Unit III (Fiscal Policy)

- Changes in the expenditures or tax revenues of the federal government.

• 2 tools of Fiscal Policy:
  -Taxes - government can increase order or decrease taxes
  -Spending - Government can increase or decrease spending

-Inverse relationship

Unit III (The Spending Multiplier Effect)

- An initial change in spending (C, IG, G, Xn) causes a larger change in any aggregate  Spending,or Aggregate Demand (AD).

-Multiplier = Change in AD / Change in Spending-Multiplier = Change in AD / Change in C, I, G, or Xn

• Calculating the Spending Multiplier:

-The Spending Multiplier can be calculated from the MPC or the MPS.

-Spending Multiplier = 1 / 1 - MPC or 1 / MPS-Spending Multipliers are (+) when there is an increase spending and (-) when there is a decrease in spending.

• Calculating the Tax Multiplier:

-When the government taxes, the multiplier works increase 

-Why?  

-Because now $ is leaving the circular flow.

-Tax Multiplier ( note: it’s negative)-Tax Multiplier = -MPC / 1 - MPC or -MPC / MPS-If there is a tax -CUT, then the multiplier is (+), because there is now more $ in the circular flow.

Unit III ( Marginal Propensity to Consume)

-The fraction of any change in disposable income that is consumed.

-MPC = Change in Consumption / Change in Disposable Income

-MPC = Change in Savings / Change in Disposable Income

• Marginal Propensities:

• MPC + MPS = 1
• .: MPC = 1 - MPC
• .: MPS = 1 - MPC
• Remember that people do two things with their disposable income, consume it or save it

Unit III (Disposable Income)

- Income after taxes or net income.

-Formula: DI = Gross Income - Taxes

-Two Choices

With disposable income, households can either :

• Consume (spend $ on goods and services)
• Save (not spend $ on goods and services)

• Consumption:

-Household Spending

-The ability to consume is constrained by:

-The amount of disposable income 

-The propensity to consume

-Do households consume if DI =0?
-No

• Saving:

-Household NOT spending 

-Ability to save is constrained by :

-Amount of DI

  - Propensity to consume

- Do households save if DI = 0?

-No

-APC and APS formulas:

• APC + APS = 1
• 1 - APC = APS
• 1 -  APS = APC
• APC > 1 (period of dissaving)
• -APS (period of dissaving)

Unit III (Shifts in Investment Demand)

• Cost of Production:

-Lower costs shifts ID right  

-Higher costs shifts ID left

•  Business Taxes:

-Lower business taxes shifts ID right 

-Higher business taxes shifts ID left

• Technological Change
  
  
  -New technology shifts ID right
  
  
  -Lack of technological change shifts ID left
  
  
• Stock of Capital:
  
  
  -If any economy is low on capital, then ID shifts right
  
  
  -If any economy has much capital, then ID shifts left
  
  
• Expectations:
  
  
  -Positive expectations shift ID right
  
  
  -Negative expectations shifts ID left
  
  
  

Unit III (Invest Rates and Investment Demand)

What is Investment?

- Money spent or expenditures on:

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

Expected Rates of Return

1. How does business make investment decisions?
1. Cost/ benefit analysis
2. How does business determine the benefits?
1. Expected rate of return
3. How does business count the cost?
1. Interest costs
4. How does business determine the amount of investment they undertake?
1. Compare expected rate of return to interest cost
• If expected return > interest cost, then invest
• If expected return < interest cost, then do not invest

Real (r%) vs. Nominal (i%)

What’s the difference?

-Nominal is the observable rate of interest. Real subtracts out inflation (π%) and is only known ex post facto.

1. How do you compute the real interest rate (r%)?
1. Formula: r% = i% - pi%
2. What then, determines the cost of an investment decision?
1. The real interest rate (r%)

Unit III ( Nominal Wages, Real Wages, Sticky Wages)

-Nominal wages: amount of money received by a worker per unit of time 

-Real wages: amount of goods and services a worker can purchase with their nominal wages 

-"purchasing power of nominal wages"

-Sticky wages: Nominal wage level is set according to an initial price level and does not vary due to labor contracts or other restrictions