Classical and Keynesian Economics(2/27)

Classical and Keynesian Economics(2/27)

Classical Economics

• Trickle down theory(help the rich1st, then everyone else)
• In the long run, the economy will balance at full employment output
• Invisible Hand

Keynesian Economics

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

more to come when comments inquire, as this was a brief topic

Spending and Tax Multiplier Effect(2/24)

Spending and Tax Multiplier Effect(2/24)

Spending Multiplier

• an initial change in spending (,Ig,G,Xn) causes a larger change in aggregate spending or AD
• multiplier = ΔAD/ΔC,Ig,G,Xn
• this is due to expenditures and income flow continuously when sets off a spending increase in the economy
• Spending Multiplier = 1/(1 - MPC) or 1/MPS
• (+) is increase in spending
• (-) is decrease in spending

 Tax Multiplier

• when the gov't taxes, multiplier works in reverse since money in leaving the circular flow
• Tax Multiplier = (- MPC/(1 - MPC)) or (- MPC/MPS)
• if there's a tax cut, the multiplier is positive due to more money in the circular flow

Consumption and Saving (2/23)

Consumption and Saving (2/23)

• Consumption(C)

• household spending
• the ability to consume is constrained by
• the amount of disposable income (DI)
• the propensity to save
• Do households consume if DI = 0; yes, (Credit), Dissaving

• Savings(S)

• household not spending
• constrained by:
• amount of DI
• propensity to consume
• Do households save if DI = 0; no

• Disposable Income(DI)

• income after taxes or net income
• DI = Gross Income - Taxes

• Calculations

• APC - Avg Propensity to Consume
• APS - Avg Propensity to Save
• MPC - Marginal Propensity to Consume
• MPS - Marginal Propensity to Consume (% of every extra $ earned that is saved)
• C/DI = APC ; S/DI = APS
• APC + APS = 1
• APC > 1 Dissaving
• - APS = Dissaving
• ΔC/ΔDI = MPC
• ΔS/ΔDI = MPS
• MPC + MPS = 1

• Determinants of C & S

• Wealth
• Expectations
• Household Debt
• Taxes

Aggregate Supply/ Aggregate Demand Model (2/21)

Aggregate Supply/ Aggregate Demand Model (2/21)

Just a concise explanation of the complex model, if a text-based info is desired, please request through the comments

Aggregate Supply (2/21)

Aggregate Supply (2/21)

AS - the lvl of Real GDP (GDPR) that firms will produce at each Price Lvl (PL)

Long Run AS - period of time where input prices are completely flexible and adjust to changes in PL; lvl of GDPR supplied is independent of PL (Vertical) ; analogous to PPC as LRAS marks the lvl of full employment in the economy

Short Run AS - period of time where input prices are sticky and do not adjust to changes in PL; lvl of GDPR supplied is directly related to PL (Upward Sloping)

Increase in SRAS - shift right

Decrease in SRAS - shift left

Key to understanding SRAR is per unit cost of production

per unit cost of production = total input cost/total output

Determinants of SRAS

Input Prices

• Domestic Resource Prices (wages, cost of capital, raw materials)
• Foreign Resource Prices
• Market Pwr (monopolies & cartels)
• Increase in Resource Prices, SRAS shifts left
• Decrease in Resource Prices, SRAS shifts right

Productivity

• productivity = total output / total input
• more productivity = SRAS shifts right
• less productivity = SRAS shifts left

Legal-Institutional Environment

• Taxes - SRAS shifts left
• Subsidies - SRAS shifts right
• Gov't Regulation - SRAS shifts left
• Gov't Deregulation - SRAS shifts right

Interest Rates and Investment Demands(2/16)

Interest Rates and Investment Demands(2/16)

Investment - essentially expenditures

• new plants (factories)
• Capital equipment (machinery)
• Tech (hardware&software)
• New Homes
• Inventories (goods sold by producers)

Expected Rate of Return

• These thins help firms make decisions, determine whether to invest, the cost of investment and so on...
• Cost/Benefit Analysis
• Expected Rate of Return
• interest costs
• comparing the expected rate of return to interest costs
• if expected rate > interest cost, invest
• if expected rate < interest cost,  don't invest%) - inflation (π%)
• the cost of investment is determined by r% as it is adjusted for inflation

Investment Demand Curve

• downward sloping due to:
• increasing interest rate = fwr investments are profitable
• decreasing interest rate = more investments are profitable

Shifts in ID

• costs of production
• business taxes
• tech changes
• stock of capital
• expectation

Aggregate Demand(2/15)

Aggregate Demand(2/15)

AD - demand by consumers, business, gov't and foreign countries

• changes in price lvl cause  a move/not a shift, of the AD curve
• AD shows the amount of real GDP that the private, public, and foreign sectors collectively desire to purchase at each possible price lvl
• relationship btwn price lvl and lvl of rel GDP (it is inverse or downward sloping)

3 Reasons why AD is downward sloping

1. Wealth Effect - higher prices reduces the purchasing power of the $; decreases the quantity of expenditures; lwr price lvl increases purchasing pwr and increases expenditures EX: inflation causes less spending
2. Interest-Rate Effect - as price lvl increases, lenders need to chare higher interest rates to get a real return on their loans; higher interest rates discourage consumer spending and business investment
3. Foreign Trade Effect - when U.S. price lvl increases, foreign buyers purchase fwr U.S. goods and Americans buy more foreign goods; Exports fall, Imports rise, causing Real GDP demanded to fall

Shifts in AD

• 2 parts cause AD to shift, a change in C, Ig, G, and/or Xn, and a multiplier effect that produces greater change than the change in the four components (C,Ig,G,Xn)
• increase in AD, shift to right
• decrease in AD, shift to left

Determinants

• ΔC - Consumer Wealth, Consumer Expectation, Household Indebtedness, Taxes
• ΔIg - Real Interest Rate(Price in Borrowing), Business Expectations, Productivity&Tech, Business Taxes
• ΔG - War, Nationalized Healthcare, Decrease in Defense Spending
• ΔXn - Exchange Rates, National Income Compared to Abroad

Unemployment (2/9)

Unemployment (2/9)

unemployment rate - percent of ppl in the labor force who desires a job but are not working

labor force - # of ppl in a country classified as employed or unemployed

employed - anyone who works 1 hr/month; temporarily absent from work; part - time

not in the labor force - kids, full-time students, ppl in mental institutions, military personnel, stay-at-home parents, retirees, incarcerated, discouraged workers (mentally and psychologically beaten)

unemployment rate = (# unemployed/ # in labor force) * 100

standard unemployment = 4% - 5%; if > 5%, possible recession

4 Types of Unemployment

• frictional - temp. unemployed, btwn jobs, individual as transferable skills  Ex: full-time student
• seasonal - specific type of frictional, depends on time of yr and nature of said job, job will come back Ex: construction worker
• structural - skills become obsolete, jobs won't come back, individual doesn't have transferable skills and must learn new skills. (permanent loss of jobs called Creative Destruction) Ex:outsourcing
• cyclical - results from downturn (recessions); Demand for goods/services decrease, Demand for labor falls and workers fired

Natural Rate of Unemployment/Full Employment (NRU) = frictional + structural (4% - 5%)

Full Employ. means to Cyclical Unemploy.

Okun's Law - when unemployment rises 1% above NRU (4 - 5%) GDP falls abt 2%

Inflation (2/6)

Inflation (2/6)

inflation - general rise in price levels

purchasing power - amount of goods/services are worth

deflation - general decline in the price lvl

disinflation - occurs when inflation rate declines

nominal interest rate - percentage increase in money that borrower pays back to lender ( not adjusted for inflation)  (Nominal IR = Real IR + expected inflation)

real interest rate - percentage increase in purchasing pwr that borrower pays to lender (adjusted for inflation) (Real IR = Nominal IR - expected inflation)

Rule of 70 - used to calc the # of yrs it'll take for the price lvl to be doubled at any given rate of inflation (Calc. by 70 / Annual Inflation Rate)

(Annual) Inflation Rate =

(( Current Yr Price Index - Last/Base Yr Price Index) / Last/Base Yr Price Index )* 100

standard inflation rate - 2% to 3%

3 Causes of inflation

• Printing too much money (Quantity Theory)
• Demand Pull - too man $ chasing too few goods, excess of demands over output pulls prices upward
• Cost Push - higher production cost increase prices

Unanticipated Inflation

• Those Hurt By It - lenders (at a fixed rate), Ppl with fixed income, Savers
• Those Helped By It - borrowers, businesses where price of product increases faster than price of resource

Nominal and Real GDP (2/3)

Nominal and Real GDP (2/3)

Nominal GDP

• value of output produced in current prices; can increase from yr to yr if output or prices increase
• N GDP = Current P * Current Q

Real GDP

• value of output produced in constant base yr prices; adjusts for inflation; can increase yr to yr if output increases
• R GDP = Base Yr P * Current Q

Other Info

• only in the base yr does N GDP = R GDP
• yrs after the base-yr, N GDP > R GDP
• yrs before the base-yr, N GDP < R GDP 

GDP Deflator

• price index used to adjust from nominal to real GDP
• (Nominal / Real) *100

Consumer Price Index (CPI)

• measures inflation by tracking change in the price of a mrkt basket of goods
• ex of market basket of goods, cars
• (Price of Mrkt Bskt in Current Yr / Price of Mrkt Bskt in Base Yr) * 100

GDP Continued (2/1)

MORE GDP CALCULATIONS!

Depreciation or Consumption of Fixed Capital:
- lost of value of capital equipment due to normal wear and tear

Gross Investment:
Net Investment + Depreciation

Net Domestic Product:
GDP - Depreciation

Net National Product:
GNP - Depreciation

GNP:
GDP + Net Foreign Factor Payment