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Keynesian/

Horizontal

Intermediate/

Upsloping

Classical/

Vertical

Low level GDP A lot of unused resources Great Depression Not full employment Not working at full capacity

Full employment Full potential Late 1800s Factory working at full capacity @ pGDP No more resources Just inflation

Economy will NOT self-adjust Economy will self-adjust if G

stays out because economy will

always be at FE

I is NOT dependable I is dependable

AS PL rGDP AS PL rGDP AS PL rGDP

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Must have G Confidence is sometimes too

low

I will not always bite @ low rIR Prices and wages are not flexible

because of contracts, instead

there will be layoffs

Inventories rising quicklybecause market sends message

the producers will:

o prices and wages

INFLATIONARY GAP/

EXPANSION GAP/

PEAK:

Higher than potential

RECESSIONARY GAP/

CONTRACTION GAP/

TROUGH:

Fall short of potential, less than

natural GDP

U than NU = U than NU =

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SHORTAGE labor SURPLUS labor

Due to labor SHORTAGE,

Wages rise

Due to labor SURPLUS,

Wages fall

CONTRACTIONARY FISCALPOLICY:

G or/and TEXPANSIONARY FISCAL POLICY:

*preferred by voters

G or/and T(G Democratic, T Republican)

Debt is a problem

Defecit = G > Tax revenues

Debt = Defecit adds up

*Wages and prices must be FLEXIBLE

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OLD NEW Economy

always @

potential

Not, onlyshort time

because self-

adjust

Fiscal Policy: changes in government expenditures (G) and taxation (T) in order to achieve

particular macroeconomic goals (controlled by legislative and executive branch) and can be used to

stimulate or slow down the economy

G: direct

T: indirect (leakage/savings)

Controlled by Congress and Presidento Problem 1: too politicalo Problem 2: time lago Problem 3: deficitsmust borrow debt

Service on debt takes away future spendingo Problem 4: G sells bonds to cover spending

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Automatic Stabilizers

Income tax Unemployment compensation

Expansion: incomes tax revenues unemployment unemployment checks G debt

G will run a DEFICIT automatically

Contraction: incomes tax revenues

G will run a SURPLUS

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HOW MUCH SHOULD G INJECT?

1.

Amount of gap2. MPC or MPS (marginal propensity to consume/save)

MPC + MPS = 1

MPC = in consumption / in incomeMPS =

in saving/

in income

Spending Multiplier = 1/MPS or 1/(1-MPC)

Amount to Inject = gap/spending multiplier

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Balance Budget Multiplier (always 1) =

spending multiplier

tax multiplier

*Tax multiplier is always 1 less than spending multiplier because

LEAKAGE/SAVING/Fact that there is a MPS

Crowding Out & Lags

Self-adjust? Crowding out: decrease in private expenditures that occurs as a consequence of increased G or

financing needs of the direct

Indirect effect of Expansionary policy T G Defecit Must borrow rIR Dont want crowding out = effective moving AD

Timing

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Data Lag/Observation Lag: info on rGDP taking in quarters may take months to see in data

Wait-and-see Lag: wait for next quarters data and there is a downturn in rGDP/economy

Transmission Lag: time takes to actually put the plan in action

Effectiveness Lag: time takes for plan to effect economy

*stimulating an already expanding economy (inflation)

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