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

·      Transfer Payments 

• Welfare Checks
• Food Stamps
• Unemployment Checks
• Corporate Dividends
• Social Security 
• Veteran's Benefits 

Fiscal Policy

How does the government stabilizes the economy?
Fixed Policy: actions by Congress to stabilize the economy or

Fiscal Policy

·Changes in the expenditures or tax revenues of the federal government

•   Two tools of fiscal policy

Taxes: government can increase or decrease taxes

Spending: government can increase or decrease spending

·      Fiscal policy is enacted to promote our nation’s economic goals: full employment, price stability, and economic growth

Deficits, Surpluses, and Debt

·   Balanced budget

•  Revenues = Expenditures

·  Budget deficit

•  Revenues < Expenditures

·      Budget surplus

•  Revenues > Expenditures

·      Government Debt

•  Sum of all deficits – Sum of all surpluses

·      Government must borrow money when it runs on a budget deficit

•   Government borrows money from
•   Individuals
• Corporations
•  Financial Institutions
• Foreign Entities or foreign government

Fiscal Policy Two Options

·      Discretionary Fiscal Policy (action)

•  Expansionary fiscal policy- think deficit
•  Contractionary fiscal policy- think surplus

·      Non-Discretionary Fiscal Policy (no action)

Three Types of Taxes

·      Progressive Taxes: takes a larger percent of income from high income groups (takes more from rich people)

•  Ex: current federal income tax system

·      Proportional Taxes (flat rate): takes the same percent of income from all income groups

•  Ex: 20% flat income tax on all income groups

·      Regressive Taxes: takes a larger percentage from low income groups (takes more from poor people)

• Ex: sales tax; any consumption taxes

·      Contractionary Fiscal Policy (The BRAKE): laws that reduce inflation, decrease GDP (close a inflationary gap)

•   Decrease government spending
•  Tax increases
•  Combination of the two

·      Expansionary Fiscal Policy (The GAS): laws that reduce unemployment and increase GDP (close a recession gap)

•  Increase government spending
•   Decrease taxes on consumers

Classical and Keynesian Economics

Classical:

• Trickle Down Theory 
• Help the rich first then everyone else
• In the long run, the economy will balance @ full employment output
• The Invisible Hand

Keynesian 

• AD is the key, not AS
• In the long run, we are dead
• Leaks cause recessions

Reasons why prices tend to be "sticky" or inflexible in a downward direction

1. Menu Cost
2. Wage Contracts
3. Minimum Wage
4. Fear of Price Wars
5. Morale, Effort-Productivity 

Loanable Funds Market

• Ig: Gross Private Domestic Investment
• r: interest rate
• Sm: supply of money

Multiplier

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

Multiplier = Change in AD / Change in Spending (C, Ig, G, Xn)

• Why: expenditures and income flow continuously which sends off a spending increase in the economy

Spending Multiplier = 1 /1-MPC or 1 /MPS

Increase in Spending = +

Decrease in Spending = - 

Tax Multiplier: When government taxes, multiplier works in reverse

• Why: Now money is leaving the circular flow

Tax Multiplier = -MPC / 1 - MPC or -MPC / MPS

• Tax Cut = +
• Now more money in the circular flow

Consumption and Saving

Disposable Income: Income after taxes or net income

DI= Gross Income - Taxes

• 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 controlled 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 and APS

APC= Average Propensity to Consume

APS= Average Propensity to Save

APC + APS = 1

1 - APC = APS

1 - APS = APC

-APS = Dissaving

APC > 1 = Dissaving

MPS and MPS

MPC= Marginal Propensity to Consume

Change in C / Change in DI

• % every extra dollar earned that is spent

MPS= Marginal Propensity to Save

Change in S / Change in DI

• % of every extra dollar earned is saved

MPC + MPS = 1

1 - MPC = MPS

1 - MPS = MPC

Determinants of Consumption and Saving

• Wealth
• Expectations
• Household Debt
• Taxes

AS/AD Model

• The equilibrium of AS and AD determines current output (GDPr) and the price level (PL)
• Full Employment: Exists where SRAS and LRAS intersects
• Inflationary Gap: Output is high and employment is less than NRU
• Recessionary Gap: Output low and unemployment is more than NRU