Economics for Business and Management

Week 12

Review
Name 3 macroeconomic goals What are some problems associated with calculating GDP? Who is included in the labor force? Who is not included? What are the four types of unemployment? What is inflation?

Review
What is the difference between GDP and GNP? What makes calculating unemployment difficult? What is a business cycle?

Review
What is AD? Why is AD downward sloping? What causes shifts in AD? What is AS? Why is AS upward sloping? What causes changes in long run potential AS? What ONLY shifts short run AS? What is the macroeconomic equilibrium?

Assignment #6 Q1

Assignment #6 Q2

Review
What is a recessionary gap? What is an inflationary gap?

Assignment #6 Q3&Q4
4. Using the AD/AS model, draw the economy when it is experiencing a recessionary gap (recession). Remember to label the axis and any lines you may draw. 5. Using the AD/AS model, draw the economy when it is experiencing an inflationary gap (inflation). Remember to label the axis and any lines you may draw.

Course Project Reminder

Final Paper 5% of course due July 23 (TODAY)
Via digital dropbox ONLY

Schedule
WEEK 10 11 12 13 14 15 CLASS DATE 9-Jul 16-Jul 23-Jul 30-Jul 6-Aug August 12-17 TOPICS COVERED Chapters 8&9 Chapter 10/ Quiz #2 Chapter 11&12 Chapters 12&13/ Quiz #3 Chapter 14 / Review Finals week

Chapter 11
Automatic Stabilizers Multiplier Effect Budget Surplus and Deficits

What are Automatic Stabilizers?

Automatic Stabilizers

Automatic stabilizers are built-in measures such as taxes and transfer payments to lessen the effects of the business cycle.

Automatic Stabilizers
During a recessionary period:
The government earns less revenue Pays more EI and Welfare

During an expansionary period:

The government earns more tax revenue Fewer people demand EI or welfare

What is the multiplier effect?

The Multiplier Effect

The multiplier effect is the magnified impact of a spending change on AD.

An initial spending change produces income and part of this new income becomes new spending. This process is repeated with each spending round smaller than the last.

The Multiplier Effect

Determined by the marginal propensity to consume (MPC) The larger the MPC, the larger the multiplier effect.

What is MPC?

MPC
Marginal propensity to consume (MPC) is the fraction of additional disposable income that a household consumes rather than saves.

The Multiplier Effect

We can calculate the multiplier and find the total impact of an initial change by:

multiplier = 1/(1-MPC)

Ex. Multiplier
Every $1 in government spending results in $.67 in consumer spending (MPC = .67) Multiplier = 1/(1-MPC) Multiplier = 1/(1-.67) = 1/.33 = 3 ~
Meaning: If government spending increased by $100 million it would result in a total increase in spending of $300 million (the initial $100 million resulted in an additional $200 million in consumer spending)

The Multiplier Effect

The Multiplier
The Federal government spends $2 billion to construct new highways, what would be the resulting change in AD?
If MPC were 1/3 If MPC were 1/2 If MPC were 2/3

Multiplier = 1/(1-MPC)

The Multiplier
The Federal government buys $2 billion worth of oil what would be the resulting change in AD? If MPC were 1/3 Multiplier = 1/(1- 1/3) = 1.5 Change in AD = 2 billion * 1.5 = 3 billion Increase in consumption = 3 billion 2 billion = 1 billion
If MPC were If MPC were 2/3

Practice
T/F When the govt increases spending, the ultimate increase in total purchases (AD) will be greater than the initial increase. T/F The multiplier is smaller when the MPC is smaller. T/F The multiplier process is instantaneous T/F Savings and money spent on imports reduce the size of the multiplier.

What are Stabilization Policies?

Stabilization Policies

Stabilization policy is government policy designed to lessen the effects of the business cycle.
Can be expansionary or contractionary.
Expansionary policy attempts to reduce unemployment and stimulate output. Contractionary policy attempt to stabilize prices and reduce output.

Stabilization Policies

Govt can use fiscal or monetary policy.

Monetary Policy
Government manipulation of the available money supply within the economy.
Money Supply Interest Rates

Fiscal Policy
The use of government spending and/or taxes to alter AD
/ G (Govt Spending) / T (Taxes)

Fiscal Policy
Fiscal Stimulus Fiscal Austerity

Fiscal Policy
Fiscal Stimulus
G (Govt Spending) T (Taxes) (Keynesian Economics)

Fiscal Austerity
G (Govt Spending) T (Taxes) Federal deficits

Why would a government follow these policies?

Benefits/Drawbacks of Fiscal Policy?

Benefits of Fiscal Policy

Regional focus target affected areas Straight-forward impact on output

Difficulty with Fiscal Policy

Delays time lags Political visibility Public debt

Political visibility
Politicians must consider voters when making decisions:
Taxes Spending

Practice
What are automatic stabilizers? What is the multiplier effect? What is MPC? What is good about fiscal policy? What makes fiscal policy difficult?

Government Revenue
How does the Govt make money?

What if the Govt spends more than its revenue?

Budget Deficit
When government spending exceeds tax revenues for a given fiscal year.
NOT the same as the TRADE DEFICIT

The opposite is a budget surplus: When revenues are greater than spending Does Canada have a budget deficit or surplus? How much?

Budget Deficits
2013 Budget of the Canadian Federal Government: Total Revenue C$263.9 billion Total Expenditures C$282.6 billion Resulting in C$18.7 billion deficit
http://www.theglobeandmail.com/news/politics/budget/infographic-the-visualsummary-of-the-2013-budget/article10012488/

Why Have a Deficit?

The Federal Government Debt

Budget Deficits
Due to a weaker economy and increases in government spending on priority areas such as health, education, transport and defence. Provide the government with the flexibility to respond to changing economic circumstances. May run deficits in response to:
War natural disaster economic downturn

The Federal Government Debt

Financing a Budget Deficit
The budget deficit is financed by issuing debt. The federal government issues bonds What is Canadas debt?

http://www.debtclock.ca/ What country has the most debt?

http://www.economist.com/content/global_debt_clock

Debt to GDP ratio

http://online.wsj.com/article/SB10001424052748703789104576272891515 344726.html

Italy Greece U.S. Canada India China Brazil

119.7% 157% 105.6% 81% 67.5% 15% 63.8%

Debt figures are derived from national definitions and therefore may vary from country to country.

The Federal Government Debt

Budget Surpluses
Policymakers must decide what to do with a surplus: Pay down the government debt Cut taxes Use for improvements in education, health care, and R&D, leading to greater economic growth

The Federal Government Debt

Government Debt
Is debt ok?

Debt
In a recession, tax revenues fall, and money is needed for social programs (EI) BUT deficits during hard times should be balanced by surpluses during good times.

Debt
How much debt is too much?

Debt
It depends
Can the government pay off its debt in the future? Developed countries can sustain higher levels of debt.

Debt
If debt is too large:
Default Austerity

Why do countries/people continue to hold US debt?

European Economic Problems

 Problem

Greece

National debt - 300 billion ($413.6 billion) Debt is 141% of GDP (2010) Unemployment 18.4% (youth rate 43.5%)

Solution
50% write-down of debt (53.5% reduction) 110 billion bailout (2010) 130 billion bailout (2012) Cut spending by 1.5% of GDP, cut minimum wage and holiday bonuses, tax increases

The goal
to cut the Greek government's debt from 160% of GDP to 120% of GDP by 2020.

Italy
Problem
National Debt 1.927 trillion Debt is 121% of GDP

Average annual growth (15yrs) - 0.75% Interest on debt (2.7% - short term, 6%+ LR)

Italy (ECB/Germanys Concerns)

bailing out Italy will simply encourages reckless spending printing money will stoke inflation if Italy failed to repay the rescue loans, it could leave the ECB itself in need of a bailout, and that could destroy its independence.

Practice
T/F The government can use fiscal policy to stimulate the economy out of a recession. T/F When tax revenues are greater than government spending a deficit exists. T/F An increase in taxes would stimulate the economy. T/F Sometimes fiscal policy can destabilize the economy T/F Time lags are a problem in the implementation of fiscal policy.

Practice
Budget surpluses exist when:
a. government spending exceeds its tax revenues. b. government tax revenues exceed its spending. c. government spending equals its tax revenues.

When taxes are increased, disposable income ____, and hence consumption ____. Fiscal policy refers to the government manipulation of what? During a recession, government transfer payments automatically ____ and tax revenue automatically ____.

Practice
What is a contractionary gap?
What action can the govt take to correct this gap?

What is an expansionary gap?

What action can the govt take to correct this gap?

Assignment #6 Q5&Q6
5. What is aggregate demand? What are the two reasons the aggregate demand curve is downward sloping? 6.Compare/Contrast the advantages and disadvantages of Monetary and Fiscal policy?

Chapter 12
Functions of Money Demand and supply for money Money multiplier

What are the functions of money?

The Functions of Money

There are three main functions that money performs:

a means of exchange a measure of value a store of purchasing power

Functions of Money
1. Medium of Exchange
The primary function of money. To facilitate transactions and lower transaction costs. Alternative to barter the direct exchange of goods and services without the use of money.

Functions of Money
2. Measure of Value
Common ruler" for comparing the values of diverse goods and services. Lowers information costs of making transactions.

Functions of Money
3. Store of Purchasing Power
A means of efficiently saving things of value. Money is cheaper and easier to store than other goods.

Facebook Credits
10 cents/credit Buy premium content inside games and applications

Could a gigantic nonsovereign like Facebook someday launch a real currency to compete with the dollar, euro, yen, and the like?

Facebook Credits
Measure of Value? Yes Credits offer a system-wide pricing scheme for app vendors across countries Store of Value? No Cant convert into something else of value (gold) Medium of Exchange? No Microsoft wont accept them Facebook banned the use of Credits as payment for tangible goods