Chapter 11 ECON

Inflation rate (Consumer Price Index over 12months)

0%

GDP (3rd Quarter)

1.5%

Debt Held by Public

12.78 trillion (74%) of whole GDP

Nominal GDP

17.9 trillion

Consumer Price Index

2%

Federal Government budget deficit

3%

Unemployment rate

5%

Multiplier

= change in real GDP / initial change in spending = 1/MPS = 1/(1-MPC)

The crowding out effect

A reduction in private spending as a result of higher interest rates generated by budget deficits that are financed by borrowing in the private loanable funds market. Usually when government expenditures are very high

Automatic or built-in stabilizers

Built in features that tend automatically to promote a budget deficit during a recession and a budget surplus during an inflationary boom, even without a change in policy. The positive idea behind automatic or but in stabilizers is that they institute countercyclical fiscal policy without the delays associated with legislative action

Private domestic economy equation :

C + 1

Employment Act of 1946

Committed the Federal Gov't to "promote maximum employment, production, and purchasing power." It created the Council of Economic Advisers and the Joint Economic Committee of Congress.

Net Exports

Exports minus imports Xn = X - M

Investment Spending

Investment spending by the business sector does not depend on the level of income, but on the interest rate that businesses have to pay for their funds to make investment expenditures.

The Aggregate Expenditures Model

Is a model of how the level of GDP is determined. The categories include personal consumption expenditures of households, investment expenditures by the business sector, government spending and net exports. GPD = C + Ig + G + Xn

Consumption expenditures decrease by

MPC x the change in disposable income

Saving decreases by

MPS x the change in disposable income

DI =

PI - T = C + S

The standardized budget also called the full employment budget

Provides a way to tell if discretionary fiscal policy is expansionary or restrictive. The full employment budget shows what the budget deficit or surplus would be if the economy were at full employment and allows us to distinguish between the cyclical deficit or surplus which results from built in stabilizers and the surplus or deficit which results from discretionary fiscal policy.

The offsetting effects of pro-cyclical state and local government finance

State government must spend less or tax more rather than go into a deficit. Revenues must equal expenditures.

Marginal Propensity to consume

The amount by which consumption expenditures change when income increases by one addition dollar ceteris paribus. The MPC is the slope of the consumption function MPC = Change in consumption expenditures / change in income

Budget Deficit

The amount by which government expenditures exceed government revenues in a given year.

Budget Surplus

The amount by which government revenues exceed government expenditures in a given year

The Consumption and Savings Functions

The consumption function describes personal consumption expenditures as a function of household income. If there is no government or foreign sector, then GDP = NI = PI = DI As a household income increases, consumption expenditures increase and vice versa. At very low levels, households my spend more than their incomes by spending out of savings. At higher levels of income households save some of their income and consumption expenditures are less than income. DI = C + S we can also derive that S = DI - C

Public Debt

The total accumulation of the deficits minus the surpluses the federal government has incurred through time.

Net income determinants of consumption and saving include :

Wealth , expectations, taxes, household debt Changes in these determinants will cause the consumption and saving functions to shift

The main determinant of investment demand is the expected rate of return on investment which depends on :

acquisition, maintenance, and operating costs business taxes technological change stock of capital goods on hand expectations changes in these determinants of investment demand will cause the investment demand curve to shift

The multiplier process causes equilibrium GDP to

decrease by the multiplier times the change in spending

Expansionary fiscal policy

designed to stimulate the economy out of a recession involves increased government spending or reductions of taxes. Expansionary fiscal policy will increase the government budget deficit. Increased government spending or tax reductions shift the aggregate demand curve to the right. In the horizontal or upward sloping portions of the aggregate supply curve this will increase real GDP Apart of Discretionary or active fiscal policy

Restrictive fiscal policy

is designed to deal with demand pull inflation involves decreased government spending or increases in taxes. Restrictive fiscal policy will reduce the government budget deficit or create a budget surplus. Decreased government spending or tax increases shift the aggregate demand curve to the left. This reduces the aggregate price level in the upward sloping or verticle portions of the aggregate supply curve.

Saving and planned investment are only equal at the equilibrium

level of GDP

Change in GDP

multiplier x change in spending Allows for the finding of the new equilibrium point

The equilibrium level of GDP

occurs where aggregate expenditures equal GDP GDP = C + I

Inflationary gap

refers to the amount by which aggregate expenditures would have to be decreased to reach the full employment level of GDP

Recessionary gap

refers to the amount by which aggregate expenditures would have to be increased to reach the full employment level of GDP

The balanced budget multiplier

refers to the fact that if government spending and taxes both increase by an equal amount so that the government's budget remains in balance, equilibrium will increase by that same amount

Fiscal Policy

refers to the use of government spending and taxes to influence employment, output, and the price level

ONLY when aggregate expenditures are equal to GDP is:

saving equal to planned investment which is another way to think of the equilibrium condition for GDP

When aggregate expenditures are greater than GDP, from the equilibrium level of GDP from the point of view of saving and investment

saving is less than planned investment

Marginal propensity to save

the amount by which saving changes when income changes by one additional dollar, ceteris paribus. The MPS is the slope of the saving function MPS = Change in saving / change in income MPC + MPS = 1

Average propensity to save

the percent of income saved APS = S/DI APC + APS = 1

Average propensity to consume

the percent of income spent on consumption APC = C/DI

When aggregate expenditures are less than GDP

there is an unplanned decrease in inventories, and businesses increase their level of output i.e., GDP decreases . Actual investment is less than planned investment