Class Notes

See my web page and EC11 news on the upper right hand corner of the main web page (which also has
Technical Notes for Students and may be helpful at some points).
1. You need to sign up for the MyEconLab. There will be 11 homework assignments due each Sunday at
midnight, of which only 10 will be graded. No late homework is accepted by MyEconLab so you must
submit by the deadline. The final deadline is Tues the 20th at 11:59 for homework set one.
2. MyEconLab is a real resource. You should play around with it until you get the hang of all of its
features. You can really use it to study in the sense that it takes through the steps of solving a
problem and shows you where in the textbook the material is. For each homework plan to spend 2-3
hours. This is after spending 2 hours reading the chapter first. After turning in the homework you
should then go back and re-read the chapter for the fine points. It might look very different on the
second read. Following this procedure should result in a very high grade.
3. We talked about the economic way of thinking...using simple models to analyze complex phenomena.
Models can be expressed mathematically, graphically and in words. To know how to do an economics
problem thoroughly you must know all three.
4. The economic way of thinking is stylized, and not for everyone; it is often criticized as having a
libertarian bias political scientists, sociologist and other social scientists. You are to understand the
economic way of thinking in this class and not necessarily believe in it or integrate it into your world
view, political position, etc.
5. A basic tenant of the economic way of thinking is: if an individual thinks he or she is better then he
or she is better off. If some individual wants to smoke, then economics has no sound scientific way
of telling them they will be better off not smoking. This is a general rule and makes economics more
objective rather than normative. Look these terms up in Chapter 1.
6. The concept of Pareto optimality was introduced. Society is better off in Paretos sense if at least one
member is better off and no one is worse off. Society as a abstract entity, in economics, does not exist.
All economic well being must be resolved at the level of the individual.
7. Many policies hurt some individuals and help others; these are not Pareto optimal.
8. However, compensation is possible in Pareto optimality. We allow side payments to bring those who
are hurt back to their previous levels of happiness or utility. Who makes these payments? Those
who benefit from the policies. The compensation principle says that if those who are worse off can be
brought back to their previous levels of utility by those who are better off, and the latter are still better
off, then the policy is Pareto superior. One can say that society as a whole is better off.
9. Theft is not Pareto optimal. Yes, the thief if better off, but the victim is worse off. The thief cannot
compensate the victim and still be better off. Hence theft is not Pareto optimal, even if the their is
poor and deserving.
10. Markets can make people better off: We introduced the example of a prisoner of war camp, in which
the Nazis have Allied prisoners and given them a ration of one pack of cigarettes and one chocolate
each day.
11. The way we tell if an individual i is better off or not is to define a utility function
p
Ui = C1 C2
where C1 is cigarettes and C2 is chocolate.
12. Another utility function for individual j might be
Uj = C1 C21
where < 0.5 indicates a stronger preference for chocolate (and weaker for cigarettes) and vice-versa
if < 0.5 . Note that when = 0.5, the second utility function is identically equal to the first one.

13. The Allied prisoners can be thought of as an economy. This is an example of an economic model.
14. Social welfare or utility is the sum of all individual utilities for all n prisoners.
S = ni=1 Ui
15. Your assignment for Wednesday is to think about how trade between prisoners might increase S.

Rationality
1. Hamlet:What a piece of work is a man, how noble in reason, howinfinite in faculties, in form and
moving how express andadmirable, in action how like an angel, in apprehension how likea god! the
beauty of the world, the paragon of animals
2. This is essence of perfect rationality
3. Rationality: uncorrelated errors. Economic agents learn from their mistakes.
4. If agents make the same mistake over and over again, they are not rational, classical stupid.
5. Rational does not mean right all the time.
6. Rational agent models assume weirdos cancel out
7. These agents always balance marginal benefit and marginal cost.
8. Rational agents are members of the species homo economicus.

Real v. Nominal
1. Economics is not about money, but rather human activity.
2. Nominal or monetary side is money, bonds and other assets.
3. Money or the financial side of the economy is analogous to a scoreboard not the physical activity.
4. Money is nominal; activity is real.
5. Economics is mostly concerned about the real side, although now the financial crises is here.
6. This is the financial side getting in the way of the real side. Most of the time, this doesnt happen.
7. Inflation doesnt matter much, unless it gets out of hand. Inflation is always a monetary phenomenon.
Helicopters dropping money from the sky in proportion to income would not change any human activity.

Efficiency
1. Not the same as efficiency in science and engineering, not thermodynamic efficiency.
2. Efficiency in economics is subjective. We may not want some machines to work efficiently, e.g. nuclear
weapons.
3. Efficiency and income distribution are unrelated.
4. Economic allocative efficiency is maximized with free trade.
5. The book distinguished productive from allocative efficiency. This is strange, but o.k.

Models and Parables

1. There are many classic stories in economics; the prisoner of war camp is one of the them. It comes in
two versions: one in the endowment of chocolates and cigarettes is equally distributed.
2. A second version has the CO getting all the chocolates and cigarettes. This is still an efficient allocation
of resources. It may be unfair but it is not inefficient, since no trade is blocked.
3. The endowment in more complete models is given in the form of factors of production: capital, labor
and land.
4. In the prisoner of war case, this is a pure trade economy, no production.
5. In general we have factors used to produce goods which are then traded. Utility of factors is zero.
6. Parables in economics are not arbitrary; dont try to make them up yourself. This will lead to disaster.

Consumer sovereignty
1. Consumer is king: we only care about the utility of the consumer. Producers be damned. Job loss is
not taken to be bad because consumers lose their jobs, but because they lose consumption.
2. We cannot recommend any amount of income redistribution objectively. It is normative and maybe
good, but there is no scientific way of defining the optimal amount the CO should give to his men.
This also means that there is nothing wrong with his distributing all the chocolates and cigarettes as
if he hadnt been given them. There is just nothing we can say.
3. The reason for this is that there is no objective way to compare utilities between different people.
4. Utilities must be revealed in order for us to measure them. Deadweight loss in utility due to regulation.
5. Economic agents are assumed to lie in their own self-interest.
6. We can only believe that someone wants a good if they are willing to give up something else to get it.
7. This is why goods should go to the highest bidder and why inheritance in not considered a good thing
in economics.
8. I want a Porsche or Lamborghini is not taken seriously by economists if the consumer is not willing to
do the things necessary to get one; e.g. train and take a high-paying job.

Utility Maximization for Rational Consumer

1. Agents demand goods so that utility constrained by a budget is maximized.
U = x y (1)
where x is good 1 and y is good 2. This is an identical equation to the one above, but with x = C1
and y = C2
2. The is the preference parameter and can be shown to be equal to the share of the budget the consumer
will spend on the first good. By definition, the rest of the budget is spent on the second good.
3. The budget constraint is
px x + py y = B
where px is the price of good X and py is the price of good Y . The budget of the consumer (endowment)
is given by B.
4. Consumer faces prices and has budget and then makes a choice of the two goods. These are demands
and from the utility max problem we can derived demand curves.
3

5. The slope of the budget constraint is px /py. To avoid problems with inflation, we usually define one
price (typically the second good) as equal to 1. Thus, we have
p=

px
or py = 1
py

Here we say that the second good is the numeraire.

6. The consumers problem is solved by picking the point of tangency
7. Indifference curve combinations of x, y that give the same level of utility.
8. Slope of budget line p. Intercept B.
y
9. Slope of indifference curve 1
x

10. Tangency condition is what makes consumer rational

p=

y
1x

which means that we set the slopes equal.

Figure 1: Utility Maximization

1. Rationality means lean from mistakes.

2. Mistakes introduce error, but in rational person errors cancel out.
3. Dan Ariely (winner of this years Ignoble Prize in Economics )Predictably Irrational challenges rational
model
4. Says mistakes dont cancel out...theyre predictable.

IndifferenceManipulate@Plot3D@x
Curves ^ alpha * y ^ H1 - alphaL, 8x, 0, 10<,

8y, 0, 10<, AxesLabel 8"good 1", "good 2", "U"<, ImageSize 8200, 200<,

PlotLabel "Cobb-Douglas Utility Function", MeshFunctions 83 &<, Mesh 5D, 8alpha, 0, 1<D
1. Definition: combinations
of the good one and two such that utility is constant, that is, the consumer
is indifferent.

2. The function U = x y 1 is 3-D.

alpha

Out[102]=

Figure
2: Indifference curves are the contour linessame height on U axis
,

Trade Model
1. Trade model asks what happens to utility when we go from autarky to trade.
2. Autarky is when there is no trade
3. Trade is determined along comparative advantage
4. Comparative advantage asks: which good can I produce more cheaply, where cheaply is defined as how
much of other good do I have to give up to get a unit of the good I want to export.
5. Specialization A[2] B[1] means country A specializes in good 2 and B specializes in good 1.

Steps to solve trade model

Part 1
1. Find aggregate budget constraint or PPF (note that when we use B it is the budget and Y is GDP;
Y =B )
2. Find the opportunity cost of good 1 in terms of good 2 (the numeraire commodity)

3. Find tangency condition

x2
=p
1 x1

4. Solve the autarkic PPF and the tangency condition to get the demand for both goods, x1 and x2 . This
is equal to supply since there is no trade in autarky.
5. Once x1 and x2 are known, then solve for the U , the autarkic level of utility or welfare.
6. Repeat for the second country. You are now done with the first part of the problem. Save your results.
Part 2
1. To do the second part, you must be given the international terms of trade and must be in between the
two price ratios.
2. Next determine the pattern of specialization by finding the opportunity cost of the first good in terms
of the second good (slope of the autarkic PPF).
3. Compare this to the international terms of trade. If the opportunity cost is lower then specialize in
good 1; if higher then specialize in good 2.
4. Determine the new GDP = specialized output times the international price. The quantity produced
in specialization is given by the PPF used above.
Y = px1 + x2
where p is the domestic price. To find the maximum production of x1 set x2 = 0 and vice versa. A
quick way is to remember that if county is specializing in good 2, then the maximum it can produce
of good 2 is the autarkic GDP. If it is to specialize in good 1, then the most it can produce is Y /p.
5. Take the maximum production and multiply it by the international price. Remember that if it is
specializing in good 2, the international price is 1. This is new budget constraint for the country.
6. Solve the new budget constraint with the tangency condition to find out demand for goods 1 and 2.
Solve for the new level of utility.
7. Subtract demand from output both in real terms (quantities). If the number is positive then it is an
export (if negative then it is an import).
8. Compute gains from trade by subtracting the old level of utility from the new one.
9. Do the same for the second country.
10. If you want to check your math, confirm that trade is in balance. The value of exports must be equal
to the value of imports.
11. These models are unrealistic because: (a) all consumers in the same country are not identical; and (b)
countries dont specialize completely.
12. Unrealistic models can still be useful since they are mathematically tractable (can be solved)
13. This prevents us from having to do experiments with live people on scales that really matter.

Supply and Demand

1. A parameter is constant for duration of the problem. Not like a true constant (e.g. the speed of light)
2. A model : systems of equations such that the number of equations is equal to the number of unknowns.
Demand = D(x, p) Supply = S(x, p). This is two equations and two unknowns and is called general
functional form. If we want to include the parameters insert a semicolon and then list them:

Demand = D(x, p; B, )
Supply = S(x, p; C, )
where x is quantity demanded, p is price, B is the budget and represents preferences, the share of
the budget spent on first good For supply, again x is quantity, this time supplied, and p is the same
price as in the demand curve. Now C is total costs and is share of the costs of the first factor of
production. (Thus, 1 beta is the share in total costs of the second factor of production).
3. . Movement along a curve is due to change in variables.
4. Shifts are due to changes in parameters.
5. A solution is defined the values of the variables expressed in terms of parameters and parameters only.
6. Experiments can then be run by changing a parameter and seeing what happens to the equilibrium
values of the variables.
7. Changing one parameter at time allows us to say something about causality. For example, a change
in the parameter B caused the rational consumer to increase demand for both goods and, therefore,
utility.
8. However, when more than one parameter is changed at a time, then we cannot say anything about
causality. Models with more than one parameter changed at a time are called simulation models.

Demand
1. Demand curves are determined by the utility maximization problem. So we have already done this.
Here is how it works: First solve the tangency condition and the budget constraint together
B = px1 + x2
x2
p=
1 x1
and solve for x2 in the second equation
x2 =

(1 )px1

and substitute into first

B = px1 +

(1)

(1 )px1

to get
x1 =

B
p

(2)

. The demand for the second good found by substituting this last equation in to equation 1.
x2 = (1 )B
So the general form of the demand equation is share of income times the budget divided by price
(note that the price of the second good is always equal to one.)

The Producers Problem

K

tangency condition w/r = [(1-)/] K/L

x0(K,L)
C=wL+rK

Figure 3: Cost minimization

Supply
1. Here L is the amount of labor hired and K is the capital stock. Also, C is cost, w is the wage rate, r is
the cost of capital, the interest rate + depreciation charges. Any profit above rK is called economic
profit.
2. Perfect competition causes economic profit to go to zero.
3. Note that the problem is exactly the same as the consumers problem
4. The w/r ratio is the same as the relative price
5. The are replaced by
6. Solve the tangency condition and budget constraint to find demand for factors of production, K, L
7. Firms take C, w and r as given and choose K and L to maximize profits.
8. Note that the slope of a line from the origin to the tangency point is k = K/L, the capital-ratio.
9. The job of firms is to make as much profit as they can by producing efficiently.
10. This means that they should be greedy as possible.
11. Adam Smith was not really an economist, since economics had not been invented yet.
12. Smith was a moral philosopher
13. Wrote the Wealth of Nations and also Theory of Moral Sentiments
14. Smith argued against the Judeo-Christian teaching that greed was a sin.
15. Smith noted that greed is good, so long as there is competition
8

16. Producers need the incentive of profits to produce. Without the incentive they will not produce
anything.
17. Producers and consumers are entirely equivalent: here is a summary: Consumers take the relative
price of the good, p and the budget, B as given and maximize utility. This gives the demand for the
two goods x1 and x2 .
18. Producers take demand as given as well as the prices of the factors of production.
(11 )

19. They use a production function of the form x1 = K12 L1

20. They then maximize profits subject to the demand constraint.

21. The demand constraint takes the form of costs, or C = wL + rK. It is as if they know they are going
to get a certain amount of money from the consumers. The price in the market is given to them. They
then set their capital-labor ratio, k so as to maximize their profits or minimize their costs (which is
the same thing.)
22. The producers problem is given by the tangency condition
w
(1 )K
=
r
L
and the budget constraint or cost condition
pQ = wL + rK
23. Solve these simultaneously. First clear the fractions in the tangency condition
wL = (1 )rK
multiply the cost constraint by and add
(1 )pQ = (1 )wL + (1 )rK
Now now subtract the first from the second
(1 )pQ wL = (1 )wL
After canceling wL on both sides
pQ
=L
w
which is the demand for labor. The demand for capital is
(1 )

pQ
=K
r

24. The demand for capital is Ki = i pi xi /r where p1 = p for good 1 and p2 = 1 for good 2.
25. The demand for labor is Li = (1 i )pi xi /w where again p1 = p for good 1 and p2 = 1 for good 2.
26. Observe that there must be more than one producer, one for each good x1 and x2
27. If they do well, then price will just cover their costs. If price is greater than costs, they earn economic
profits. These profits attract other producers and supply expands. This drives down price until price
is just equal to cost.
28. At this point everyone is doing as well as they can. Producers are just getting by and consumers have
the highest level of utility they can. We say that the market is efficiently allocating scarce resources in
the sense that no one can be better off unless someone is worse off.

29. Perfectly competitive market A market that meets the conditions of (a) many buyers and sellers, (b)
all firms selling identical products, and (c) no barriers to new firms entering the market.
30. Substitutes: price goes up of x2 and consumers substitute x1 for it. If consumers dont substitute, then
the rise in price makes them poorer. They can get higher utility of they substitute away from higher
priced goods
31. Complements: utility functions describe substitutes. Note that x1 and x2 cannot be complements since
an increase in the demand for one would cause and increase in the demand for the other. That cant
happen.
32. Hence it is better to think of complements as goods that make up x1 , that is goods that are inside of
x1 and move in its same direction. That is, think of x1 as a vector or list of goods that are demanded,
more or less, together.
33. Usually when B rises, demand for both goods increases; see the demand functions 2 and 1 above. But
if demand falls an increase in income, this is called an inferior good. Goods that are not inferior are
called normal goods.
34. Demand schedule A table showing the relationship between the price of a product and the quantity of
the product demanded.
35. Quantity demanded The amount of a good or service that a consumer is willing and able to purchase
at a given price.
36. Demand curve A curve that shows the relationship between the price of a product and the quantity of
the product demanded.
37. Market demand The demand by all the consumers of a given good or service.
38. Major determinants of the demand curve: B income (so long as the good is normal), , tastes,
population or demographics and the expected price of goods in the future.
39. Note that economics assumes that goods available at different times are different goods. We could
easily say that x1 and x2 were the same goods, but just todays and tomorrows consumption. Here
we could think of all goods consumed while one was working x1 and x2 as all goods consumed while
in retirement.

Derivation of Supply Curve

1. Let Q = quantity supplied. In market equilibrium this is equal to quantity demanded.
2. Supply is determined by a production function
Q = AK L(1)

(3)

where A is a technological change constant, K is the capital stock, L is labor and is the share of the
return to capital in total costs.
3. Factor demand equations (analogous to demand for goods equations)
L = (1 )pQ/w

(4)

K = pQ/r

(5)
(6)

where p is the price of the good, w is the wage rate and r is the cost of capital.
4. For an upward sloping supply curve, there must be some fixed factor. It might be fertile land as in

David Ricardos classic work or something else. Here we take it to be capital. Let K = K

10

5. Now substitute the factor demand equations 5 and 6 into the production function 3
Q = AK [(1 )pQ/w](1)
where A is the calibration constant. Now write this as

(1)
(1) * p wL ^ Hbeta H1 - betaLL,<, 8p, 0, 10<,
Manipulate@Plot@8A
Capital
* HH1
-Q
betaL
Q = AK *[(1
)p/w]
AxesLabel 8"p", "Q"<, ImageSize 8200, 200<, PlotLabel "Supply curve"D,
and divide by Q(1)8beta,
to get 0, 1<, 8A, 1, 10<, 8w, 1, 10<, 8Capital, 1, 10<, 8p0, 1, 10<D
In[75]:=

Q/Q(1) = AK [(1 )p/w](1)

Note that this can be written as

Q = AK [(1 )p/w](1)
and taking the 1/ root

beta

Q = A(1/) K[(1 )p/w](1)/

we have the equation for the

A supply curve.
6. The market supply curve, Qm , simply sums all the suppliers, Qi
w

Qm = i Qi
Capital

7. Consider the special case of = 0.5 or the square-root production function

Q = AKp/2w
p0

Out[75]=

Supply curve
Q
8
6
4
2

10

Figure 4: = 0.3, K = 2, A = 4
,

Market equilibrium
1. To get the price-quantity solution for market equilibrium, solve the supply curve and demand curve
simultaneously. The demand curve is given by
X = B/p
Set this equal to the supply Q to get
B/p = Kp/2w
where we set A = 1 since we are not calibrating this to any specific data set. Simplifying
r
2wB
p=
K
11

2. Substitute this into either the demand or supply curve to get the quantity
r
r
K 2wB
BK
Q=
=
2w
K
2w
3. Excess demand is when price is below equilibrium and there is upward pressure on price.
4. Excess supply (negative excess demand) that puts downward pressure on price.

Elasticity
1. Economists use elasticity to avoid having to deal with units.
2. Elasticity is responsiveness. It is how one variable responds or changes with respect to another.
3. It is much easier to think of a percent change in price, rather than just a change in price which would
necessarily involve some units of measure, both for the good itself and for currency in which the price
of the good is expressed.
4. With elasticities, units problems melt away. They are also good for seeing how growth rates affect each
other.
5. Elasticity is just percent change of the dependent variable with respect to the percent change in the
independent variable. Hence if we have
Y = mX + b
as the expression for some economic quantity, demand, supply or really anything
Y X =

dY /Y
dX/X

or Y X the elasticity of Y with respect to X. When you have a continuous function, this work fine.
But when no function is given, use the discrete form1
Y X =

Y /Y
X/X

6. Here is it easy to see that we are just working with a ratio of percent changes. Elasticity usually
changes from point to point so we have to know where to start. Lets say we have a point X0 , Y0 . We
want to calculate the elasticity from this point to X1 , Y1 . We know that by definition
X = X1 X0 and Y = Y1 Y0
Keep in mind that Y is always measured as the second point minus the first point even if the second
point is smaller. This just gives a negative elasticity.
7. Lets say the demand curve is
q = 4p + 6
We wish to calculate the elasticity of quantity demanded with respect to price at p = 1. The slope
dq/dp = 4 and p = 1 gives q = 2.Hence the elasticity is  = 4(1/2) = 2. It will be different at a
different p.
8. Elasticity can be visualized as the slope of the tangent to a function divided by the slope of the chord
line. That is, the slope of a line from the origin to the point at which the elasticity is to be determined.
9. This is shown in Figure 1 for the function y = f (x)

12

Elasticity = slope of function/slope of chord

6

4
function

slope
chord

0
0

10

15

20

25

30

35

Figure 5: Elasticity is the slope of the function, f 0 (x), divided by the slope of the chord line, y/x.

Figure 6: Perfectly or infinitely elastic function

13

Figure 7: Perfectly or infinitely inelastic function

10. The slope of the chord line is 1 and the slope of the function is 1/2 so the elasticity at the point
x = 1 is  = 1/2. Here are some extreme examples:
11. It makes a big difference which variable is on which axis.
12. Note that we have consistently defined at the elasticity of the y variable with respect to the x variable.
13. It is easiest to stick with this convention. It is the same for slopes: it is always the rise (difference in
the y-axis variable) over the run (difference in the x-axis variable.) Think of an elasticity as a slope on
steroids.
14. When we talk about supply and demand the elasticity is always about quantity with respect to price.
When the quantity is on the x-axis, the elasticity is the change in quantity with respect to price divided
by the ratio of quantity to price.
15. Flat supply or demand curves are thus infinitely elastic while vertical supply or demand curves are
perfectly inelastic.
16. A straight line that goes through the origin is unitary elastic, i.e., it has an elasticity of one.
17. A hyperbola is also unitary elastic but with a negative sign. The equation is
y = A/x
The slope is dy/dx = A/x2 . Divide this by the average y/x to get
dy/dxx/y = A/x2 x/y = 1

National Income and Product Accounts (NIPA)

1. GDP=gross domestic product: market value of all final goods (sold but not resold) produced in a year
(or quarter) by domestic factors of production (labor, land and capital).
1 The

calculus form is when the X goes to zero; that is:

limX0

Y /Y
dY /Y
=
X/X
dX/X

14

2. Final: does not include intermediate goods.

3. Period of time means that GDP is flow not a stock.
4. Domestic factors of production: factors owned by both nationals and foreigners but operated inside
the political boundary of the country.
5. GNP Gross national product: factors of production owned by nationals.
6. GDP = GNP + net foreign factor payments.

Components of the SAM

7. SAMs have at most 4 agents: firms, households, government and foreign.
8. Each agent has a row and column.
9. When income (rows) = expenditure (columns) for all agents of the SAM, then total savings is equal
to total investment.
10. When solving a SAM problem, make sure that total investment is equal to total savings first.
11. Then go through each agent and make sure their their row sum (where they get their money) is equal
to the column sum (where the spend their money).
12. Note that savings is included in expenditure (think of buying a savings account or a bond).
13. Gross value of production is the row sum for the firms.
14. The GDP is GVP less intermediate goods, plus government wages.
15. GNP is GDP less foreign factor payments.
16. Net national product is GNP less depreciation.
17. National income is NNP less sales tax.
18. Personal income is NI less retained earnings less corporate direct taxes (profit tax) less social security
contributions (payroll taxes) plus transfers (social security, welfare, unemployment compensation) plus
interest on government debt.
19. Personal disposable income is PI less direct taxes on households.
20. The foreign deficit is foreign savings (total imports less total exports).
21. We call this foreign savings because it is owed to foreigners since we didnt pay for all of our imports
with exports.
22. Foreigners are therefore saving in our country.
23. the sum of firm savings, households saving, government savings and foreign savings is equal to investment.
24. The government deficit is the negative of government savings.
25. When firms operate they have some payments that are contractual, intermediates, wages, indirect
taxes, profit taxes, foreign factor payments.
26. The difference between GVP and these payments is called the gross operating surplus or GOS.
27. Firms have discretion about what they do with the gross operating surplus.
28. They may pay out some as dividends to households.

15

29. They usually saving some of it as a provision for depreciation.

30. What is retained is net business savings or firms savings. This is retained earnings.
31. Everything that firm does not pay out they put into the capital market. So that inflows into the capital
market (banks and investment banks) consist of the depreciation fund and retained earnings.
32. During a recession, PI is greater than NI but during good times PI is less than NI.
33. This is an example of an automatic stabilizer.
34. Government income is made up of three kinds of taxes: direct, indirect (sales tax) and payroll taxes.
35. Government expenditure is made up demand for goods and services from firms, payments to households
in the form of government wages, interest payments on government debt and transfers.

16