government policies to address… macro – unit 5 – part 2 and

Government Policies to Address…

Macro – Unit 5 – part 2

and

______ _____ policies – seek to improve the economy by shifting the _____ curve towards ______________ -- monetary & fiscal policy

Types of Policies

If an economy is not at full employment equilibrium or does not show growth there are 2 types of policies a government may pursue:

AD

______ _____ policies – seek to improve the economy by shifting the _______ curve out – (1) tax subsidies for investment, (2) encourage R&D, (3) encourage trade

equilibrium

LRAS

Demand side

Supply side

A. Demand Side Policies

______________ ______________Fiscal Policy Monetary Policy

1.

2.

1.

2.

3.

Taxes Gov’t Spending

discount rate

required reserves open market operations

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A. Demand Side Policies

May cause problems

deficitTo fund _______ spending, governments must borrow increasing _______ rates _________ out private Investment.

interest

So if M ___

1.

2.

crowding

M V = P Q

P

Thus expansionary policies may cause inflation.

A. Demand Side Policies

May cause problems

3.Short Run Trade-Off Between Unemployment & Inflation

PL

SRAS

AD2005

LRAS

AD1PL

Y Y1

PL1

Q=realGDP=Y

Is this economy at full employment?

What happens if the Gov’t seeks to improve employment?

3.Short Run Trade-Off Between Unemployment & Inflation

Inflation Rate (Percent / year)

Phillips Curve

3%

4% 7%

6%

Unemployment Rate (percent)

In 1958 British Economist A.W. Phillips published an article on the relationship between unemployment and inflation.

Phillips CurveWhen inflation lowered from 6% to 3%, what happened to unemployment?

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Phillips based his curve on unemployment & inflation data he collected in Great Britain from 1950-1968:

Colander, p. 696

Inflation Rate (Percent / year)

Phillips Curve

3%

4% 7%

6%

Unemployment Rate (percent)

What’s a good trick to remember which axis is labeled which?

Phillips Curve

Inflation is same as PL

Employment = GDP = Y is always on this axis.

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But after the paper was published and the Phillips Curve was widely accepted, look what happened to the data.

In the Long Run

Inflation Rate (Percent / year)

L-R Phillips Curve

3%

4%

6%

Unemployment Rate (percent)

Economists Milton Friedman and Edmund Phelps later published papers in 1968 denying the existence of a short-run Phillips Curve.

L-R Phillips Curve

Having more $ printed can’t make more people work.

Monetary growth may cause inflation, but that is just an increase in the price level; having more money printed does not affect “real” variables such as output and employment.

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Rational Expectations – people optimally use all the information they have, including information about government policies when forecasting the future

When economic policies change, people adjust their expectations of inflation accordingly. The expected price level affects nominal wages.

A. Demand Side Policies

May not be effective b/c of …

54. According to the theory of rational rational expectationexpectation, a fully anticipated fully anticipated expansionary monetary policyexpansionary monetary policy will a. increase potential output b. increase unemployment c. have no impact on real output d. promote the production of consumer goods over capital goods e. result in deflation

Consumers would anticipate higher inflation &Consumers would anticipate higher inflation &at contract time ask for higher wages than inat contract time ask for higher wages than inthe past. Firms would not experience increasingthe past. Firms would not experience increasingprofits so the economy would not expand.profits so the economy would not expand.

From 2005 exam

52% got it correct

B. Supply Side Policies

______ _____ policies – seek to improve the economy by shifting the _______ curveLRASSupply side

PLLRAS

AD

SRAS1

PL

Q

PL2

Q2

AD2

computersLRAS1

housing

Shifting out the LRAS is the same as shifting out what other curve?

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Long-Run Economic Growth

Significance of growth: higher GDP indicates a higher standard of living

Why such large differences in living standards around the world? Primary Reason:

Productivity

Country

Real GDP / person in 1900

Growth Rate / year

Real GDP / person in 2003

Japan $1,280 $28,620 2.79%

Mexico $ 987 $ 8,950 2.16%

USA $3,412 $37,500 1.82%

Pakistan $ 628 $ 2,060 1.16%

Long-Run Economic GrowthProductivity – the quantity of goods & services

produced from each unit of labor.

Determinants of Productivity

Physical Capital / Worker – stock of equipment & structures that are used to produce G & S

Human Capital / Worker – knowledge & skills acquired thru education, training & experience

Natural Resources / Worker – land, rivers, mineral deposits

Technological Knowledge

1.

2.

3.

4.

Long-Run Economic GrowthPublic Policy to Promote Growth

Saving & Investment – capital is a produced factor of production, so a society can invest its resources into producing more capital. To invest more a society must s________ more and c_________less.

Investment from Abroad

Education

Health & Nutrition

1.

2.

3.

4.

5.

6.

7.

8.

9.Property Rights

Political Stability

Free Trade

R________ & D_________

Population Growth

ave onsume

esearch evelopment

Important aspects:

dollar amount

multiply

1. The multiplier model allows a prediction of a ____________ of the output of the economy.2. If you’re told the multiplier is 4, the multiplier model proves that just a $100 change in G will _________ and increase the economy by _______.

$400

3. The Keynesian/multiplier model assumes ____________ is constant.price level

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some questions for review

some questions for review

What are the 3 curves drawn in the AS / AD model?

PL

Q=realGDP=Y

LRAS

Y

AD

SRAS

Why is LRAS vertical...what does it represent?

some questions for review

In this particular drawing is the economy in a recession, inflationary period or at equilibrium?

PL

Q=realGDP=Y

LRAS

YF

AD

SRAS

What is LRAS frequently labeled? Explain why.

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Keynesian Range

Intermediate Range

Classical Range

Single Aggregate Supply curve consists of 3 parts...

alternative format to draw AS/AD model....

label?PL

label?

label?AD

Y = Real GDP =Q

Which range is which?

Keynesian RangeIntermediate Range

Classical Range

Keynesian Range

Intermediate Range

Classical RangeWhat is represented if the economy is at this point?

alternative format to draw AS/AD model....

PL

AD

Y = Real GDP =Q

YFFull employment income..which is ____% unemployment.

5

Where would you draw AD curve to show an inflationary gap?

PL

AD

Y = Real GDP =Q

YFY1

Long-Run Economic Growth In the USA real

GDP/capita has grown by about ___% / year. This is known as the _________ growth trend.

PL

Q=realGDP=Y

LRAS

YF

AD

SRAS

How would you illustrate long term growth on this graph?

LRAS1

Y1

2

secular

So what if you’re told there’s a decrease in G? What does it affect?

G is a part of ....

PLLRAS

YF

AD

SRAS

PL

Q

PL2

Q2

AD2

GDP=Y=Q24 of 27

PLLRAS

YF

AD

SRAS

PL

Q

PL2

Q2

AD2

GDP=Y=Q

Now that you know what shifted, it might ask... what happened to output? where do you look? what happened to inflation?

what happened to employment?

what happened to income?what happened to the overall level of prices?

So what if you’re told there’s an increase in the discount rate? The discount rate is the interest rate the Fed charges banks to borrow money. ____ ____ ____ & ____ ____

PLLRAS

YF

AD

SRAS

PL

Q

PL2

Q2

AD2

iMS ICAD

Crowding out

The government should spend the money it earns through ______. If the government it spending more than it’s taxing, it is conducting ______ spending. To spend what it doesn’t have, the gov’t needs to ________ money. The government borrowing money increases the demand for __________ funds which drives the ____ up. With the interest rate up, private investment is _______ ___.

deficit

taxes

borrowloanable

i

crowded out27 of 27