Skills&Principles Summary
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Transcript of Skills&Principles Summary
1
Problem Explanation
Week 1
Voluntary exchange
Real-Nominal Principle
Determinants of Demand
Demand Function
Demand Curve
Income Effect
Substitution Effect
Giffen Goods
Bandwagon Effect
Snob Effect
Veblen Effect
Supply
Determinants of Supply
Market Supply
Supply Curve
Shift of D Curve
Shift of S Curve
Voluntary exchange > both better offOne will not agree, until gain something off it
People ≠ interested in nominal valuesBut real values, i.e. 5000 (nominal) = 2,500 (real), incl. taxes
Prices of the good in question (Px), Prices of related goods (Pr), Expectations of Price Changes (Pe),Consumer Incomes (Yc),Consumer Tastes and preferences (Tc),Advertising (A),Others (government policy, demographics, etc)
QDx = f (Px, Pr, Pe, Yc, Tc, A, etc.)
Quantity demanded in relation to the Price
Falling price, causes people to feel richer = people buy more
Other goods are consumed, prices fall, Q increases
Rise in their prices make people buy more(rice and noodles in China, gasoline, parfum e.g.)
Increasing D, others buy the commodity as well
Decreasing D, others buy the commodity as well
Increasing D, cause increasing Price (luxury cars, e.g.)
Quantities a Firm is willing to supply
Prices of the Good in Question (Px)Prices of Inputs (Pf)Availability of Inputs (Sf)Technology (T)Environment (W)Government Policy (G)
QSx = f (Px, Pf, Sf, T, W, G)
Quantity Supplied in relation to the Price of the Commodity(higher P, higher Y; lower P, lower Y)
To the Right: Increasing D, Increasing Y (Px constant)To the Left: Decreasing D, Decreasing D (Px constant)
Down: Increasing S, Decreasing PxUp: Decreasing S, Increasing Px
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Equilibrium (D+S)Market Price in Competitive Markets
Law of Demand
Law of Supply
Willingness to pay
Consumer Surplus
Total Consumer Surplus
Willingness to accept
Producer Surplus
Producer Surplus
Total Surplus
Market Equilibrium
The Invisible Hand
Elasticity
(1) Point Elasticity
(2) Arc Elasticity
(3) Calculus Approach
Intersection of D and S Curve
Upward Shift in D, shortage, increasing P(new market Equilibrium)
Upward Shift in S, surplus, decreasing P(new market Equilibrium)
Max. amount you’re willed to pay
Difference between your willingness and the price(willed: 10€, paid: 5€, consumer surplus: 5€)Measured by the area below Equilibrium, above P
Sum of consumer surpluses in the market
Min. amount willing to pay = marginal cost of production
Difference between Price received and marginal cost(cost: 10€, charges: 20€, producer surplus: 15€)Measured by the area above Equilibrium, below P
Sum of surpluses earned by all producers
Consumer + Producer Surplus
Highest possible Surplus, therefore Efficient
Most efficient market Equilibrium, in case of:(1) No external Benefits (pollution)(2) No external Costs (free riders)(3) Perfect Information (statistics)(4) Perfect Competition
Measures the degree of sensitivity of quantity demanded,or quantity supplied to changes in any determinant
Measures the percentage change in the dependent variableCaused by the percentage change in the independent variable(determinant), holding the values of other variables constant:
Measures E at a specific point on the Curve
Calculates the Average E between points on the Curve
(summary measure of all points)
Uses differential Calculus (derivatives) in measuring EMeasures E by visual Inspection
3
(4) Geometric or GraphicalApproach
Elasticity CoefficientE = 1E > 1E < 1E > 0E < 0E = 0
More Elastic
Less Elastic
Total Revenue(Total Sales)
Elasticity CoefficientE > 1E < 1E = 1
Week 2
Governmental Intervention
Price Ceiling
Price Floor
Consumer Choice
Consumer Equilibrium
Producer Choice
Producer Equilibrium
Law of dim. MU
Price/Supply/Output ElasticityUnitary ElasticElastic (Luxury)Inelastic (Necessity)
- (Normal) = Substitute- (Inferior) = Complement- Unrelated
Substitutes, Multiple Uses, Large Outlays, Luxuries
Complements, Limited Uses, Small Outlays, Necessities
TR = P * QMR = Slope of TR Equation(change in TR, when one more unit is sold)TR = max when MR = 0
Elastic (P increases, TR falls; P decreases, TR rises)Inelastic (P increases, TR rises; P decreases, TR falls)unitary(P increases, TR max; P decreases, TR max)
Price Controls, Taxes, Controlling QuantityCauses Deadweight Losses
Price below the Equilibrium Price (shortage)
Price above the Equilibrium Price (surplus)
Maximize satisfaction (combination of goods)X and Y goods that yield the same level of utility
Indifference CurveMarginal Rate of Substitution of Y for XMUX / MUY
Tangency budget line and indifference Curve (highest possible)
Maximize Profits (combination of goods)Two inputs > specific level of output
Isoquant CurveMarginal Rate of Substitution of L for K in producingMPL/MPK
Tangency isocost line and isoquant curve (highest possible)
Extra Utility you get for a certain commodity diminishesas extra units are obtained, and increases attractivenessof other commodities
Extra productivity or addition to output obtained by a firm
4
Law of dim. MR
Factors of Production
Marginal Product
Average Product
Output Elasticity
Optimal Hiring Rule
Increasing Returns
Constant Returns
Decreasing Returns
Oppurtuntiy Cost
Profit
Variable Costs (TVC)
Fixed Costs (TFC)
Total Costs (TC)
Average Fixed Costs (AFC)
Average Variable Costs (AVC)
Average Total Costs (ATC)
Elasticity of Total Cost (EC)
Diseconomics of Scale
by using an extra unit of variable input (L, K) diminisheswhen combined with fixed quantities of another input (R)
Fixed Inputs: cannot change (land, buildings, factory)Variable Inputs: directly related to Y (labor hours, machines)
Change in total product per unit change in the variable inputMPL = dTP / dL or MPk = dTP / dK
Total product divided by the quantity used of variable inputAPL = TP / L or APK = TP / K
EL = MPL / APL
EK = MPK / APK
MRP = MRCMRP = Marginal Revenue Product of the variable Input(+1 worker = +1 sale)MRC = Marginal Resource Cost of the variable Input(+1 worker = increase in total costs)
Y increases greater then increase in Inputs (inc. slope)
Y increases in same proportion as Inputs (const. slope)
Y increases in a smaller proportion as Inputs (dec. slope)
You sacrifice A, to get B (Slide 75)
Total Revenue – Total CostAccounting Profits = TR - Explicit CostEconomic Profits= TR - Explicit - Implicit Cost
Costs that are a function of Output
Costs that do not vary directly with Output (e.g. Rents)
TC = TFC + TVC
AFC = TFC / Q
AVC = TVC / Q
ATC = TC / Q = AFC + AVC
Measures the percent change in TC, resulting from a 1% change in Output QEC = (dTC / dQ)/TC / Q = MC / ATC
When Firm increases its outputs, long-run average cost of production increases, two reasons:a, coordination problems and b, increasing input costs
Marginal Product of L Change in Output, from one additional unit of L
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Marginal Revenue Productof Labor (MRP)
Output Effect
Input-substitution-effect
Why Wages differ
Lorenz Curve
Gini coefficient
WEEK 3
Structure-
Conduct-
Performance-
Matrix
Perfect Competition (S.4)
Contribution Margin
Extra revenue generated from additional unit of LMRP = marginal product x price of output
Change in Quantity of Labor demandedresulting from a change in Y
Change in Quantity of Labor demandedResulting from an increasing price of L, relative to the price of other Inputs
Few people with required SkillsHigh Training CostsUndesirable Working ConditionsArtificial barriers to entry (e.g. Doctors, licensing)Racial DiscriminationLearning Effect (learning skills, college graduates)Signaling Effect (information about skills, college graduates)
Represents Income distributionCumulative distributive Function of a probability distributionPercentage of Households: X-AxisPercentage of Income: Y-AxisTherefore, measures social inequality
Area between the line of perfect equality and theobserved Lorenz Curve, percentage change between boththe higher the coefficient, the more unequal the distribution is
Description of key features of the market (buyers, sellers)
Description of the behavior of firms (pricing)= Competition among firm
Description of the welfare effects (use of resources)= deadweight-losses?
determines the behavior of firms = determines the various aspects of market performance
no single Firm can influence prices (large number of firms)perfect information: buyers/sellers = same Informationhomogenous products (standardized)mobility of sourcesmarket operates (buyers/sellers are price takes)short-run profit, long-run: break-even (see also S. 5)Firms produce, Price = LAC (lowest possible price for consumer)Long-Run: resources are efficiently utilized, no idle capacityTo Maximize profits: Produce when MR = MCBreak-Even Point: TR = TC
How much of fixed costs is being recovered when a product
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Average Contribution
Break-Even Point (S. 22)
Operation of Firms
Short-Run Curve
Short-Run Equilibrium
Long-Run Equilibrium
Long-Run SupplyAC increases
Constant-Cost-Industry
Symptoms of Market Failure
Imperfect Markets (S. 41)
Monopoly (S. 42)
sells at a certain price:TCM = TR – TVC
Difference between the selling price of the product and the unit variable costACM = P – AVC
Profit = Area below TR and TC, after intersection of TR and TCmaximizing profits:reducing fixed costsreducing the average variable cotsraising the price
TR > variable costs (firms operate)TR < variable costs (firms shut-down) = MC = AVC
Relationship between market price and the quantity supplied(by all firms in the short-run)
Quantity Supplied = Quantity DemandedMaximization of Profits, given the market price
both short-run conditions are met, plus,each firm earns zero economic profit(no incentive for other firms to leave the market, or to enter)
Increasing Input Price (limited amounts drive up competition)Less Productive Inputs
AC of production = constant horizontal long-run supply curve
Microeconomic Level Existence of imperfect markets presence of externalities asymmetric information provision of public goods
Macroeconomic Level Income inequalities Existence of unemployment and business cycles
Perfect Competition = IDEAL Imperfect Competition Monopoly Oligopoly Duopoly Monopolistic Competition
Single Seller, product has no close substitutesbarriers to entry, control over market resources, patentsPrice > MR (earns extraordinary profits)produces where MR = MCTherefore, can increase profits and cause price discriminationproduces less, charges higher prices (misallocation of R)Negatively sloping Demand Curve
7
Monopolist’s Output
Deadweight Losses (S. 49)
Price DiscriminationSlides 55 – 57
Natural Monopoly
Price Controlsof Monopolies
Antitrust Policy
to sell more, lower prices: MR < PMR curve is below the Demand CurveExtraordinary profits, because of AC Curve (above MR)Governmental intervention (taxing profits), or lower price
Quantity Supplied = Intersection of MR and MCProfits = Intersection of AC and MC up to Demand (S. 43)
Q satisfies marginal principle, MR = MCDemand Curve determines the price associated with QProfit per Unit sold = P – ACTotal Profit = Profit per Unit * Number of sold Units
A measure of the inefficiency from monopoly;equal to the decrease in the market surplus
Charging different Prices for different GroupsOpportunity for Price Discrimination, when
Firm got market Power Different Consumer Groups Resale is not possible
Idea: Reduce Deadweight Loss arising from monopolyand recapture loss in Consumer SurplusConsumer’s Loss causes increasing Producer’s benefitExamples: airline tickets (discounts), discount coupons, etc.
A market in which large economies of scale ensure thatonly a single large firm can surviveGovernment can intervene by regulating the priceA monopoly can sometimes be better for efficiency reasons
Output Level: MR = MC
A Second Firm won’t enter the market, becauseits demand curve will always lie below the Long-Run AC
Price Controls, Antitrust Laws Breaking Up Monopolies Blocking Mergers Regulating business practices Deregulation and privatization
e.g. AC Pricing Policy:D Curve intersects the long-run AC Curve(=governmental intervention, new prices)
To break up dominant firms, prevent some corporate mergers,and regulate business practices that reduce competition
1, e.g. break up one firm into several smaller firmsTrust = arrangement under which the owners of several firmstransfer their decision-making powers to small group of trustees
2, to block mergers that would reduce competition and lead to higher prices (merger = one or two firms combine operations)3, Tie-in-Sales (buyers are forced two buy a second product)
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Monopolistic Competition(brand markets)
Short-Run
Long-Run
Monopolistically Com-petitive Market
Effects of Market Entry
Entry-Stops:Long-Run Equilibrium
Monopolistic vs.Perfect Competition (A)(S. 85)
Monopolistic vs.Perfect Competition (B)(S. 86)
WEEK 4
3, Predatory Pricing (firm decrease price to drive out rivals)= both will practices will be supervised by government
Many firms selling a differentiated productease of entryblend of competition and monopoly (brand loyalty)availability of close substitutes limits monopoly powerfirms engage in non-price competition (Advertising) toraise market shareclustering of pricesfirms misallocate resources but to lesser degree (sincedemand is elastic)more variety of consumers, but advertising and productdifferentiation may be excessive and wasteful
Negatively sloped Demand Curve (more elastic due toavailable substitutes)Maximization of Profits at MR = MC but P > AVC
Firms are attracted, because of short-run profitsor leave, faced with losses until D Curve of remainingfirm is tangent to AC and firms break even (P=AC) (S. 76)
Each firm produces a slightly different product(narrowly defined monopoly)Products sold by different firms are close substitutes(keen competition between firms for consumers)
Decreasing Profits, due to market price drops quantity produced decreases firm’s AC of production increases
Firms enter the market until such point that prices areequal to AC (break even). Thereafter, firms will neitherenter nor exit the Industry (S. 83)
Perfectly competitive market, firm-specific D Curveis horizontal at the market price, and MR equals Price.Equilibrium: Price = MC = ACThe Equilibrium occurs at the minimum of the AC Curve
Monopolistically competitive market, firm-specific D Curveis negatively sloped and MR < Price.Equilibrium: MR = MC and Price = AC
9
Oligopoly
Cournot Duopoly (S. 5)
Bertrand Duopoly (S. 6)
Edgeworth Duopoly (S. 7)
Sweezy Oligopoly (S. 8)
Oligopolistic Behavior
Game Theory (S. 11)
Few sellersProducts may be homogeneous or differentiatedEntry Barriers exist (Cartels, established firms lower prices)Firms are mutually interdependentFirms engage in non-price competition (Advertising)Firms collude on what prices to charge orhow to divide the market to prevent new entrantsPrices tend to be rigidFirms misallocate resources and can earn profits in thelong-run because of restricted entryExcessive Advertising and differentiation, spend on R&D
Involves Uncertainty about Reaction of the Competitor
Two firms react to each other’s output changes untilboth reach an equilibrium positionReaction continue until both firms have equal output
Two firms react to each other’s output changes untilboth reach an equilibrium positionBoth firms set prices, assuming the other firm’s priceis independent of its own choice of outputIf both firms set equal Prices > MC, outbalanced market sharebut, if one lowers, it gains the whole marketBoth are therefore tempted to lower pricesFirm won’t P < MC, otherwise lossIntersection of both, P = MC
Firms act as a monopolist, Profit Maximization MR = PCharacterized by price undercuttingsPrice undercutting continues until both reach Max. Output
Kinked Demand CurveD Curve is bent at the prevailing market Price (kink)price increase: other firms won’t change their prices(quantity will decrease by large amount, elastic)price decrease: other firms will also decrease their prices(quantity will increase by small amount, inelastic)
Responses to Uncertainty
Cartel Pricing1, Cartel = group which coordinates pricing decisions(often charging the same price for a particular good)2, Arrangement under which the two firms act as one(coordination their pricing decisions = price fixing)
Study strategic behavior of oligopolists, study of decision-making in strategic situationsBasic Elements
Players (Parties) Strategies (Possible Actions) Payoffs (Each receives for following a strategy)
dominant strategy = yields a higher payoff, no matter what
10
Duopolists’ Dilemma
Guaranteed Price Matching
Overcoming the Dilemma(S. 26)
Price Leadership
Limit Pricing
How to measure MarketPower?
1, Lerner Index(S. 35)
2, Herfindahl Index(S. 36)
Concentration Ratios
the other player choosesdominated strategy = leads to a lower payoff than analternative choice, regardless of what the other chooses
Although both firms would be better off if they chose thehigh price, each firm chooses the low price (SS. 16 – 17)
occurs because the two firms are unable to coordinatetheir pricing decisions and act as one (s.a. Prisoner’s dilemma)
Strategy where a firm guarantees it will match a lower priceby a competitorEliminates the duopolists’ dilemma and makes cartel profitsand pricing possible, even without a formal cartel
Leads to higher priceBUT, guarantees that consumers will pay the high price
1, duopoly pricing strategy2, grim-trigger strategyi.e. firm responds to underpricing by choosing a price so lowthat each firm makes zero economic profit3, tit-for-tat strategyi.e. one firm chooses whatever price the other firm chosein the preceding period
One Oligopolist = Price Leadersets a price, while expecting that other firms will match the Pricebut, signals may be misinterpreted1, change in market conditions, just match the price, butprice fixing continues2, under pricing, price war may be triggered, result:destroying the price-fixing agreement
Picking a price which is lower than normal monopoly Price
1, Lerner Index2, Herfindahl Index
Indicator of monopoly Power, defined as:L = (P – MC) / PPerfect Competition: P = MC (value of zero)P > MC, Index varies between 0 and 1The closer to 1, the greater the degree of Monopoly
Index measures industrial market concentrationindividual market share of each firm in fractional terms is squaredthe H-index is given by the sum of the squared terms:H = Σ si
2 (si = market share of the firm)
H-Index takes into account the number of firms,and their size differencesN-equal-sized firms = 1/N, Monopoly = 1, tend to one when fewfirms and/or greater degree of inequality in market sharesMeasure Industry Concentration, degree of market control
11
Exercises:Slides 42 – 45
Monopsony (S. 47)
Monopoly vs. Monopsony(S. 50)
WEEK 5
Macroeconomic Goals
Macro- Instruments (S. 3)
Circular Flows of IncomeSlides 4 – 9
Dual Gap Analysis
Real Sector Indicators
National Accounts
Ratio = Proportion of total Output produced by the firms,focusing on the largest firms (≠ HHI, focus on entire industry)
e.g. ratio over 90% of industry’s output produced by the fouror the eight largest firms, indicates oligopolistic marketstructures, significant market control (S. 38)
One single buyer of a producte.g. government marketing board buys all Y of Farmers
Positively sloped market supply of laborto hire more workers, pay higher wages(Marginal Labor Costs > Wage)
Hire more workers:Marginal Benefit of Labor = Marginal Labor Cost
Monopoly: single seller of output high price of output small quantity of output monopolist uses market power to increase P
Monopsony: single buyer of input low price of input small quantity of input monopsonist uses market power to decrease wages, or other input prices
achieve sustainable economic growth (GDP/GNP) contain inflation to moderate levels provide employment / reduce unemployment attain external balance distribute fruits of growth equitably
Monetary Policy (money supply, interest rates, etc.)Fiscal Policy (taxation, expenditures, etc.)External Policy (exchange rate, debt management)
Financial Sector Gap: S – IGovernment Sector Gap: T – GExternal Sector Gap: X – M(S – I) + (T – G) = (X – M)
GDP / GNP (nominal, real, per capita)Price Indicators (CPI, PPI, WPI, RPI, GDP deflator)Employment (Labor force, employment rate, unemployment)Business Cycle Indicators (leading, co-incident, lagging)
1, Gross Domestic Product (GDP)
12
GDP
Real GDP
Nominal GDP
How to measureNational Income
Private Investment
Net Exports
= final output produced in a given country2, Gross National Product (GNP)= final output produced by nationals of a country, includingthose who are abroard; GDP + income from abroad = GNP3, Net National Product (NNP)4, Gross National Income (GNI)5, Net National Income (NNI)= GNP less depreciation6, Disposable Income (DI)7, National Income= NNP less indirect taxes
Total market value of all the final goods and services producedwithin an economy in a given yeartotal market value = Q * P
only newly produced goods are included in GDP
Takes into account Price changesmeasure of total output does not increase just because pricesincrease, uses prices as of a base year, prices are thereforekept constant, i.e. only Q changes
current prices to measure GDPPrices can increase due to higher costs of Production
1, production approachmeasuring value added in all firms and industriesGDP by industrial originthree major groupings: agriculture, industry and servicesvalue added = additional value at each stage of productionfinal products are counted; ≠ intermediate inputs2, income approachmeasuring value added contributed by economic factorsadding up all rewards for factor incomes:
wages (labor income) profits and dividends (firm’s income) interest income (on savings) rent (landlord’s income)
3, expenditure approachmeasuring all components of aggregate demandadding up all demand in the economy, consisting of
private consumption private investments government spending net exports (exports less imports)
Spending on new plants and equipmentNewly produced HousingAdditions to Inventories during the current year
New investment expenditures = gross investmentNet Investment = Gross Investment – Depreciation
Total Exports – Total Imports
13
Trade Deficit
Trade Surplus
GDP Equation
Personal disposableIncome
Fluctuations in GDP(S. 34)
Inflation Rate
CPI(S. 39)
Costs of Inflation
How to measureUnemployment
Labor Force
Cyclical Unemployment
Frictional Unemployment
Structural Unemployment
Seasonal Unemployment
Income-Expenditure-Model
Consumption Function
Import > Export
Import < Export
YGDP = C + I + G + NXGDP = Consumption + Investment + Government Purchases+ Net Exports
Income of household after paying income taxes
1, Peakoutput starts to decline: recession starts2, Troughoutput starts to increase: recession begins to end3, Expansionrecovery period4, Recessionsix consecutive months of declining real GDP
dP/P (percentage rate of change of a price index)
Measures changes in a fixed basket of goods
CPI in year K = (cost of basket in year K)/(in base year) * 100
Creates Winners and LosersIndividuals and Institutions will change behavior+50%/month: Hyperinflation (s.a. Scooter – Hyper Hyper)
unemployment rate = unemployed / labor force
Employed + Unemployed
accompanies fluctuations in real GDP
occurs because it takes time to find a job / hire workers
occurs when jobs are eliminated and new jobs are created
harvest season, winter season, etc.
Developed by J. M. KeynesHigher Expenditures = generate higher levels of income
Equilibrium Output = y* = C + I = planned expenditures
Keynesian Cross (S. 64)
Output > Demand (glut), production would fallOutput < Demand (shortage), production would rise
Relationship between Consumption spending and
14
Savings Function
The Multiplier(S. 73)
Government Spendingand Taxation
Fiscal Multipliers
Automatic Stabilizers
the level of Income
C = Ca + byCa = autonomous consumption, does not depend on incomeby = Marginal Propensity to Consume (MPC)i.e. the fraction of additional income that is spent
Increase/decrease in Ca shits the entire function up/down increase in consumer wealth, increasing Ca
increase in consumer confidence, increasing Ca
Increase/decrease in MPC increases/decreases the slope
Equilibrium Output:C + I intersect 45° line, at that level of output,y* = desired spending equals output
Relationship between level of saving and Level of IncomeIncome is either spent (C) or saved (S)
Therefore, Marginal Propensity to Save = 1 – MPC1 = MPC + MPS
Equilibrium Output = I = SLevel of Savings ≠ fixed, depends on GDP
Fraction to save determined by MPS
When Investment increases by ΔI from I0 to I1, Equilibrium output increases by ΔY from Y0 to Y1
The Result: ΔY > ΔI
Government Spending and Level of Taxationaffect the level of GDP in the Short-Run (influence on D)
Keynesian Fiscal Policy:Taxes and spending to influence the level of GDP
Planned expenditures including government = C + I + G
multiplier for government spending:
or the Consumption Function with Taxes is:
Disposable income is: y- T
Tax Multiplier:
or
Automatic Stabilizers are taxes and transfer payments thatstabilize GDP without requiring policy-makers to take explicit
15
Aggregate Demand(S. 87)
Equilibrium Output
Multiplier forInvestment
actions: when income is high, G collects more taxes, and pays
out less transfer payments, decreasing consumer spending when output is los, G collects less taxes, and pay
out more in transfer payments, increasing consumer spending
AD Curve shows the combination of prices and Equilibrium Output
Prices Fall > Expenditures Increase > Y increases (S. 87)G increases > Expenditures Increase > Y increases (S. 88)Increasing G Spending shifts the AD Curve Up
Output = planned expenditures = C + IOutput = C + I
Consumption Function
For a new Level of Investment I0, we have
For a new level of Investment I1, we have
Substituting for the levels of Output, we have
Because (I1 – I0) is the Change in Investment, we can write:
16
Government Spendingand Taxes(S. 94)
Summary
WEEK 6
Government Spending and Taxes:
Government Expenditure: 1 / MPSTax Multiplier: -MPC / MPSBalanced Budget: 1With Trade: 1 / (1 – MPC + MPM)With Tax and Trade: 1 / (1 – MPC (1 – t) + MPM)
MPC = Marginal Propensity to ConsumeMPS = Marginal Propensity to SaveMPM = Marginal Propensity to Importt = Tax Rate
17
Phillips Curve
Stagflation
Friedman
Rational Expectations
Natural Rate ofUnemployment
Velocity of Money
Quantity Theory ofMoney
Money as a veil
Money is desired as
Negative Relationship btw. wages and unemployment(wages were indicators of Inflation)Increasing Money Supply leads to decreasing Unemployment,but increasing Inflation
Stagnation (Recession) combined with Inflationtrade-off between unemployment and Inflation (Phillips) isno longer observed
Demand-Pull Inflation:Shifting D Curve: Unemployment dec., Inflation inc.
Cost-Push InflationShifting S Curve: Unemployment inc., Inflation inc.
Introduced the idea of adaptive Inflation expectations
Expectations Philips Curve:Relationship between Unemployment and Expectations,when taking into account expectations of Inflation
Unemployment varies with unanticipated Inflation
When economy experiences a boomUnemployment is below natural rate, Inflation is higher than expected
When economy experiences a recessionUnemployment is above natural rate, Inflation is lower than expected
People look at all variable information in making judgmentspolicy = ineffective, people will outguess governmentPeople will realize trend in policies and incorporate this intheir expectations
Public forecasts the future correctly, on average
Rate of Unemployment can shift demographics, composition of workforce institutional changes state of the economy changes in growth of labor productivity
velocity of money = nominal GDP / money supply
M * V = P * YIncrease in Money Supply leads to an increase in Prices
Money has a neutral effect on physical or real quantitiesof output
temporary abode of purchasing power and store of wealth
18
a commodity
Money Neutrality
Money Dichotomy
Fisher’s Equation
Hyperinflation
Price stability accordingto Friedman
Keynes vs. Friedman
Fiscal Policy
Expansionary andContractionary Policies
FriedmanContributions (S. 38)
Government Spending
WEEK 7
Change in Supply of Money will not change Y in the long-run
Distinction between nominal and real values;money is a veil in the long- and the short-run
M * V = P * T(V, T = constant, change in M will increase P)
Arises when Government allows money supply to grow inorder to finance the gap between government spendingand revenues – the budget deficit
Governments could use a mix of borrowing funds from thepublic and printing money to cover the deficit
Government is forced to print new moneyto stop Hyperinflation, eliminate G deficit = stop printing
Rate of growth of money supply equal to long-run rate ofeconomic growth = price stabilityMV = GDP
Slide 40Monetarism vs. Fiscal
Allocation (provision of goods and services) Distribution (altering distribution of income) Stabilization (address problems of unemployment) Regulation (legal framework)
Expansionary: increase ADContractionary: decrease AD
Lags: Inside (Problem – Implementation) versus Outside Lags (Policy – Impact)
Monetary: Inside Lag (Short) Immediate Implementation of BanksOutside Lag (Long) 1-3 years for interest rates or moneysupply to have an impact on inflation
Fiscal:Inside Lag (long) Government takes time to enact tax measuresOutside Lag (Short) Taxes are raised, immediate impact
general public services defense education health social security and welfare debt servicing, economic services
19
Spiderpig, Spiderpig,does whatever a Spiderpig does…
Can he swing from a web? No, he can’t, he’s a pig.Look Out! Here is a Spiderpig!