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40 Cards in this Set
- Front
- Back
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Aggregate Demand
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A schedule or curve that shows the amounts of real output (real GDP) that buyers collectively desire to purchase at each possible level.
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The AD curve slopes downward because of the following effects of a change in price level
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1. Real-balances Effect
2. Interest-rate Effect 3. Foreign Trade Effect |
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Determinants of Aggregate Demand
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Changes in Consumer Spending
Changes in Investment Spending Changes in Government Spending Changes in Net Export Spending |
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4 Factors Affecting Changes in Consumer Spending
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- Consumer wealth
- Consumer expectations - Household borrowing - Personal taxes |
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Factors Affecting Changes in Investment Spending
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Interest Rates
Expected Returns - Expectations about future business conditions - Techonology - Degree of excess capacity - Business taxes |
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Factors Affecting Changes in Government Spending
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- Government spending increases, aggregate demand increases (as long as interest rates and tax rates do not change)
- Government spending decreases, aggregate demand decreases --> less transportation projects |
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Factors Affecting Changes in Net Export Spending
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- National income abroad
- Exchange rates |
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Aggregate Supply
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A schedule or curve showing the relationship between the price level of output and the amount of real domestic output that firms in the economy produce.
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AS in the Immediate Short Run
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- Both input and output prices are fixed
- The aggregate supply curve is horizontal at an economy's current price level - With output prices fixed, firms collectively supply the level of output that is demanded at those prices |
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AS in the Short Run
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- Begins after the immediate short run ends.
- A period of time during which output prices are flexible but input prices are either totally fixed or highly inflexible. - Curve is upward-sloping, shows a positive relationship between the price level and the amount of real output that firms will offer for sale - It is relatively flat below the full-employment output, and relatively steep beyond the full-employment output |
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AS in the Long Run
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- For the economy as a whole, it is the time horizon over which all output and input prices are fully flexible
- Begins after the short run ends - Price-level changes do not affect firms' profits and thus they create no incentive for firms to alter their output. |
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Determinants of Short-Run Aggregate Supply
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1. Change in input prices
a. Domestic resource price b. Price of imported resources 2. Change in productivity 3. Change in legal-institutional environment a. Business taxes and subsidies b. Government regulation |
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Equilibrium
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Occurs at the price level that equalizes the amount of real output demanded and supplied
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Increases in AD: Demand-Pull Inflation
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For any initial increase in aggregate demand, the resulting increase in real output will be smaller the greater is the increase in the price level.
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Decreases in Aggregate Demand
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Recession
Cyclical Unemployment |
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Deflation
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A decline in the price level - a rarity in the Canadian economy.
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Decreases in AS: Cost-push inflation
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Effects of a leftward shift in AS are doubly bad.
- output decreases - price level increases |
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Increases in Aggregate Supply
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Full Employment with Price-Level Stability
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Relationship of the AD curve to the Aggregate Expenditures Model
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- A change in the price level alters the location of the aggregate expenditures schedule through the real-balances, interest-rate, and foreign-trade effects.
- The AD curve can be derived from the aggregate expenditures (AE) model by allowing the price level to change and observing the effect on the AE schedule and thus on equilibrium GDP. |
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AD shifts and the Aggregate Expenditures Model
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- With the price level held constant, increases in consumption, investment, government, and net export expenditures shift the AE schedule upward and the AD curve to the right.
- Decreases in these spending components produce the opposite effects. |
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Fiscal Policy
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Since 1945, fiscal policy has been one of the government's main stabilization policy tools.
- Considered "active" if changes in gov't spending or taxes are at the option of the government - "Non-discretionary" if independent of parliamentary aciton |
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Expansionary Fiscal Policy
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Used when recession occurs
Options: - increased government spending - tax reductions - may create a budget deficit |
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Contractionary Fiscal Policy
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Used to combat demand-pull inflation
Options: - decreased government spending - increased taxes |
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Policy options: to expand the size of the government
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- If recession, then increase government spending
- If inflation, increase taxes |
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Policy options: to reduce the size of the government
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- If recession, then decrease government spending
- If inflation, decrease taxes |
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Built-In Stability
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Net tax revenues vary directly with GDP
- Taxes rise when GDP rises, and vice versa - Transfer payments fall when GDP rises, and vice versa Leads to automatic stabilization over the business cycle |
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Automatic or Built-In Stabilizers
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A structure of taxation and spending that:
- increases the deficit (reduces the surplus) during recession - increases the surplus (reduces the deficit) during inflation |
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Economic importance of built-in stabilizers
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- the stabilizers will automatically restrain economic expansion and cushion economic contraction
- taxes reduce spending and aggregate demand - reductions in spending are desirable when the economy is developing inflationary pressures, wheras increases in spending are desirable when the economy is slumping |
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Tax Progressivity
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Tax progressivity can be:
- Progressive - Proportional - Regressive The more progressive the tax system, the greater the economy's built-in stability. |
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Evaluating Fiscal Policy
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- Adjust deficits and surpluses to eliminate automatic changes in tax revenues
- Compare adjusted budgets to GDP |
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Cyclically Adjusted Budget
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Shows what the budget balance would be if the economy were operating at full employment.
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Recent Canadian Fiscal Policy
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- Neutral to mildly expansionary in the early 1990s
- Contractionary in late 90s - Between '95 and '07, actual deficits have given way to actual surpluses - In '08, "Canada's Economic Action Plan" and the federal budget moved quickly to a deficit - In '09, expansionary fiscal policy |
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Problems, Criticisms, and Complications of the Fiscal Policy
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Problems of Timing
- Recognition Lag - Administration Lag - Operational Lag Political Considerations Future Policy Reversals Offsetting Provincial and Municipal Finance Crowding-Out Effect expansionary fiscal policy may lead to: - higher interest rates - reduction in interest-sensitive spending May not be significant in a recession Fiscal policy can be accommodated by increases in money supply. |
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Fiscal Policy: The Effects of Crowding Out and the Net Export Effect
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With an upward-sloping aggregate supply curve, a part of the impact of an expansionary policy will be reflected in a rise in the price level rather than an increase in real output and employment.
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Net Export Effect of Expansionary & Contractionary Fiscal Policy
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Expansionary: Net exports decline (AD decreases, partially offsetting the expansionary fiscal policy)
Contractionary: Net exports increase (AD increases, partially offsetting the contractionary fiscal policy) |
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Budget Surplus
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Annual amount by which government revenues exceed government expenditures
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Budget Deficit
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Annual amount by which government expenditures exceed taxes
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Public Debt
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Accumulation of all past deficits and surpluses
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False Concerns in regard to Public Debt
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Bankruptcy
- refinancing - taxation Burdening Future Generations - Canada owes a substantial portion of the public debt to itself |
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Significant Issues in regard to Public Debt
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Income Distribution
Incentives External Debt Crowding-Out Revisited |
