People who owe debt




Cola adjustment (elderly)

-automatic wage increase when inflation occurs

     *New York
     *California
-cost of living adjustment

Equations:

Budget Equation:

Government purchases of goods and services + government transfer payments - government tax and free collection


Trade:

Export - Imports


National Income:

2 equations:

1)  Compensation of employees + rental income + interest income + corporate profits + proprietors income

2) GDP - indirect business taxes - depreciation - net foreign factor payment


Disposable Personal Income ( DPI):

national income - personal household taxes + government transfer payments


National Domestic Product (NDP):

GDP- depreciation


Nat National Product (NNP): 

GNP - depreciation


Gross National Product:

GNP= GDP + net foreign factor payment

Budget:
+ = deficit
- = surplus 

Trade:
+ = surplus


**DEPRECATION = CONSUMPTION OF FIXED CAPITAL**
---------------------------------------------------------------------------------------------------------------------

Normal GDP: is the value of out put produced in current year prices ( quantity)
    -  can increase from year to year if either out put or prices increases


Real GDP: is the value of out put produced in constant or based year prices ( adjusted for inflation)
   - can increase from year to year only if quantity increases


******************** Economic growth use real GDP*********************


********Measure price increases (inflation) use Nominal GDP*********




Check out this link below for some great reference on how to calculate and different types of scenarios.

http://www.econport.org/content/handbook/NatIncAccount/CalculatingGDP/Examples.html