AD/AS

Day 13

•    Aggregate demand.

           -shows the amount of real GDP that private, public, and foreign sector collectively desire to purchase              at each possible price level.
           -inverse relationship between price level and level of real GDP.



3 reasons why downward slope of AD.

• Real - Balance Effect

                  - when price level high households and businesses cannot afford to purchase as much output.
                  - when price level low households and businesses can afford to purchase more output.

• Interest - Rate Effect

                       - higher price level increases the interest rate most people tend to not invest.
                       - lower price level decrease the interest rate which tends to encourage investment.

• Foreign - Purchases Effect

                       - higher price level increases the demand for relatively cheaper imports.
                       - lower price level increases the foreign demand for relatively cheaper U.S. exports.

Shifts in (AD) graphs.

• 2 parts to a shift in AD:

         - A change in C, IG, G, XN.

            - Multiplier effect that produces a greater change than the original change in the 4 components.

• Increase in AD = AD shift to right.
• Decrease in AD = AD shift to left.

Consumption

• Having Spending is affected by
• Consumer wealth
• more wealth equals more spending (AD right)
• less wealth equals less spending (AD left)
• Consumer expectation
• positive expectations (AD right)
• negative expectations (AD left)
• Household indebtedness
• less debt is more spending (AD right)
• more debt is less spending (AD left)
• Taxes
• less taxes is more spending (AD right)
• more taxes is less spending (AD left)

Gross Private Investment

• Investment Spending is sensitive by
• Real Interest Rate
• Low Interest is more investment (AD right)
• More interest is less investment (AD left)
• Expected returns
• higher expected returns is more invest (AD right)
• lower expected returns is less invest (AD left) 
• Expected returns influenced by
• expectation in future profitability
• technology
• degree of excess capacity (existing stock of capital)
• Business taxes

Govt Spending

• More govt spending (AD right)
• less govt spending (AD left)

Net Exports sensitive to:

• Exchange rate
• Strong $ is more imports fewer exports (AD right)
• Weak $ is less imports more exports (AD left)
• Relative Income
• Strong Foreign economics is more exports (AD right)
• Weak Foreign economics is less exports (AD left)

Day 14

Aggregate Supply

Long run vs Short Run

Long Run

• Period of time when input prices are completely flexible and adjust to changes in the price level
• The level of real GDP supplied by 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 is directly related to price level.

Long run LRAS- marks the level of full employment in the economy (analogous to PPC)

Changes in SRAS

• increase in SRAS (right)
• decrease in SRAS (left)

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

Per unit cost of production= Total Input cost/Total output cost

Determinants of AD

• Input prices
• Productivity
• Legal institution Environment 

• Input Prices
• wages 95% of all business costs
• Raw materials commodity prices
• Cost of Capital
• Foreign Resource Price
• Strong $ lower foreign resource price
• Weak $ higher foreign resource price
• Increase in resource price SRAS( right)
• Decrease in resource price SRAS(left)

Productivity

• Prod=total output/total input
• more productivity = lower unit production cost SRAS(right)
• less productivity = higher unit production cost SRAS(left)

Legal Institution Environment

• Taxes and Subsides
• Taxes increase on business increase per unit cost SRAS(right)
• Subsides to business reduce per unit cost SRAS(left)
• Govt regulation
• Govt regulation creates a cost of compliance SRAS(right)
• Deregulation creates reduction of compliance cost SRAS(left)

AS/AD

Equilibrium of AS and AD determines current output(GDP Real) and price level

Full Employment equilibrium exists where AD intersects SRAS and LRAS of the same point.

Recessionary GAP exists when equilibrium occurs (allow full employment output)

Inflationary GAP exists when equilibrium occurs beyond full employment output.

Day 15

• Horizontal or Keynesian: includes only levels of real output that are less than full employment output, implies that the economy is a recession, therefore you have a decrease in real output
• Vertical or Classical: the economy reaches it's full capacity real output
• Intermediate Range: expansion of real output and price level

Day 16

Disposable Income (DI):
-Income after taxes or net income
-Two choices, households can either consume or save
DI=(gross income)-(taxes)

Consumption:
-Household spending
-The ability to consume is constrained by:

The amount of disposable income
The propensity to save
Autonomous consumption
Dissaving
APC=C/DI=% DI that is spent

Saving:
-Household not spending
-The ability to save is constrained by:

The amount of disposable income
The propensity to consume
APS=S/DI=% DI that is not spent

APC & APS
-APC: average propensity to consume
-APS: average propensity to spend

APC+APS=1
1-APC=APS
1-APS=APC
APC>1: Dissaving
(-APS):Dissaving

MPC & MPS
-Marginal Propensity to Consume
-Percent of every extra dollar earned that is spent
MPC=(Change in Consumption)/(Change in Disposable Income)

-Marginal Propensity to Save
-Percent of every extra dollar earned that is saved
MPC=(Change in Savings)/(Change in Disposable Income)
MPC+MPS=1
1-MPC=MPS
1-MPS=MPC

Why does this happen?
Expenditures & income flow continuously which sets off a spending increase in the economy

Calculating the Spending Multiplier

• The Spending multiplier can be calculated from the MPC or MPS
• Multiplier = 1/1- MPC or 1/MPS
• Multipliers are (+) when there is an increase in spending and (-) when there is a decrease

Calculating the Tax multiplier

• money is now leaving the circular flow
• Tax Multiplier (its negative)
•  = -MPC/1-MPC or -MPC/MPS
• If there is a tax CUT, then the multiplier is + because there is now more money in the circular flow

Day 18
Investment - money spent or expenditure on:

• New plans (factories)
• Capital equipment (machinery)
• Technology (hardware/software)
• New homes
• Inventories (goods sold by producers)

Expected Rate of Return
How does business make investment decision?
Cost/benefit analysis.

How does business determine the benefits?
Expected rate of return.

How does business count the cost?
Interest cost.

•  How does business determine the amount of investment they undertake?
• Compare expected rate of return to interest cost.
• Expected cost > interest cost, then invest.
• Expected cost < interest cost, then don't invest.

Real (r %) vs. Nominal (n %)
Differences?
Nominal - observable rate of interest.
Real - subtracts out inflation(π %) and is only known ex post facto.

• Real interest rate (r %)

r % = i % - π %

What determine the cost of investment decision?

• The real interest rate (r %).

Investment Demand Curve (ID)

• Downward sloping.
• When interest rate is high, fewer investments are profitable.
• When interest rate is low, more investments are profitable.

Determinants

• Cost of production
• Business tax
• Technological changes
• Stock of capital
• Expectation

Day 19

Changes in the expenditure or tax revenues of the federal government

•   2 tools of fiscal policy
•   taxes: gov't can increase or decrease
• spending: gov't can increase or decrease

Fiscal Policy is enacted to promote our nation's economic goals: full employment, price stability, economic growth

Defecits, Surpluses, & Debt

• Balanced Budget: revenue = expenditures
• Budget Deficit: revenue < expenditures
• Budget surplus: revenue > expenditures
• Gov't Debt: sum if all deficit - sum of all surpluses

Gov't must borrow money when in a budget deficit from:

  1. Individuals

  2. Corporations

  3. Financial institutions

  4. Foreign Entities

DISCRETIONARY FISCAL POLICY: (action)

Expansionary: think deficit

Contractionary: think surplus

NONDISCRETIONARY: (Nonaction)

Discretionary: Increase or decrease in gov't spending and/or taxes in order to return the economy to full employment

 Automatic: unemployment compensation & marginal tax rates are examples that help miligate the effects of recession & inflation

Contractionary: decrease AD (control inflation)

Expansionary: increase AD

Expansionary:

•  Recession is countered with this policy
• (Increase gov't spending, decrease taxes)

Contractionary: inflation is countered (decrease gov't spending, increase taxes)

Note That unemployment increased this means contractionary