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382 Cards in this Set
- Front
- Back
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1.
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When we ask why the AD curve slopes down we are really asking what?
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Why does a lower price level result in more spending?
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2.
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Explain the Wealth Effect (Real Balances Effect)
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Everything else the same, when the price level drops the purchasing
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3.
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Explain
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When the price level drops, the real interest money supply
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4.
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Explain the International Trade Effect
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As the price level drops, our exports become cheaper to foreigners
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5.
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When we ask what shifts the AD curve to the right we are really asking what
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What would increase the level of spending holding the price level
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2.
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How could monetary policy be used to shift the AD curve to the right?
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The FED could __increase _ the money supply which would lower
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3.
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How could fiscal policy be used to shift the AD curve to the right?
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Congress could decrease taxes and/or increase government spending.
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4.
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How could a change in expectations shift the AD curve to the right?
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Households and firms could become more optimistic about future
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5.
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How could an increase in foreign income shift the AD curve to the right?
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An increase in foreign income would increase the spending
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by foreigners on everything including imports. When foreigners buy
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6.
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What does it mean when we say the dollar has depreciated relative to
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a foreign currency?
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It means that in takes foreigners less of their own currency to buy the
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7.
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How could a depreciation of the U.S. dollar shift the AD curve to the right?
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As the dollar depreciates, U.S. exports increase and so Net
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How many euros does it take to buy a dollar?
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When we buy from abroad, dollar is depreciating (because it shifts to the right)—if dollar depreciates, foreign currencies have relatively appreciated.
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If Germans decide to buy more from us, dollar appreciates
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8.
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What are four reasons which explain the upward sloping Short Run
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1.
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Contracts make some wages and prices “sticky” (slow/difficult to adjust)
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2.
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Firms are often slow to adjust wages.
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3.
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Menu costs make some prices _sticky.
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4.
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__Shortages_ and ____bottlenecks_ can develop as the economy approaches the level of full employment YFE
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7.
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Explain the Profit Effect
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As the price level increases, revenues
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increase faster_ than do costs.
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Profit is equal to Total Revenue minus
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Total Costs.
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As profit margins expand, existing and new
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suppliers increase the amount of output
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supplied
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8.
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What is the difference between a shortage and a bottleneck?
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With regard to a shortage, at the existing price, the quantity demanded
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As the economy approaches the full employment level of output,
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8.
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How do the Profit Effect and the Cost Effect affect the slope of the Short
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The PROFIT EFFECT explains why the short run AS curve slopes up
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The COST EFFECT explains why the AS curve gets ______steepers_____ as
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9.
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Name five factors which shift the Short Run AS curve to the right
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1.
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Increases in the labor force and in the capital stock.
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2.
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__Technology__ change.
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3.
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An expected ____decrease________ in the future price level
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10.
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Why did “Classical School” Economists think that the economy would self
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Unemployed workers would offer to work for less money. Wages
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11.
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If the short run AD and AS curve are initially intersecting at YFE but then the
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When the economy attempts to move beyond YFE, there will be a
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shortage of workers in the labor market. This will ___raise_______
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12.
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If we accept that wages adjust according to the Classical School argument,
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Whatever happens to the AD and AS curves in the short run, in the
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YFE.
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13.
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What does the Classical School argument imply about the shape of the
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It is _______vertical_________ at YFE. Whatever happens in the economy,
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14.
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Do changes in the price level affect the level of Long Run Aggregate
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15.
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What is meant by validating inflation? Why do we say it “validates” it?
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Draw the graph.
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We validate inflation when we use fiscal or monetary policy to shift the
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If the AS curve has shifted left, raising prices and increasing
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16.
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When we draw our short run AD and AS curves, it appears that big
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price level changes could be a common result. However, in the actual
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has been rare. Why?
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In reality, the U.S. economy normally is growing over time and a result
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17.
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Does productivity growth reduce employment in the long run?
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___No___.
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18.
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What makes it so hard to predict what will happen to the level of Y in the
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Aggregate Demand and Aggregate Supply both depend on
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The AD and AS curves depend on expectations! When economic
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1..
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What was the point that John Maynard Keynes was trying to make when he
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The Classical School proponents were not considering how long it
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2.
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What is the “Sticky Wages” criticism of the Classical School argument?
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Labor markets take longer to adjust to full employment because
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3. What are the three leakages that must equal injections if the economy is to be
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at equilibrium?
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Leakages
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__Savings_____ + ______Imports__ + ____Taxes___ = _____Investment___ + ___Government Spending_____ + ____Exports____
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4.
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What did Keynes say was required for the economy to reach an
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_____Planned_______ Spending = Income
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No.
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5.
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What is Say’s Law? What does it mean?
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______Supply_____________ creates its own demand.
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The money earned producing output is equal to the cost of producing
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the output.
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6.
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Define endogenous, exogenous, and autonomous:
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Endogenous – determined _______within___________ the model
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Exogenous - determined ________outside of__________ the model
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Autonomous - _____constant___________ within the model.
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7. Leaving out Government spending and net exports, it is always true that
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savings equals ___investment__________?
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1. Income
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2. expectations
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3. Wealth (change in consumption for a dollar increase in wealth is
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4. ____Interest_______ Rates
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5. Credit Availability
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6. Taxes
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7. Price Level (Real Balance Effect)
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1.
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Expectations
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2.
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___Interest________ Rates
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3.
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Technology and Innovation
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4.
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Size of the Capital Stock (replacement investment)
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5.
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Taxes
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6.
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___Cash___ Flow
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10. Draw the Investment Demand Curve graph and write the Investment
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equation. Define “b” and explain it’s significance. What is the implication of
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b = the ____interest_______ rate sensitivity of investment demand.
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If b = 0 then investment demand is unaffected by interest rates. The
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A steady increase.
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12. What has caused investment spending since 1979 to occasionally decrease?
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Recessions
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A fairly steady increase.
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They dropped like a rock.
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1.
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The price level in the U.S. relative to the price levels in other countries.
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2.
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The growth rate of GDP in the U.S. relative to the growth rates of GDP in other countries.
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3.
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The ___exchange_______ rate between the dollar and other currencies.
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16.
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With regard to the above list, what three things could happen to
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The U.S. __price_______ level could ___drop______, other economies could
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17.
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Why does the demand curve in the Keynesian model (Aggregate Demand
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Because instead of price on the vertical axis we have planned
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18
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In the Keynesian diagram, does the 45 degree line represent aggregate
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Aggregate __supply_______________.
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19. In the graph of the Keynesian model, what is the significance of the 45
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degree line?
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Along a 45 degree line, vertical distance always equals
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In the Keynesian diagram, vertical distance is _____planned spenging________
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Therefore, at any point on the 45 degree line, ________planned spending________
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_____Equilibrium____________ will occur at some point on the 45 degree line!
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20. What is the effect of a lower price level on the Quantity of Aggregate
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Demand?
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Price level is __exogenous______________ in the Keynesian model so it is not on
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21. What is the difference between inventory investment and planned inventory
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investment? How does this relate to the “60 day rule”?
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When goods are produced but not ___sold________ they are considered to
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be ____inventory___________ investment. However, businesses have an
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22. Draw the Keynesian diagram and indicate areas of excess and depleted
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inventories – explain the movement toward equilibrium.
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23.
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How can we determine the full employment level of Y with reference to the
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We ___cannot___________.
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24. Graph the Consumption Function, write the Consumption equation, and
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25. Define Marginal Propensity to Consume (MPC) and the Average Propensity
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to Consume (APC).
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c = The Marginal Propensity to Consume
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= MPC
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= C / Y
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= The slope of the Total Consumption Curve
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Hint: Marginal is ALWAYS the slope of a
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Total Curve
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The Average Propensity to Consume
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= C / Y
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26. Define the Marginal Propensity to Save and the Average Propensity to
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Save.
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s = The Marginal Propensity to Save
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= MPS
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= S / Y
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= The slope of the Total Savings Curve
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The Average Propensity to Save
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= S / Y
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27.
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What is the relationship between the MPS and the MPC? Between the APC
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By definition, people can only do two things with their income, either
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consume it or ____save_______ it.
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The fraction saved (s) plus the fraction consumed (c) must equal
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s + c = ____.
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Likewise, the APS plus the APC must equal one.
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28. On the same graph, graph the consumption function and the implied saving
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function.
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29.
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Derive the Savings equals Investment equilibrium condition for the Keynsian
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Income = Planned Spending (Aggregate Demand)
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Y = C + I = AD
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Y – C = AD –C
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___ = ___
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30. Graph equilibrium in the Keynesian model using the savings equals
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investment approach
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31. Define the Paradox of Thrift and illustrate the answer to the paradox
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graphically
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See essay handouts
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Y = C + I = AD
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Y = A + cY
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Y – cY = A
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Y (1 – c ) = A
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Y = 1 * A
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33. Illustrate the equivalence of the planned spending equals income approach
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and the savings equals investment approach by graphing both on the same
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34. The multiplier is defined as the amount by which equilibrium Y changes
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when Autonomous Aggregate Demand increases by one unit
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35.
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What is the formula for the simple multiplier in the Keynesian model?
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1 = 1 = 1 / (1-MPC) = 1 / MPS
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36.
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Given an initial change in spending, what will be the ultimate change in the
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Y = * Spending
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37. When we use the Keynesian multiplier to calculate the change in Y that
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result from increased spending, we assume that the price level is
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38.
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The fact that the Keynesian model ignores price level changes is o.k.
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As long as the AS curve is __________.
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39. What is the formula for the multiplier in a Keynesian model with endogenous
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taxes?
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40.
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If the MPC equals .9 and the marginal tax rate t = .1, by approximately
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By approximately one half.
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41.
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Show how to derive the multiplier graphically.
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See Multiplier Essay Handout
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42.
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What is the definition of an “Automatic Stabilizer”? Define both the words
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Automatic means that no policy change is required.
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Stabilizer means that it ________________ fluctuations in the
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level of Y.
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43.
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Show graphically that endogenous taxes serve as an automatic stabilizer.
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See Multiplier Essay Handout
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44. Other than taxes, what are three other reasons the economy has become
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more stable since WWII?
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1. Services have become _more _ important and goods have become
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2.
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Automatic stabilizers such as unemployment insurance.
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___1_____.
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47. Which has the bigger effect on the economy – the Government spends $10
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billion or the Government sends out checks to citizens for $10 billion?
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______Government_____ spending has the bigger effect. If you send
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48. What is the multiplier for transfer spending? How does it compare to the
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Government spending multiplier?
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= [1 / (1-MPC) ] * c TR where TR is the transfer spending.
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The Government spending multiplier is greater because it just
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49. Illustrate an inflationary and deflationary gap using the Keynesian model and
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using the AD / AS model
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The Keynesian Model ignores ___price?______ level changes.
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51. Using the AS / AD model, illustrate why the Naive Keynesian model will
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underestimate the change in spending needed when the AS curve is
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An inside lag refers to how long it takes to put a policy in place so that
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An outside lag refers to how long it takes a policy once it is in place to
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have its effect on the economy
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1.
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The “Inside Lag” is very long for fiscal policy
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2.
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Where is YFE? If economy is at full employment
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3.
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Where does the money come from? Did it reduce other spending?
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5. How will the multiplier be affected by changing expectations?
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54.
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Answer the following problem:
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Y = C + I y is total spending
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C = 100 + .8Y
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I = 50
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1.
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What is equilibrium Y?
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2.
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What is the level of saving at equilibrium? Y-C
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3.
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If Y = 800, what is the level of involuntary inventory investment? What would total spending be if y=800? Subtract the total spending from 800
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4.
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If I increases to 100, what is the new equilibrium level of Y?
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Y=100+.8y+100
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5.
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What is the value of the multiplier?
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55. Explain the “Consumption Puzzle”. What is the significance of a positive
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versus a zero intercept for the consumption function?
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Read Consumption Puzzle Essay Handout
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If the total consumption curve has a positive intercept then the __APC____
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If the total consumption curve has a zero intercept then the APC
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The puzzle is that when the consumption curve is estimated over short
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See Life Cycle Theory of Consumption handout
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57. What is the answer of the Life Cycle Theory of Consumption to the
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“Consumption Puzzle”?
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The ratio of wealth to disposable income varies greatly
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in the short run but not in the longrun. This fact
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generates an APC that appears to decrease with increases in
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1. Money earns ____interest___________.
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2. People have wealth from sources other than labor
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3. People want to leave bequests (estates)
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59. What are five forecasting difficulties that complicate averaging consumption
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over your lifetime as proposed by the Life Cycle Theory of Consumption?
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1.
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How will your personal income change over time?
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4.
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What rate of return will you earn on savings?
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5.
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What will happen to Social Security and Government provided healthcare?
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60. Has most of the expansion in average life spans come from increasing the
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maximum age or from people not dying as frequently at younger ages?
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Not dying as frequently at younger ages.
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61.
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What appears to happen to people’s ability to spend money as they get
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It decreases.
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62.
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Three implications of the Life Cycle Hypothesis are that aggregate
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1. The age_ distribution of the population.
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2. Retirement age.
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3. Social Security.
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63. Graphically explain the Permanent Income Theory of Consumption –
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carefully label the axes and the curves.
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See Permanent Consumption Theory handout.
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64. With reference to the Permanent Income Theory of Consumption graph and
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using the simple Keynesian multiplier, explain why the change in Y will be
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The MPC out of _permanent__ income is greater than the MPC out of
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In a Ponzi scheme, there are no real investments. Earnings paid out
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66. The Social Security Trust funds has net assets equal to what amount?
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Explain.
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Old folks’ homes were awful
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Give elderly people enough money to prevent poverty
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Net Assets equal _zero__. Assets owned by the Social
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Workers pay 6.2% or earnings and employers “pay” 6.2% of earnings. Only on first $102,000 of earnings
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67.
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What are four criticisms of Social Security?
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1. Has benefited older generations at the expense of
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2. Social Security discriminates against ____higher_____ income
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3. Social Security discriminates against single women or
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4.
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Political dependency results from the system.
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“The third rail of American politics”- don’t touch, or you’ll die
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68. How does Social Security discriminate against married women or men?
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You can receive either the Social Security benefits you qualify for
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40% of pre-retirement income for average person
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60% for low income
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20% for high income
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Private sectors are too expensive due to adverse selection
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The diminished role of “Defined Benefit Pension Plans”
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Give yourself an annuity so that you don’t outlive your money
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Consumption smoothing
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If social security has just replaced private savings, then it has not solved a consumption smoothing problem.
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If you work one more year you will:
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1-
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pay an extra year of payroll taxes on your earnings
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2-
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Receive one less year of benefits
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3-
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Get a higher benefit level
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1.
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Reduce _benefits___________:
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a.
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____Means__ Testing
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b.
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Raise retirement Age- effectively reduced benefit- but lower income people may not live long enough
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c.
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Change AIME formula or index with the CPI minus 1%
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d.
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For higher income groups
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e.
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Could index wages using price level instead of wage growth changes
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2.
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Raise _____taxes- payroll tax from 12.4% to 15.6%
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3.
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Borrow from the _____public_________.
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4.
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____Private___ Accounts
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5.
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Extend the base of taxable wages
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1.
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Bring in state and local pension plans
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2.
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Encourage immigration
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3.
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Raise max amt of earnings subject to tax
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70. What is the obstacle in allowing people to own their own Social Security
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contributions within private accounts?
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Social Security redistributes income from ___high________ income
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earners to ____low___ income earners. Where would the money
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for this transfer come from if it all goes into privateaccounts?
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Congress could use money for other things
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US govet becomes a substantial owner of US business
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Is it possible to design ironclad safeguards?
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Increase investment funds available to the economy
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Deposits in a bank are, to them, liabilities
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to us they are assets
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When we ask why the AD curve slopes down we are really asking what?
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Why does a lower price level result in more spending?
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Explain the Wealth Effect (Real Balances Effect)
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Everything else the same
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The nominal money supply is fixed along the AD curve
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When the price level drops
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4. Explain the International Trade Effect
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As the price level drops
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What would increase the level of spending holding the price level constant?
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The FED could __increase _ the money supply which would lower interest rates which would increase spending.
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Congress could decrease taxes and/or increase government spending.
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Households and firms could become more optimistic about future economic conditions and this could cause them (everything else the same) to increase their level of spending at any current price level.
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An increase in foreign income would increase the spending
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by foreigners on everything including imports. When foreigners buy more imports this means that U.S. exports increase. As a result
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at any given price level
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It means that in takes foreigners less of their own currency to buy the dollars which will be used to buy our exports. In effect
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our exports have become _cheaper_ to them.
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As the dollar depreciates
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U.S. exports increase and so Net Exports (NX) increase. Y = C + I + G + NX and so at any given price level
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When we buy from abroad
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dollar is depreciating (because it shifts to the right)—if dollar depreciates
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If Germans decide to buy more from us
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dollar appreciates
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As the price level increases
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revenues
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As profit margins expand
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existing and new
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With regard to a shortage
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at the existing price
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As the economy approaches the full employment level of output
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___shortages________ and ___bottlenecks_________ occur
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11. If the short run AD and AS curve are initially intersecting at YFE but then the AD curve shifts right
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what will happen? Draw the graph.
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When the economy attempts to move beyond YFE
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there will be a
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12. If we accept that wages adjust according to the Classical School argument
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what conclusion can we draw about the long run equilibrium position of the economy?
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Whatever happens to the AD and AS curves in the short run
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in the long run the __AD____ curve will shift to intersect the __AS____curve at
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It is _______vertical_________ at YFE. Whatever happens in the economy
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eventually the AS curve shifts to intersect AD at YFE. Therefore
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If the AS curve has shifted left
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raising prices and increasing unemployment
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16. When we draw our short run AD and AS curves
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it appears that big
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|
price level changes could be a common result. However
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in the actual U.S. economy price levels changes have been moderate and deflation
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In reality
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the U.S. economy normally is growing over time and a result the price level impacts of increases in demand tend to be offset by increases in supply. In downturns
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The AD and AS curves depend on expectations! When economic events occur
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how will expectations be affected?
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6. Define endogenous
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exogenous
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7. Leaving out Government spending and net exports
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it is always true that savings equals ___investment__________?
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16. With regard to the above list
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what three things could happen to increase U.S. net exports?
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The U.S. __price_______ level could ___drop______
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other economies could grow _____faster________ than the U.S. economy
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18 In the Keynesian diagram
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does the 45 degree line represent aggregate demand or aggregate supply?
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19. In the graph of the Keynesian model
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what is the significance of the 45 degree line?
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Along a 45 degree line
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vertical distance always equals ____horizontal__________ distance.
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In the Keynesian diagram
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vertical distance is _____planned spenging________ ___________ and horizontal distance is ________income_________
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Therefore
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at any point on the 45 degree line
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Price level is __exogenous______________ in the Keynesian model so it is not on either axis of the graph. At any given level of income
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the lower the price level the __higher___________ the level of spending in the economy so the AD curve is shifted ___up____.
|
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be ____inventory___________ investment. However
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businesses have an optimal level of sales relative to _____inventory__________. That optimal level is called _______planned ___________ inventories.
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24. Graph the Consumption Function
|
write the Consumption equation
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By definition
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people can only do two things with their income
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Likewise
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the APS plus the APC must equal one.
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28. On the same graph
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graph the consumption function and the implied saving function.
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36. Given an initial change in spending
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what will be the ultimate change in the level of Y?
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37. When we use the Keynesian multiplier to calculate the change in Y that result from increased spending
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we assume that the price level is ____________.
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40. If the MPC equals .9 and the marginal tax rate t = .1
|
by approximately how much does the introduction of an endogenous income tax reduce the multiplier compared to the simple Keynesian multiplier without taxes?
|
|
44. Other than taxes
|
what are three other reasons the economy has become more stable since WWII?
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However
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since we are dealing with a “balanced budget” and G = T
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51. Using the AS / AD model
|
illustrate why the Naive Keynesian model will underestimate the change in spending needed when the AS curve is upward sloping.
|
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Delta y/ delta spending is the multiplier—except that other things are happening at the same time that would have affected the change in y
|
which warrants the question “how well did you control the things that may affect y”
|
|
When you get on the steeper part of the AS curve
|
much more is needed to reach Y(fe) because part of spending just raises price level
|
|
3. If Y = 800
|
what is the level of involuntary inventory investment? What would total spending be if y=800? Subtract the total spending from 800
|
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4. If I increases to 100
|
what is the new equilibrium level of Y?
|
|
The difficulty is that if you take consumption vs income
|
you don’t get an intercept that’s statistically different from zero
|
|
The puzzle is that when the consumption curve is estimated over short periods of time it has a positive intercept but when estimated over long periods of time such as decades the intercept appears to be zero. In other words
|
the puzzle becomes is the APCconstant or does it decrease with income?
|
|
64. With reference to the Permanent Income Theory of Consumption graph and using the simple Keynesian multiplier
|
explain why the change in Y will be greater for a permanent tax cut compared to a temporary tax cut.
|
|
In a Ponzi scheme
|
there are no real investments. Earnings paid out to new customers are coming solely from money paid in by new customers.
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|
Began in 1935
|
when average age of death was 64- eligible for benefits at 65
|
|
If abolished
|
what do you do about workers who now receive nothing?
|
|
Deposits in a bank are
|
to them
|
|
Workers pay 6.2% or earnings and employers “pay” 6.2% of earnings. Only on first $102
|
000 of earnings
|
|
If you are married
|
you can claim as your benefit one-half of your spouse’s benefit if that is more than your benefit.
|
|
If your spouse dies
|
you can claim his/her benefits
|
|
Benefits reduced one dollar for every two dollars earned over $14
|
160. Applies to recipients ages 62-64.
|
|
3. Social Security discriminates against single women or men in the work force
|
against men
|
|
“The third rail of American politics”- don’t touch
|
or you’ll die
|
|
By some estimates
|
SS keeps 60% of elderly out of poverty
|
|
If social security has just replaced private savings
|
then it has not solved a consumption smoothing problem.
|