Macroeconomics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION, MISSISSIPPI.

Macroeconomics

James B. Wilcox

RESOURCES PROVIDED BY:

THE UNIVERSITY OF SOUTHERN MISSISSIPPICENTER FOR ECONOMIC AND ENTREPRENEURSHIP

EDUCATION,MISSISSIPPI STATE UNIVERSITY, & VIRTUAL ECONOMICS

Economics…

is the study of how individuals and society choose, with or without the use of money, to employ scarce productive resources to produce various commodities over time and distribute them for consumption, now and in the future, among various people and groups in a society.

Introduction to Macroeconomics

3

Macroeconomics4

Macro is the study of: The structure and performance of a national economy

4 important variables: 1. GDP

Gross Domestic Product 2. P

the price level 3. UNE

national unemployment rate 4. r

interest rate

U.S. Macro Economy5

Very complicated 95 million households 20 million firms 80 thousand governments

Macro Terms6

Stock: A quantity at a point in time

Flow: A quantity during a period of time

Macro Terms7

GDP, (Y) Gross Domestic Product: Value of total production of all final goods and

services during a period of time Flow variable

Potential GDP (YN): The economy’s maximum sustainable output when

resources are allocated efficiently not over-utilized nor under-utilized

Macro Terms8

Unemployment types Frictional – voluntary unemployment that arises

because of the time needed to match job seekers with job openings

Structural – unemployment caused by massive mismatch of skills or geographic location

Seasonal – unemployment caused by seasonal changes in labor supply and demand during the year

Cyclical – unemployment that is incurred by business cycles, or more specifically by economic recessions

GDPFinal Outputs

9

GDP consists of only: Final goods and services

GDP does not include: 1. Intermediate outputs in order to avoid over-counting

Intermediate outputs are used as inputs to make final outputs e.g. capital goods

2. Used goods they were counted the first time they were purchased

3. Financial assets e.g. stocks, bonds

Which of the following is an example of an intermediate good?

A. A pair of jeans sold by a clothing retailer

B. Cloth sold to a suit manufacturerC. A share of Wal-Mart stockD. A used Ford Mustang sold from one

neighbor to another

10

Which of the following is an example of an intermediate good?

A. A pair of jeans sold by a clothing retailer

B. Cloth sold to a suit manufacturerC. A share of Wal-Mart stockD. A used Ford Mustang sold from one

neighbor to another

11

Limitations of Real GDP12

Real GDP is used to: Estimate the speed at which the economy is moving

Does not count: Non-market activities

Things that are not priced E.g., Household production, underground economy

If individuals were paid for their household production, GDP would

A. increaseB. decreaseC. Not changeD. Not enough information

13

If individuals were paid for their household production, GDP would

A. increaseB. decreaseC. Not changeD. Not enough information

14


GDP is not a perfect measure of the welfare of a nation:

It does not include measures of: Quality of life Leisure time Conditions of environment


Robert Kennedy 1968 Presidential bid: “[GDP] does not allow for the health of our children, the

quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.”


GDP doesn’t measure many things, but nations with greater GDP can afford…… better health care for their children better educational system to teach more people to read and enjoy poetry

Intelligence, integrity, courage, wisdom, devotion to country are easier to foster when people are less concerned about affording basic necessities.

We conclude that GDP is a good measure of welfare for most, but not all,

purposes

GDP and Standard of Living18

International data leave no doubt that a nation’s GDP is closely associated with its citizens’ standard of living

Use per capita GDP when comparing across nationsPer capita GDP = GDP/population

19

Country RealGDP perperson (1993)

life expectancy adultliteracy

U.S. $24,680 76 years 99%

Japan 20,660 80 99

Germany 18,840 76 99

Mexico 7,010 71 89

Brazil 5,500 67 82

Russia 4,760 67 99

Indonesia 3,270 63 83

China 2,330 69 80

Pakistan 2,160 62 36

Nigeria 1,540 51 54

Bangladesh 1,290 56 37

India 1,240 61 51

GDP = AE = AI20

Aggregate Expenditures (AE): The total amount that buyers pay for the final goods and

services produced

Everything a firm receives from the sale of its output is paid out as income to the resource owner (AI): Wages go to labor owners Rent goes to land owners Interest goes to capital owners Profit goes to owners of entrepreneurial ability

GDP = AE = AI21

The buyers of GDP pay an amount equal to aggregate expenditures (AE)

The sellers of GDP receive an amount equal to aggregate income (AI)

Therefore, GDP = AE = AI

For an economy as a whole Income must equal expenditure For every transaction there is a buyer and a seller

Calculating Real GDP22

3 ways to calculate GDP: 1. Expenditure approach 2. Factor Income approach 3. Value Added approach

We will use the expenditure approach GDP = C + I + G + NX

C, personal consumption expenditure I, gross private investment expenditure G, government expenditure NX, net export expenditure

Consumption Expenditure, C23

Consumption, C Spending by households on new goods and services,

with the exception of new housing e.g. Purchases of food, clothing, services, autos, other

durable goods like furniture

Gross Investment Expenditure, I24

Investment, I Spending on capital equipment, inventories, and structures

including household purchases of new housing Nonresidential investment

E.g. machinery, equipment, factories, warehouses, offices purchased by firms

Residential investment purchases of newly built homes

Inventory change firms’ accumulation of their output

25

A. Newly constructed residential housingB. Factory buildingsC. Stocks and bondsD. Additions to inventoryE. All of the above are included in

investment

Which of the following is NOT included in the investment category under the

expenditure approach to GDP accounting?

Which of the following is NOT included in the investment category under the

expenditure approach to GDP accounting?

A. Newly constructed residential housingB. Factory buildingsC. Stocks and bondsD. Additions to inventoryE. All of the above are included in

investment

26

Residential construction is generally included in which category of GDP?

A. consumptionB. investmentC. Government expendituresD. Net exports

27

Residential construction is generally included in which category of GDP?

A. consumptionB. investmentC. Government expendituresD. Net exports

28

Government Expenditure, G29

Government, G Spending on goods and services by local, state, and

federal governments E.g., salaries, computers, military hardware, etc.

Does NOT include transfer payments like social security, welfare, etc.

Government purchases include all of the following except:

A. Welfare paymentsB. Salaries of senatorsC. Fighter jets purchased by the

governmentD. The military payroll

30

Government purchases include all of the following except:

A. Welfare paymentsB. Salaries of senatorsC. Fighter jets purchased by the

governmentD. The military payroll

31

Net Export Expenditure, NX32

Net Exports, NX Spending by foreigners on domestically produced goods

(exports) minus spending by domestic residents on foreign goods (imports)

Net Exports (NX)= Exports (X)- Imports (M)If M > X =>

NX are negative, I.e. trade deficit

Americans spent more on foreign goods and services than foreigners spent on American goods and services

Net Export Expenditure, NX33

Purchases of foreign goods and services are included in C, I, G

E.g. American spending on a Volvo (Swedish car) is included in C

We minus imports because we are trying to get a measure of domestic activity

Net exports are defined as

A. Exports plus importsB. Exports minus importsC. Imports minus exportsD. Exports plus imports minus tariffs

34

Net exports are defined as

A. Exports plus importsB. Exports minus importsC. Imports minus exportsD. Exports plus imports minus tariffs

35

Consumption is the largest single component of GDP. In recent years it

represents approximately _____ % of GDP.

A. 55B. 60C. 65D. 70E. 75

36

Consumption is the largest single component of GDP. In recent years it

represents approximately _____ % of GDP.

A. 55B. 60C. 65D. 70E. 75

37

GDP Components38

GDP Estimates39

Estimates are constantly being revised

Advance estimates: released 15 days after the quarter ends and are based on

only the first month of the quarterPreliminary estimates:

first revision, 45 days after the end of the quarterFinal estimates:

second revision, 75 days after the end of the quarter

GDP Estimates

Annual estimates: numbers are then revised once a year for two years

Benchmark estimates: revisions made every 5 years

40

GDP Estimates41

The media focuses on: Advance estimates

Range of revisions can result in changes ranging from –2.5 % points to +3.5% points from

advance estimates until benchmark estimates

GDP Estimates42

If advance estimates show a 3% annualized growth rate in real GDP, find the range of actual real GDP once all revisions are made: Lower bound:

3% - 2.5% = .5% actual annualized growth rate Upper bound:

3% + 3.5% = 6.5% actual annualized growth rate

Serious implications for policy makers

Saving, Investment, and Financial Intermediaries

43

Ebenezer Scrooge: Accidental Promoter of Economic Growth?

44

Learning Objective 21.2Makingthe

Connection

Who was better for economic growth: Scrooge the saver or Scrooge the spender?

Who was better for the economy?

A. Scrooge the saverB. Scrooge the spender

45

Who was better for the economy?

A. Scrooge the saverbest for long run economic growth

B. Scrooge the spenderbest if we are in a recession

46

“Saving”47

When a person earns more than he spends Individuals can deposit the unspent income into a

bank, or buy a bond or some stock

Individuals often refer to this activity as “investing” However, macroeconomists call this “saving”

U.S. vs Japanese savings rates

“Investment”48

Investment Purchase of new capital

Equipment or buildings

Examples of investment An individual who borrows to finance building a new

house A firm sells some stock to build a new factory

S = I49

For the macroeconomy as a whole Saving (S) must equal investment (I)

Recall that GDP equals Y = C + I + G + NX

Assume the economy is closed so that NX = 0 Y = C + I + G Each unit of output sold in a closed economy is

consumed, invested, or bought by the government

S = I50

To emphasize the link between saving and investment, subtract C and G from both sides

You get, Y – C - G = I

Y – C – G is the total income in the economy that remains

after paying for consumption and government purchases

i.e., national saving, SWhich leaves,

S = I

Financial Institutions51

The financial system is made up of institutions that Coordinate individuals who are saving and

individuals who are investing

Savers supply their money to the financial system With the expectation of earning interest

Borrowers demand funds from the financial system Knowing they will be required to pay it back with

interest

Financial MarketsBond Market

52

Bond Promise to pay back a loan

Large corporations can borrow money directly from the public by selling bonds The person who buys the bond gives money to the

firm Firm uses the funds to expand their business This is called debt financing

The buyer can either hold the bond until maturity can sell the bond to someone else

Financial MarketsStock Market

53

Stock Represents ownership in a firm

Stockholders own the company Thus, they own the profits or losses Stocks are riskier than bonds Pay a higher rate of return

Firms can sell stock in order to raise funds to expand This is called equity financing

Financial MarketsStock Market

54

After the firm issues the stock The shares are traded on organized stock

exchanges NYSE, NASDAQ, AMSE

Corporations themselves do not earn anything from the trades

Prices of stocks are determined by the demand and supply for each one Reflects the beliefs about the value of a company

Stock index A computed average of a group of stock prices

Dow Jones Industrial Average--30 major U.S. companies Standard and Poor’s—500 major companies

Financial IntermediariesBanks

55

In order to borrow funds, most firms must use banks Only the largest and most widely recognized

firms can borrow funds through bonds and stocks

Banks Take deposits from people who are saving and

pay them an interest rate Give loans to those who are borrowing and

charge them an interest rate The difference in the interest rate paid out and

charged provides profits to the bank owners

Financial IntermediariesMutual Funds

56

Mutual Fund An institution that sells shares to the public and

buys a portfolio of stocks and bonds Many different types of stocks and bonds

Enables savers to Diversify

Lowering risk Receive services of professional money managers

Index fund A fund that buys all the stocks in a given stock

index

Market for Loanable Funds57

Because the economy has many types of financial institutions There are many different interest rates All are determined through the demand and

supply of funds

Assume for simplicity that there is just one market for loanable funds All savers go to this market to deposit saving All borrows go to this market in order to invest

Supply of Loanable Funds58

The source of the supply of loanable funds is Saving

At higher interest rates Saving is more attractive The quantity saved increases

At lower interest rates Saving is less attractive The quantity saved decreases

Demand for Loanable Funds59

The source of the demand of loanable funds is Borrowing I.e., investment

At higher interest rates borrowing is less attractive The quantity borrowed and invested decreases

At lower interest rates borrowing is more attractive The quantity borrowed and invested increases

Equilibrium Real Interest Rate, rr*

60

The equilibrium real interest rate occurs where the supply and demand for loanable funds

intersectsIf the interest rate were lower than rr*

There would be a shortage of loanable funds Lenders would be scarce and borrowers plentiful Increasing the interest rate

If the interest rate were higher than rr* There would be a surplus of loanable funds Lenders would be plentiful and borrowers would

be scarce Decreasing the interest rate

Invisible Hand61

Financial markets work much like other markets

In this case Saving represents the supply of loanable funds Investment represents the demand for loanable funds Interest rate adjust to balance the supply and demand

in the market for loanable funds

Government Policy to Increase Saving

62

Taxes on saving Lower saving for every given interest rate

If the government decided to reduce taxes on saving The incentive to save would increase for every given

interest rate 1. Increase the supply of saving curve 2. Reduce the equilibrium interest rate 3. Increase the level of investment

Government Policy to Increase Investment

63

Giving firms an investment tax credit would Encourage more firms to borrow and invest in new

capital for every given interest rate 1. Increase the demand for investment 2. Increase the interest rate 3. Increase the amount of saving

Inflation64

Macro Terms65

Average (Aggregate) Price Level, P: The average price of all outputs Absolute concept, not relative

Inflation: Process of rising prices

Nominal: NOT adjusted for inflation “current dollars”

Real: Adjusted for inflation “constant dollars”

Macro Terms66

Hyperinflation: Inflation that exceeds 50% a month

Deflation: Process of falling prices

Disinflation: Slowing of inflation

Real v. Nominal GDP

Nominal GDP: GDP valued in current dollars not adjusted for inflation

Real GDP: GDP valued in constant dollars adjusted for inflation

More informative than nominal often compared across time

67

Business Cycles68

Macro Terms69

Business Cycle: Shows fluctuations in GDP around potential GDP

Recession: Real GDP decreases for at least two successive quarters associated with rising unemployment, falling profits and

incomeDepression:

Extremely severe decline in real GDPExpansion:

Rising real GDP associated with falling unemployment, higher profits

and income

The Business Cycle

Peak

Recession

Trough

Expansion

TIME

RE

AL

GD

P

70

Y and YN

71

0100020003000400050006000700080009000

GD

P

Year

Actual Real GDP and Potential Real GDP

What We Learn From GDP72

By looking at the graph, we learn that:1. real GDP grows over time

output of goods and services has grown over time averaging about 3% per year

allows the typical American to enjoy greater prosperity than his/her parents and grandparents

2. growth is not steady upward climb is occasionally interrupted by periods of

decline

Macroeconomics is about explaining both--the long-run trends and the short-run fluctuations

73

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Activity 1774

75

FEDERAL RESERVE SYSTEMTOOLS OF THE FED

EXPANSIONARY MONETARY POLICYCONTRACTIONARY MONETARY POLICY

POLICY DEBATES

76

Money and Monetary Policy

The Federal Reserve was established in 1913 to

77

A. Prevent inflation by decreasing the money supply

B. Stimulate the economy by increasing bank reserves

C. Stop bank panics by acting as a lender of last resort

D. Prevent bad loans by requiring banks to hold reserves

The Federal Reserve was established in 1913 to

78

A. Prevent inflation by decreasing the money supply

B. Stimulate the economy by increasing bank reserves

C. Stop bank panics by acting as a lender of last resort

D. Prevent bad loans by requiring banks to hold reserves

Which of the following is not a function of the “Fed”?

79

A. Acting as lender of last resortB. Acting as a banker’s bankC. Performing check clearing servicesD. Insuring deposits in the banking systemE. Taking actions to control the money

supply

Which of the following is not a function of the “Fed”?

80

A. Acting as lender of last resortB. Acting as a banker’s bankC. Performing check clearing servicesD. Insuring deposits in the banking systemE. Taking actions to control the money

supply

Federal Reserve System81

The Fed Is a special kind of bank

a bank for banks The Fed acts as a central banking system with

centralized economic power

The Fed’s job: Is to manage the money supply in what it perceives to

be the national interest


Fed was established in 1913 Very recent

Federal Reserve System is made up of 12 central banks, each with its own region

The Fed is run by a 7 member Board of Governors Appointed by the President and confirmed by the

Senate 14 year terms President designates a chairman for a 4 year term Headquartered in Washington, D. C.


Once appointed, the governors are independent of the rest of government

This is to give the Fed the ability to make decisions on objective, technical criteria rather than on political agendas

FOMC84

Federal Open Market Committee, FOMC: Works with the Board of Governors and largely

determines the size of the U.S. money supplyFOMC has 12 members:

7 governors 5 presidents of district banks

FOMC meets every six weeks

Policy implementation is normally done through the New York Fed Bank

85

Money

86

Liquidity

Liquidity The ease of an asset’s ability to be converted to cash

An asset is completely “liquid” if one can spend it now

87

Definitions of the Money Supply

There are 3 measures of the money supply M1

The most liquid of all definitions of the money supply M2 M3

Currency held by banks in the form of reserves is NOT counted as part of the money supply because it is not available for individuals to make

purchases with

88

Definitions of the Money Supply

M1= Sum of all currency, coin, traveler’s checks in the

hands of the public 30%

Sum of all of the most liquid checking accounts 70%

M2= M1 + savings accounts, money market mutual funds,

small time deposits (cd’s < 100,000)

M3= M1 + M2 + large time deposits

89

Which of the following assets is most liquid?

A. moneyB. bondC. savings accountD. stock

90

Which of the following assets is most liquid?

A. moneyB. bondC. savings accountD. stock

91

Money Creation Process

Banks hold 100% of their checking deposits as vault cash to ensure that bank runs do not occur.

92

A. TrueB. False

Banks hold 100% of their checking deposits as vault cash to ensure that bank runs do not occur.

93

A. TrueB. False

94

Money Creation Process

Fractional Reserve Banking System: Banks keep only part of all its deposits

When a bank gets a new deposit: it keeps a portion of it in reserves and then lends

out the rest Individuals and firms receiving the loans then

deposit their loan checks into their banksThose banks:

repeat the process by keeping a portion of the deposit and then lending out the rest

Hence, a fractional reserve system creates money i.e., increases the money supply

95

Which of the following best describes how banks create money?

A. Banks charge higher interest rates on loans than they pay on deposits

B. Banks charge fees for providing financial advice

C. Banks create checking account deposits when making loans from excess reserves

D. Banks make loans from reserves

96

Which of the following best describes how banks create money?

A. Banks charge higher interest rates on loans than they pay on deposits

B. Banks charge fees for providing financial advice

C. Banks create checking account deposits when making loans from excess reserves

D. Banks make loans from reserves

97

Tools of the Federal Reserve

The Fed directly controls the interest rate and inflation rate.

98

A. TrueB. False

The Fed directly controls the interest rate and inflation rate.

99

A. TrueB. False

Tools of the Fed100

The Fed uses 3 tools to control the money supply 1. Open market operations 2. Required reserve ratio 3. Discount rate

RRR101

The Fed sets the RRR

If the Fed increases the RRR Banks are required to hold more of their deposits decreasing the money supply

If the Fed decreases the RRR Banks are free to lend out more of their deposits increasing the money supply

Discount Rate102

Discount Rate the interest rate that individual banks pay to the

Fed in order to borrow fundsIf the Fed increases the discount rate

It is more expensive to borrow from the Fed banks tend to hold more excess reserves decreasing the money supply

If the Fed decreases the discount rate It is less expensive to borrow from the Fed banks tend to hold fewer excess reserves increasing the money supply

OMO103

Open Market financial marketplace made up of non-government

sectorsIf the Fed sells government securities:

Individuals and firms begin to buy them from the Fed Money goes from the open market (in the Ms) to the

Fed (out of the Ms) The money supply falls

If the Fed buys government securities: Individuals and firms begin to sell them to the Fed Money goes from the Fed (out of the Ms) to the open

market (in of the Ms) The money supply increases

The three main monetary policy tools used by the Fed to manage the money supply are

104

A. Interest rates, tax rates, and government spending

B. Tax rates, government purchases, and transfer payments

C. Open market operations, discount policy, and reserve requirements

D. Open market operations, the exchange rate, and government purchases

The three main monetary policy tools used by the Fed to manage the money supply are

105

A. Interest rates, tax rates, and government spending

B. Tax rates, government purchases, and transfer payments

C. Open market operations, discount policy, and reserve requirements

D. Open market operations, the exchange rate, and government purchases

Expansionary Monetary Policy106

The Fed can increase the Ms by doing the following Buying government bonds Decreasing the RRR Decreasing the discount rate

*sM rr I GDP

Contractionary Monetary Policy107

The Fed can decrease the Ms by doing the following Selling government bonds Increasing the RRR Increasing the discount rate

*sM rr I GDP

Expansionary monetary policy refers to the _____ to increase real GDP.

108

A. Government’s increasing spending and lowering taxes

B. Government’s decreasing spending and raising taxes

C. Federal Reserve’s increasing the money supply and decreasing interest rates

D. Federal Reserve’s decreasing the money supply and increasing interest rates

Expansionary monetary policy refers to the _____ to increase real GDP.

109

A. Government’s increasing spending and lowering taxes

B. Government’s decreasing spending and raising taxes

C. Federal Reserve’s increasing the money supply and decreasing interest rates

D. Federal Reserve’s decreasing the money supply and increasing interest rates

Which of the following is true about the Fed’s ability to prevent recessions? The Fed

110

A. Does not try to eliminate recessions, but instead focuses on preventing inflation

B. Can fine tune the economy and realistically hope to keep the economy from experiencing recessions

C. Cannot realistically fine tune the economy, but seeks to keep recessions shorter and milder than they would otherwise be

D. Cannot realistically fine tune the economy and has little to no effect on the magnitude and length of recessions

Which of the following is true about the Fed’s ability to prevent recessions? The Fed

111

A. Does not try to eliminate recessions, but instead focuses on preventing inflation

B. Can fine tune the economy and realistically hope to keep the economy from experiencing recessions

C. Cannot realistically fine tune the economy, but seeks to keep recessions shorter and milder than they would otherwise be

D. Cannot realistically fine tune the economy and has little to no effect on the magnitude and length of recessions

112

Should Policymakers Try to Stabilize the Economy?

Yes, Policymakers Should Stabilize113

Argument: Economies fluctuate on their own and there is no

reason to suffer through booms and busts Recession lead to lower real GDP and higher

unemployment Expansions lead to higher inflation

During a recession policymakers should Increase government spending, cut taxes, and

expand the money supplyDuring an expansion policymakers should

Decrease government spending, raise taxes, and decrease the money supply

No, Policymakers Should Not Stabilize114

Argument: Allow the economy to heal itself and “do no

harm”Substantial obstacles to the effective use of

policy changes to influence the economy Time lags can be anywhere from 6 months to

several years Policymakers need accurate information on the

future of the economy to make accurate policy changes Economic forecasts are imprecise

Policy changes can make matters worse

115

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FISCAL POLICY AND DEMANDSUPPLY-SIDE ECONOMICS

116

Fiscal Policy

Fiscal Policy117

Fiscal Policy The use of the federal budget to achieve macro

goals full employment sustained economic growth price level stability

This use of fiscal policy came after the Great Depression of the 1930’s and the

thinking of John Maynard KeynesPrior to that,

governments allowed the economy to regulate itself

the federal budget was used only to finance the activities of the federal government

Tools of Fiscal Policy118

3 tools of fiscal policy G Taxes Transfers

To analyze each one Hold everything else constant

Changes in G Expansionary Contractionary GDPG

GDPG

Fiscal Policy and AD119

Changes in Taxes DI = Income – taxes + transfers Expansionary Contractionary

Changes in Transfers Expansionary Contractionary

GDPCDItaxes

GDPCDItaxes

GDPCDItransfers

GDPCDItransfers

The Effects of Fiscal Policyon Real GDP and the Price Level

PROBLEMTYPE OF POLICY

ACTIONS BY CONGRESS AND THE PRESIDENT RESULT

Recession Expansionary Increase government spending or cut taxes

Real GDP and the price level rise.

Rising Inflation Contractionary Decrease government spending or raise taxes

Real GDP and the price level fall.

120

Learning Objective 15.2

Table 15-1

Countercyclical Fiscal Policy

Don’t Let This Happen to YOU!Don’t Confuse Fiscal Policy and Monetary Policy

An increase in individual income taxes _____ disposable income, which _____ consumption

spending.121

A. Increases; increasesB. Increases; decreasesC. Decreases; increasesD. Decreases; decreases

122

A. Increases; increasesB. Increases; decreasesC. Decreases; increasesD. Decreases; decreases

An increase in individual income taxes _____ disposable income, which _____ consumption

spending.

If the economy is falling below potential real GDP, which of the following would be an appropriate fiscal

policy? An increase in 123

A. The money supply and a decrease in interest rates

B. Government purchasesC. Oil pricesD. Taxes

124

A. The money supply and a decrease in interest rates

B. Government purchasesC. Oil pricesD. Taxes

If the economy is falling below potential real GDP, which of the following would be an appropriate fiscal

policy? An increase in

If real GDP exceeded potential real GDP and inflation was increasing, which of the following would be an

appropriate fiscal policy?125

A. A decrease in the money supply and an increase in the interest rate

B. An increase in government spendingC. An increase in taxesD. An increase in oil prices

126

A. A decrease in the money supply and an increase in the interest rate

B. An increase in government spendingC. An increase in taxesD. An increase in oil prices

If real GDP exceeded potential real GDP and inflation was increasing, which of the following would be an

appropriate fiscal policy?

127

Fiscal Policy and Aggregate Supply


128

“Supply-side economics” Attempts to increase YN, potential real GDP

Taxes create Disincentives which decrease potential real GDP

So, lower income taxes Strengthens the incentive to work Increases aggregate supply

Marginal Tax Rates129

Marginal tax rates of the richest Americans: Carter 50% Reagan 28% Bush 31% Clinton 39.6% W. Bush 35%


130

Tax policies encouraging I Lead to higher stocks of capital Increases aggregate supply

Tax relief for firms in R & D Encourage new technology Increases aggregate supply

Supply-Side Economics and Aggregate Demand

131

However, lowering taxes and increasing investment Also increase AD GDPCDItaxes

GDPI

Supply-Side Economics132

Supply-side is largely effective in the SR because of its effects on Aggregate Demand

Supply-side economics is largely effective in the LR because of its effects on Aggregate Supply

Which of the following would be classified as fiscal policy?

133

A. The federal government passes tax cuts to encourage firms to reduce air pollution

B. The Federal Reserve cuts interest rates to stimulate the economy

C. A state government cuts taxes to help the economy of the state

D. The federal government cuts taxes to stimulate the economy

Which of the following would be classified as fiscal policy?

134

A. The federal government passes tax cuts to encourage firms to reduce air pollution

B. The Federal Reserve cuts interest rates to stimulate the economy

C. A state government cuts taxes to help the economy of the state

D. The federal government cuts taxes to stimulate the economy

Which of the following best describes supply-side economics?

135

A. Labor productivity impacts aggregate supply

B. Education impacts labor productivity which impacts aggregate supply

C. Education impacts the incentive to work, save, and invest, and therefore aggregate supply

D. Tax rates, particularly marginal tax rates, affect the incentive to work, save, and invest, and therefore aggregate supply

136

A. Labor productivity impacts aggregate supply

B. Education impacts labor productivity which impacts aggregate supply

C. Education impacts the incentive to work, save, and invest, and therefore aggregate supply

D. Tax rates, particularly marginal tax rates, affect the incentive to work, save, and invest, and therefore aggregate supply

Which of the following best describes supply-side economics?

Activities 30 / 31137

138

139

140

141

Should We Worry About the National Debt?

If we took all of our nation’s income and paid off the national debt, how long will it take?

A. More than 10 yearsB. Five yearsC. Two yearsD. One yearE. Less than one year

If we took all of our nation’s income and paid off the national debt, how long will it take?

A. More than 10 yearsB. Five yearsC. Two yearsD. One yearE. Less than one year

Federal Budget144

Deficit/Surplus Revenues > Expenditures

surplus Expenditures > Revenues

deficit

A deficit (or surplus) is a flow variable

Debt is a stock variable

Government debt is sold by issuing bonds Treasury “T” bills to the public

The Federal Budget Deficit145


FIGURE 15.13

The Federal Budget Deficit, 1901–2006

Reasons NOT to worry about the debt

146

The following work to “reduce” the figures 1. Take figures in relation to GDP 2. Adjust for state and local surpluses and debt

owned by government “Net public debt”

3. Adjust for the cyclical component of the economy

4. Adjusting for capital outlays It is normal for capital outlays to grow in a growing

economy 5. Adjusting for inflation

Federal Government Debt147


Current Debt148

The current debt is $11.9 trillion dollars$4.4 trillion is held by government agencies

Therefore, the U.S. net public debt is about $7.6 trillion

Nominal GDP is about $14.2 trillion

In other words, net public debt makes up 53.5% of GDP

If we used all of the nation’s resources to pay off the debt alone, how long would it take to pay it off? About 7 months

Should we worry about the debt?149

The cause of the debt is important to whether it is a burden

Until the 1980’s most debt was acquired because of war or recession These are taken to be good reasons to incur debt

1980’s and 1990’s and early 2000s have seen rising structural deficits due to expansionary

policy Cause for concern for incurring debt

Reasons TO worry about the debt150

1. The ensuing inflation 2. Effects on Investment

A deficit is negative saving Supply of national saving decreases Increasing the interest rate Some private investment is “crowded out”

The “I” in GDP Leads to lower capital stock, K, in the future Lower productivity and standard of living

Reasons TO worry about the debt151

3. Borrowing from abroad About 40% of net public debt is held by foreigners The higher interest rates encourage more investment in

the U.S. by foreigners The higher interest rates cause the dollar to appreciate Twin deficits

4. Growth of interest payments Opportunity cost

152

Should the Federal Government Have a Yearly Balanced Budget?

State of the Economy on Deficits153

Larger deficits do not always mean the government has undertaken

expansionary fiscal policy

The same fiscal policies can lead to large or small deficits depending on the state of the

economy

With no change in policy: Recessions increase deficits Expansions decrease deficits


Recessionary Gap Tax revenues fall Transfer payments rise =>Deficits increase

Under a yearly balanced budget, gov’t expenditures must: Decrease, making the gap worse


Expansionary Gap Tax revenues rise Transfer payments fall =>Deficits decrease

Under a yearly balanced budget, gov’t expenditures must: Increase, making the gap worse “boom the boom”


Economists prefer using the structural deficit rather than the actual deficit

Structural deficit is based on what expenditures would be if the

economy were at full employment changes as policy changes, not as the economy

changes

If the goal is a balanced budget The structural deficit should be balanced over the

business cycle

A recession tends to cause the federal budget deficit to _____ b/c tax revenues _____ and government spending on

transfer payments _____.157

A. Increase; rise; fallB. Increase; fall; riseC. Decrease; rise; fallD. Decrease; fall; rise

A recession tends to cause the federal budget deficit to _____ b/c tax revenues _____ and government spending on

transfer payments _____.158

A. Increase; rise; fallB. Increase; fall; riseC. Decrease; rise; fallD. Decrease; fall; rise

Macroeconomics

James B. Wilcox

RESOURCES PROVIDED BY:

THE UNIVERSITY OF SOUTHERN MISSISSIPPICENTER FOR ECONOMIC AND ENTREPRENEURSHIP

EDUCATION,MISSISSIPPI STATE UNIVERSITY, & VIRTUAL ECONOMICS

Macroeconomics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION, MISSISSIPPI.

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