Module 3: 3.04, 3.06, and 3.07 Lessons

Example Problem: Expenditures and Taxes

-RGDP: $1200 million -Full Employment: $400 million -MPC: 0.8 what will the Congress' action be?

Example Problem: Expenditure and Tax Multipliers

-decrease taxes and expenditures by $100 million -MPC is 0.9 •what is the impact of GDP?

Example Problem: MPC and MPS

-what is the MPC and MPS? •Year 1: -income: $20,000 -consumption: $20,000 -savings: $0 •Year 2: -income: $22,000 -consumption: $21,000 -savings: $1,000

Monetary Policies

determined by the Federal Reserve System & involves control of & changes in the supply of money

Sticky Prices

prices that do not always adjust rapidly to maintain the equality between quantity supplied and quantity demanded

Capital Investment

putting money into the means by which goods are produced (making machinery)

Example: Balance Budget Multiplier

want to increase GDP by $200, increase spending and taxes by $200

MPC and MPS

will always equal 1 (MPC + MPS = 1)

Example Work: MPC and MPS

•MPC = change consumption / change income -21,000-20,000 / 22,000-20,000 -1,000 / 2,000 =0.5 •MPS = change savings / change income -1,000 / 2,000 =0.5 *this means that the person will save and spend $0.50 for every additional dollar of income

Common Expenditure and Tax Multipliers

•MPS: -0.9; expenditures is 10 and taxes is 9 -0.8; expenditures is 5 and taxes is 4 -0.75; expenditures is 4 and taxes is 3 -0.5; expenditures is 2 and taxes is 1

Example Work: Expenditure and Tax Multipliers

•Tax Multiplier: -MPC/MPS =9 •Taxes affect GDP: change in taxes X tax multiplier -(-100) X 9 =-900 -taxes will have a $900 million increase to GDP •Expenditure Multiplier: 1/(1-MPC) =10 •Expenditures affect GPD: change in expenditures X expenditure multiplier -(-100) X 10 =(-1,000) -expenditures will have a $1 billion decrease to GDP *the total effect will be a $100 million decrease in GDP since expenditures minus the taxes is $100 million

Expenditure Multiplier

•aids in calculating the change in GDP when expenditures change •*Formula: to find expenditure multiplier* -1 / (1-MPC) or 1 / MPS -(change in GDP) / (change in spending) •*Formula: to find change in GDP* -(change in spending) X multiplier

Tax Mulitplier

•aids in calculating the change in GDP when taxes change •*Formula: to find tax multiplier* -(-MPC) / MPS -(change in GDP) / (change in taxes) •*Formula: to find change in GDP* -(change in taxes) X multiplier *tax multiplier is negative; use absolute values and then determine if change in added/subtracted to GDP based on increase/decrease in taxes

Keynesian Theory and Government

•believe that prices and wages are "sticky", which results in the theory of government involvement using monetary policies (Federal Revenue Bank) and fiscal policies (Congress; the most reliable) to reach price level, employment, and output goals (use policies to shift AD as a method of controlling the economy) •key aspect is the role of government (they use discretionary fiscal policies to try to correct inflationary or recessionary problems)

Balanced Budget Multiplier

•change both taxes and spending by same amount for government to increase GDP without increasing national debt •used to create a change in GDP that's equal to the change in government spending •always equal 1

Keynesian Theory

•economy may be in equilibrium in the short-run, either above or below full employment (economy is unstable and never at full employment of resources due to not enough demand for goods and services) •price level not a factor for Keynesians (believe output is constantly changing but price levels remain stable

Government Involvement in Economy

•government can track investment spending, government spending, net exports, and (to some extent) consumer spending to see how much the multipliers will affect the GDP

Marginal Propensity to Consumer (MPC)

•how much of every extra dollar would be consumed •defined as the change in the amount of additional income that you're willing to spend on buying some consumer goods or services divided by the change in disposable income

Marginal Propensity to Save (MPS)

•how much of every extra dollar would be saved •defined as the change in the amount of additional income that you are willing to save divided by the change of disposable income

Government Expenditures Programs

•if economy has slowed down (leading to a recession), to increase AD, government will increase expenditures (increasing wages or spending on infrastructure) •if economy growing rapidly (leading to inflation), government decrease AD by cutting expenditures on programs

Government Taxes

•intervene an economy by increasing or decreasing taxes (personal income, excise taxes, corporate taxes, etc.) •Keynesians want to change personal income taxes to shift AD •economy growing too slowly, government lower taxes (consumers will have more disposable income-->leads to increased spending) •economy moving too rapidly, government increase taxes (decrease disposable income and consumption)

Interest Rates and Economic Growth

•investment spending dependent upon interest rates •for businesses to borrow, banks lower interest rates when they have extra to loan out; businesses borrow this money which increases investment spending (in long run, affects *capital investment*) •increase in capital investment cause economic growth (any change in interest rate means a change in economic growth caused by a change in capital investment)

Marginal Propensities

•marginal about how much you will get from the next "one" or an additional unit of something •measure what part of additional income will be either consumed or saved

Economic Growth: AD/AS Curve and PPC

•most important factor of impacting real growth is productivity •increased productivity means that producers must get mire out of scarce resources during production process (technological advancement) •new resources also cause increase in growth (positive shifts of LRAD and PPC) •new resources may also cause other curves to shift

Productivity

•productivity growth depends on increases in real investment or capital, improvements in human skills (human capital), technological advancement, and a legal and social environment that rewards achievement and improves economic organization •*Formula*: productivity = real ouput / input

Expenditure and Tax Multipliers

•tax multiplier less than expenditure multiplier •any change in government spending hits economy right away but there's a delay in change in taxes (need time to adjust what people will do with savings when personal taxes are changed)

Fiscal Policy

•the government's use of tax and spending (expenditure) policies to battle problems in the economy (stimulate or slow down the economy)

Expenditures and Taxes

•used together to ensure federal budget remains balanced •expenditure multiplier directly changes AD •tax multiplier less change on AD because more people save some of their changes in taxes (government collects enough to cover increase in spending)

Multiplier Effect

•when consumer, government, or investment spending changes, the economy expands more than the initial spending •use MPS and MPC to explain how much an economy would change

Example Work: Expenditures and Taxes

Given: -we know that the economy has currently $1200 million for RGDP -we also know that the economy can only take $400 million; this causes an inflationary gap (inflation) -we need to reduce the RGDP by (1200 - 400 = 800) $800 million -to reduce, we need to either affect taxes or expenditures •to affect expenditures, use the formula 1/(1-MPC) -the expenditure multiplier will then be 5; this means that we have to multiply a number by 5 (800/ 5 = 160) which is 160 to reach the $800 million to close the inflationary gap -the Congress' action will be decreasing expenditures by $160 million to decrease AD •to affect taxes, use the formula -MPC/MPS -the tax multiplier will then be -4; this means that we have to multiply a number by -4 (800 / -4 = -200) which is 200 to reach $800 million to close the inflationary gap -the Congress' action will be increasing taxes by $200 to decrease in AD