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Macroeconomics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION, MISSISSIPPI.

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Presentation on theme: "Macroeconomics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION, MISSISSIPPI."— Presentation transcript:

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2 Macroeconomics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION, MISSISSIPPI STATE UNIVERSITY, & VIRTUAL ECONOMICS

3 Economics… is the study of how individuals and society choose, with or without the use of money, to employ scarce productive resources to produce various commodities over time and distribute them for consumption, now and in the future, among various people and groups in a society.

4 Introduction to Macroeconomics 3

5 Macroeconomics 4 Macro is the study of: The structure and performance of a national economy 4 important variables: 1. GDP Gross Domestic Product 2. P the price level 3. UNE national unemployment rate 4. r interest rate

6 U.S. Macro Economy 5 Very complicated 95 million households 20 million firms 80 thousand governments

7 Macro Terms 6 Stock: A quantity at a point in time Flow: A quantity during a period of time

8 Macro Terms 7 GDP, (Y) Gross Domestic Product: Value of total production of all final goods and services during a period of time Flow variable Potential GDP (Y N ): The economys maximum sustainable output when resources are allocated efficiently not over-utilized nor under-utilized

9 Macro Terms 8 Unemployment types Frictional – voluntary unemployment that arises because of the time needed to match job seekers with job openings Structural – unemployment caused by massive mismatch of skills or geographic location Seasonal – unemployment caused by seasonal changes in labor supply and demand during the year Cyclical – unemployment that is incurred by business cycles, or more specifically by economic recessions

10 GDP Final Outputs 9 GDP consists of only: Final goods and services GDP does not include: 1. Intermediate outputs in order to avoid over-counting Intermediate outputs are used as inputs to make final outputs e.g. capital goods 2. Used goods they were counted the first time they were purchased 3. Financial assets e.g. stocks, bonds

11 Which of the following is an example of an intermediate good? A. A pair of jeans sold by a clothing retailer B. Cloth sold to a suit manufacturer C. A share of Wal-Mart stock D. A used Ford Mustang sold from one neighbor to another 10

12 Which of the following is an example of an intermediate good? A. A pair of jeans sold by a clothing retailer B. Cloth sold to a suit manufacturer C. A share of Wal-Mart stock D. A used Ford Mustang sold from one neighbor to another 11

13 Limitations of Real GDP 12 Real GDP is used to: Estimate the speed at which the economy is moving Does not count: Non-market activities Things that are not priced E.g., Household production, underground economy

14 If individuals were paid for their household production, GDP would A. increase B. decrease C. Not change D. Not enough information 13

15 If individuals were paid for their household production, GDP would A. increase B. decrease C. Not change D. Not enough information 14

16 Limitations of Real GDP 15 GDP is not a perfect measure of the welfare of a nation: It does not include measures of: Quality of life Leisure time Conditions of environment

17 Limitations of Real GDP 16 Robert Kennedy 1968 Presidential bid: [GDP] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.

18 Limitations of Real GDP 17 GDP doesnt measure many things, but nations with greater GDP can afford…… better health care for their children better educational system to teach more people to read and enjoy poetry Intelligence, integrity, courage, wisdom, devotion to country are easier to foster when people are less concerned about affording basic necessities. We conclude that GDP is a good measure of welfare for most, but not all, purposes

19 GDP and Standard of Living 18 International data leave no doubt that a nations GDP is closely associated with its citizens standard of living Use per capita GDP when comparing across nations Per capita GDP = GDP/population

20 19

21 GDP = AE = AI 20 Aggregate Expenditures (AE): The total amount that buyers pay for the final goods and services produced Everything a firm receives from the sale of its output is paid out as income to the resource owner (AI): Wages go to labor owners Rent goes to land owners Interest goes to capital owners Profit goes to owners of entrepreneurial ability

22 GDP = AE = AI 21 The buyers of GDP pay an amount equal to aggregate expenditures (AE) The sellers of GDP receive an amount equal to aggregate income (AI) Therefore, GDP = AE = AI For an economy as a whole Income must equal expenditure For every transaction there is a buyer and a seller

23 Calculating Real GDP 22 3 ways to calculate GDP: 1. Expenditure approach 2. Factor Income approach 3. Value Added approach We will use the expenditure approach GDP = C + I + G + NX C, personal consumption expenditure I, gross private investment expenditure G, government expenditure NX, net export expenditure

24 Consumption Expenditure, C 23 Consumption, C Spending by households on new goods and services, with the exception of new housing e.g. Purchases of food, clothing, services, autos, other durable goods like furniture

25 Gross Investment Expenditure, I 24 Investment, I Spending on capital equipment, inventories, and structures including household purchases of new housing Nonresidential investment E.g. machinery, equipment, factories, warehouses, offices purchased by firms Residential investment purchases of newly built homes Inventory change firms accumulation of their output

26 25 A. Newly constructed residential housing B. Factory buildings C. Stocks and bonds D. Additions to inventory E. All of the above are included in investment Which of the following is NOT included in the investment category under the expenditure approach to GDP accounting?

27 A. Newly constructed residential housing B. Factory buildings C. Stocks and bonds D. Additions to inventory E. All of the above are included in investment 26

28 Residential construction is generally included in which category of GDP? A. consumption B. investment C. Government expenditures D. Net exports 27

29 Residential construction is generally included in which category of GDP? A. consumption B. investment C. Government expenditures D. Net exports 28

30 Government Expenditure, G 29 Government, G Spending on goods and services by local, state, and federal governments E.g., salaries, computers, military hardware, etc. Does NOT include transfer payments like social security, welfare, etc.

31 Government purchases include all of the following except: A. Welfare payments B. Salaries of senators C. Fighter jets purchased by the government D. The military payroll 30

32 Government purchases include all of the following except: A. Welfare payments B. Salaries of senators C. Fighter jets purchased by the government D. The military payroll 31

33 Net Export Expenditure, NX 32 Net Exports, NX Spending by foreigners on domestically produced goods (exports) minus spending by domestic residents on foreign goods (imports) Net Exports (NX)= Exports (X)- Imports (M) If M > X => NX are negative, I.e. trade deficit Americans spent more on foreign goods and services than foreigners spent on American goods and services

34 Net Export Expenditure, NX 33 Purchases of foreign goods and services are included in C, I, G E.g. American spending on a Volvo (Swedish car) is included in C We minus imports because we are trying to get a measure of domestic activity

35 Net exports are defined as A. Exports plus imports B. Exports minus imports C. Imports minus exports D. Exports plus imports minus tariffs 34

36 Net exports are defined as A. Exports plus imports B. Exports minus imports C. Imports minus exports D. Exports plus imports minus tariffs 35

37 Consumption is the largest single component of GDP. In recent years it represents approximately _____ % of GDP. A. 55 B. 60 C. 65 D. 70 E

38 Consumption is the largest single component of GDP. In recent years it represents approximately _____ % of GDP. A. 55 B. 60 C. 65 D. 70 E

39 GDP Components 38

40 GDP Estimates 39 Estimates are constantly being revised Advance estimates: released 15 days after the quarter ends and are based on only the first month of the quarter Preliminary estimates: first revision, 45 days after the end of the quarter Final estimates: second revision, 75 days after the end of the quarter

41 GDP Estimates Annual estimates: numbers are then revised once a year for two years Benchmark estimates: revisions made every 5 years 40

42 GDP Estimates 41 The media focuses on: Advance estimates Range of revisions can result in changes ranging from –2.5 % points to +3.5% points from advance estimates until benchmark estimates

43 GDP Estimates 42 If advance estimates show a 3% annualized growth rate in real GDP, find the range of actual real GDP once all revisions are made: Lower bound: 3% - 2.5% =.5% actual annualized growth rate Upper bound: 3% + 3.5% = 6.5% actual annualized growth rate Serious implications for policy makers

44 Saving, Investment, and Financial Intermediaries 43

45 Ebenezer Scrooge: Accidental Promoter of Economic Growth? 44 Learning Objective 21.2 Making the Connection Who was better for economic growth: Scrooge the saver or Scrooge the spender?

46 Who was better for the economy? A. Scrooge the saver B. Scrooge the spender 45

47 Who was better for the economy? A. Scrooge the saver best for long run economic growth B. Scrooge the spender best if we are in a recession 46

48 Saving 47 When a person earns more than he spends Individuals can deposit the unspent income into a bank, or buy a bond or some stock Individuals often refer to this activity as investing However, macroeconomists call this saving U.S. vs Japanese savings rates

49 Investment 48 Investment Purchase of new capital Equipment or buildings Examples of investment An individual who borrows to finance building a new house A firm sells some stock to build a new factory

50 S = I 49 For the macroeconomy as a whole Saving (S) must equal investment (I) Recall that GDP equals Y = C + I + G + NX Assume the economy is closed so that NX = 0 Y = C + I + G Each unit of output sold in a closed economy is consumed, invested, or bought by the government

51 S = I 50 To emphasize the link between saving and investment, subtract C and G from both sides You get, Y – C - G = I Y – C – G is the total income in the economy that remains after paying for consumption and government purchases i.e., national saving, S Which leaves, S = I

52 Financial Institutions 51 The financial system is made up of institutions that Coordinate individuals who are saving and individuals who are investing Savers supply their money to the financial system With the expectation of earning interest Borrowers demand funds from the financial system Knowing they will be required to pay it back with interest

53 Financial Markets Bond Market 52 Bond Promise to pay back a loan Large corporations can borrow money directly from the public by selling bonds The person who buys the bond gives money to the firm Firm uses the funds to expand their business This is called debt financing The buyer can either hold the bond until maturity can sell the bond to someone else

54 Financial Markets Stock Market 53 Stock Represents ownership in a firm Stockholders own the company Thus, they own the profits or losses Stocks are riskier than bonds Pay a higher rate of return Firms can sell stock in order to raise funds to expand This is called equity financing

55 Financial Markets Stock Market 54 After the firm issues the stock The shares are traded on organized stock exchanges NYSE, NASDAQ, AMSE Corporations themselves do not earn anything from the trades Prices of stocks are determined by the demand and supply for each one Reflects the beliefs about the value of a company Stock index A computed average of a group of stock prices Dow Jones Industrial Average--30 major U.S. companies Standard and Poors500 major companies

56 Financial Intermediaries Banks 55 In order to borrow funds, most firms must use banks Only the largest and most widely recognized firms can borrow funds through bonds and stocks Banks Take deposits from people who are saving and pay them an interest rate Give loans to those who are borrowing and charge them an interest rate The difference in the interest rate paid out and charged provides profits to the bank owners

57 Financial Intermediaries Mutual Funds 56 Mutual Fund An institution that sells shares to the public and buys a portfolio of stocks and bonds Many different types of stocks and bonds Enables savers to Diversify Lowering risk Receive services of professional money managers Index fund A fund that buys all the stocks in a given stock index

58 Market for Loanable Funds 57 Because the economy has many types of financial institutions There are many different interest rates All are determined through the demand and supply of funds Assume for simplicity that there is just one market for loanable funds All savers go to this market to deposit saving All borrows go to this market in order to invest

59 Supply of Loanable Funds 58 The source of the supply of loanable funds is Saving At higher interest rates Saving is more attractive The quantity saved increases At lower interest rates Saving is less attractive The quantity saved decreases

60 Demand for Loanable Funds 59 The source of the demand of loanable funds is Borrowing I.e., investment At higher interest rates borrowing is less attractive The quantity borrowed and invested decreases At lower interest rates borrowing is more attractive The quantity borrowed and invested increases

61 Equilibrium Real Interest Rate, rr* 60 The equilibrium real interest rate occurs where the supply and demand for loanable funds intersects If the interest rate were lower than rr* There would be a shortage of loanable funds Lenders would be scarce and borrowers plentiful Increasing the interest rate If the interest rate were higher than rr* There would be a surplus of loanable funds Lenders would be plentiful and borrowers would be scarce Decreasing the interest rate

62 Invisible Hand 61 Financial markets work much like other markets In this case Saving represents the supply of loanable funds Investment represents the demand for loanable funds Interest rate adjust to balance the supply and demand in the market for loanable funds

63 Government Policy to Increase Saving 62 Taxes on saving Lower saving for every given interest rate If the government decided to reduce taxes on saving The incentive to save would increase for every given interest rate 1. Increase the supply of saving curve 2. Reduce the equilibrium interest rate 3. Increase the level of investment

64 Government Policy to Increase Investment 63 Giving firms an investment tax credit would Encourage more firms to borrow and invest in new capital for every given interest rate 1. Increase the demand for investment 2. Increase the interest rate 3. Increase the amount of saving

65 Inflation 64

66 Macro Terms 65 Average (Aggregate) Price Level, P: The average price of all outputs Absolute concept, not relative Inflation: Process of rising prices Nominal: NOT adjusted for inflation current dollars Real: Adjusted for inflation constant dollars

67 Macro Terms 66 Hyperinflation: Inflation that exceeds 50% a month Deflation: Process of falling prices Disinflation: Slowing of inflation

68 Real v. Nominal GDP Nominal GDP: GDP valued in current dollars not adjusted for inflation Real GDP: GDP valued in constant dollars adjusted for inflation More informative than nominal often compared across time 67

69 Business Cycles 68

70 Macro Terms 69 Business Cycle: Shows fluctuations in GDP around potential GDP Recession: Real GDP decreases for at least two successive quarters associated with rising unemployment, falling profits and income Depression: Extremely severe decline in real GDP Expansion: Rising real GDP associated with falling unemployment, higher profits and income

71 The Business Cycle Peak Recession Trough Expansion TIME REAL GDP 70

72 Y and Y N 71

73 What We Learn From GDP 72 By looking at the graph, we learn that: 1. real GDP grows over time output of goods and services has grown over time averaging about 3% per year allows the typical American to enjoy greater prosperity than his/her parents and grandparents 2. growth is not steady upward climb is occasionally interrupted by periods of decline Macroeconomics is about explaining both--the long- run trends and the short-run fluctuations

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75 Activity 17 74

76 75

77 FEDERAL RESERVE SYSTEM TOOLS OF THE FED EXPANSIONARY MONETARY POLICY CONTRACTIONARY MONETARY POLICY POLICY DEBATES 76 Money and Monetary Policy

78 The Federal Reserve was established in 1913 to 77 A. Prevent inflation by decreasing the money supply B. Stimulate the economy by increasing bank reserves C. Stop bank panics by acting as a lender of last resort D. Prevent bad loans by requiring banks to hold reserves

79 The Federal Reserve was established in 1913 to 78 A. Prevent inflation by decreasing the money supply B. Stimulate the economy by increasing bank reserves C. Stop bank panics by acting as a lender of last resort D. Prevent bad loans by requiring banks to hold reserves

80 Which of the following is not a function of the Fed? 79 A. Acting as lender of last resort B. Acting as a bankers bank C. Performing check clearing services D. Insuring deposits in the banking system E. Taking actions to control the money supply

81 Which of the following is not a function of the Fed? 80 A. Acting as lender of last resort B. Acting as a bankers bank C. Performing check clearing services D. Insuring deposits in the banking system E. Taking actions to control the money supply

82 Federal Reserve System 81 The Fed Is a special kind of bank a bank for banks The Fed acts as a central banking system with centralized economic power The Feds job: Is to manage the money supply in what it perceives to be the national interest

83 Federal Reserve System 82 Fed was established in 1913 Very recent Federal Reserve System is made up of 12 central banks, each with its own region The Fed is run by a 7 member Board of Governors Appointed by the President and confirmed by the Senate 14 year terms President designates a chairman for a 4 year term Headquartered in Washington, D. C.

84 Federal Reserve System 83 Once appointed, the governors are independent of the rest of government This is to give the Fed the ability to make decisions on objective, technical criteria rather than on political agendas

85 FOMC 84 Federal Open Market Committee, FOMC: Works with the Board of Governors and largely determines the size of the U.S. money supply FOMC has 12 members: 7 governors 5 presidents of district banks FOMC meets every six weeks Policy implementation is normally done through the New York Fed Bank

86 85 Money

87 86 Liquidity The ease of an assets ability to be converted to cash An asset is completely liquid if one can spend it now

88 87 Definitions of the Money Supply There are 3 measures of the money supply M1 The most liquid of all definitions of the money supply M2 M3 Currency held by banks in the form of reserves is NOT counted as part of the money supply because it is not available for individuals to make purchases with

89 88 Definitions of the Money Supply M1= Sum of all currency, coin, travelers checks in the hands of the public 30% Sum of all of the most liquid checking accounts 70% M2= M1 + savings accounts, money market mutual funds, small time deposits (cds < 100,000) M3= M1 + M2 + large time deposits

90 89 Which of the following assets is most liquid? A. money B. bond C. savings account D. stock

91 90 Which of the following assets is most liquid? A. money B. bond C. savings account D. stock

92 91 Money Creation Process

93 Banks hold 100% of their checking deposits as vault cash to ensure that bank runs do not occur. 92 A. True B. False

94 Banks hold 100% of their checking deposits as vault cash to ensure that bank runs do not occur. 93 A. True B. False

95 94 Money Creation Process Fractional Reserve Banking System: Banks keep only part of all its deposits When a bank gets a new deposit: it keeps a portion of it in reserves and then lends out the rest Individuals and firms receiving the loans then deposit their loan checks into their banks Those banks: repeat the process by keeping a portion of the deposit and then lending out the rest Hence, a fractional reserve system creates money i.e., increases the money supply

96 95 Which of the following best describes how banks create money? A. Banks charge higher interest rates on loans than they pay on deposits B. Banks charge fees for providing financial advice C. Banks create checking account deposits when making loans from excess reserves D. Banks make loans from reserves

97 96 Which of the following best describes how banks create money? A. Banks charge higher interest rates on loans than they pay on deposits B. Banks charge fees for providing financial advice C. Banks create checking account deposits when making loans from excess reserves D. Banks make loans from reserves

98 97 Tools of the Federal Reserve

99 The Fed directly controls the interest rate and inflation rate. 98 A. True B. False

100 The Fed directly controls the interest rate and inflation rate. 99 A. True B. False

101 Tools of the Fed 100 The Fed uses 3 tools to control the money supply 1. Open market operations 2. Required reserve ratio 3. Discount rate

102 RRR 101 The Fed sets the RRR If the Fed increases the RRR Banks are required to hold more of their deposits decreasing the money supply If the Fed decreases the RRR Banks are free to lend out more of their deposits increasing the money supply

103 Discount Rate 102 Discount Rate the interest rate that individual banks pay to the Fed in order to borrow funds If the Fed increases the discount rate It is more expensive to borrow from the Fed banks tend to hold more excess reserves decreasing the money supply If the Fed decreases the discount rate It is less expensive to borrow from the Fed banks tend to hold fewer excess reserves increasing the money supply

104 OMO 103 Open Market financial marketplace made up of non-government sectors If the Fed sells government securities: Individuals and firms begin to buy them from the Fed Money goes from the open market (in the M s ) to the Fed (out of the M s ) The money supply falls If the Fed buys government securities: Individuals and firms begin to sell them to the Fed Money goes from the Fed (out of the M s ) to the open market (in of the M s ) The money supply increases

105 The three main monetary policy tools used by the Fed to manage the money supply are 104 A. Interest rates, tax rates, and government spending B. Tax rates, government purchases, and transfer payments C. Open market operations, discount policy, and reserve requirements D. Open market operations, the exchange rate, and government purchases

106 The three main monetary policy tools used by the Fed to manage the money supply are 105 A. Interest rates, tax rates, and government spending B. Tax rates, government purchases, and transfer payments C. Open market operations, discount policy, and reserve requirements D. Open market operations, the exchange rate, and government purchases

107 Expansionary Monetary Policy 106 The Fed can increase the M s by doing the following Buying government bonds Decreasing the RRR Decreasing the discount rate

108 Contractionary Monetary Policy 107 The Fed can decrease the M s by doing the following Selling government bonds Increasing the RRR Increasing the discount rate

109 Expansionary monetary policy refers to the _____ to increase real GDP. 108 A. Governments increasing spending and lowering taxes B. Governments decreasing spending and raising taxes C. Federal Reserves increasing the money supply and decreasing interest rates D. Federal Reserves decreasing the money supply and increasing interest rates

110 Expansionary monetary policy refers to the _____ to increase real GDP. 109 A. Governments increasing spending and lowering taxes B. Governments decreasing spending and raising taxes C. Federal Reserves increasing the money supply and decreasing interest rates D. Federal Reserves decreasing the money supply and increasing interest rates

111 Which of the following is true about the Feds ability to prevent recessions? The Fed 110 A. Does not try to eliminate recessions, but instead focuses on preventing inflation B. Can fine tune the economy and realistically hope to keep the economy from experiencing recessions C. Cannot realistically fine tune the economy, but seeks to keep recessions shorter and milder than they would otherwise be D. Cannot realistically fine tune the economy and has little to no effect on the magnitude and length of recessions

112 Which of the following is true about the Feds ability to prevent recessions? The Fed 111 A. Does not try to eliminate recessions, but instead focuses on preventing inflation B. Can fine tune the economy and realistically hope to keep the economy from experiencing recessions C. Cannot realistically fine tune the economy, but seeks to keep recessions shorter and milder than they would otherwise be D. Cannot realistically fine tune the economy and has little to no effect on the magnitude and length of recessions

113 112 Should Policymakers Try to Stabilize the Economy?

114 Yes, Policymakers Should Stabilize 113 Argument: Economies fluctuate on their own and there is no reason to suffer through booms and busts Recession lead to lower real GDP and higher unemployment Expansions lead to higher inflation During a recession policymakers should Increase government spending, cut taxes, and expand the money supply During an expansion policymakers should Decrease government spending, raise taxes, and decrease the money supply

115 No, Policymakers Should Not Stabilize 114 Argument: Allow the economy to heal itself and do no harm Substantial obstacles to the effective use of policy changes to influence the economy Time lags can be anywhere from 6 months to several years Policymakers need accurate information on the future of the economy to make accurate policy changes Economic forecasts are imprecise Policy changes can make matters worse

116 115

117 FISCAL POLICY AND DEMAND SUPPLY-SIDE ECONOMICS 116 Fiscal Policy

118 117 Fiscal Policy The use of the federal budget to achieve macro goals full employment sustained economic growth price level stability This use of fiscal policy came after the Great Depression of the 1930s and the thinking of John Maynard Keynes Prior to that, governments allowed the economy to regulate itself the federal budget was used only to finance the activities of the federal government

119 Tools of Fiscal Policy tools of fiscal policy G Taxes Transfers To analyze each one Hold everything else constant Changes in G Expansionary Contractionary

120 Fiscal Policy and AD 119 Changes in Taxes DI = Income – taxes + transfers Expansionary Contractionary Changes in Transfers Expansionary Contractionary

121 The Effects of Fiscal Policy on Real GDP and the Price Level PROBLEM TYPE OF POLICY ACTIONS BY CONGRESS AND THE PRESIDENTRESULT RecessionExpansionaryIncrease government spending or cut taxes Real GDP and the price level rise. Rising InflationContractionaryDecrease government spending or raise taxes Real GDP and the price level fall. 120 Learning Objective 15.2 Table 15-1 Countercyclical Fiscal Policy Dont Let This Happen to YOU! Dont Confuse Fiscal Policy and Monetary Policy

122 An increase in individual income taxes _____ disposable income, which _____ consumption spending. 121 A. Increases; increases B. Increases; decreases C. Decreases; increases D. Decreases; decreases

123 122 A. Increases; increases B. Increases; decreases C. Decreases; increases D. Decreases; decreases An increase in individual income taxes _____ disposable income, which _____ consumption spending.

124 If the economy is falling below potential real GDP, which of the following would be an appropriate fiscal policy? An increase in 123 A. The money supply and a decrease in interest rates B. Government purchases C. Oil prices D. Taxes

125 124 A. The money supply and a decrease in interest rates B. Government purchases C. Oil prices D. Taxes If the economy is falling below potential real GDP, which of the following would be an appropriate fiscal policy? An increase in

126 If real GDP exceeded potential real GDP and inflation was increasing, which of the following would be an appropriate fiscal policy? 125 A. A decrease in the money supply and an increase in the interest rate B. An increase in government spending C. An increase in taxes D. An increase in oil prices

127 126 A. A decrease in the money supply and an increase in the interest rate B. An increase in government spending C. An increase in taxes D. An increase in oil prices If real GDP exceeded potential real GDP and inflation was increasing, which of the following would be an appropriate fiscal policy?

128 127 Fiscal Policy and Aggregate Supply

129 128 Supply-side economics Attempts to increase Y N, potential real GDP Taxes create Disincentives which decrease potential real GDP So, lower income taxes Strengthens the incentive to work Increases aggregate supply

130 Marginal Tax Rates 129 Marginal tax rates of the richest Americans: Carter50% Reagan28% Bush31% Clinton39.6% W. Bush35%

131 Fiscal Policy and Aggregate Supply 130 Tax policies encouraging I Lead to higher stocks of capital Increases aggregate supply Tax relief for firms in R & D Encourage new technology Increases aggregate supply

132 Supply-Side Economics and Aggregate Demand 131 However, lowering taxes and increasing investment Also increase AD

133 Supply-Side Economics 132 Supply-side is largely effective in the SR because of its effects on Aggregate Demand Supply-side economics is largely effective in the LR because of its effects on Aggregate Supply

134 Which of the following would be classified as fiscal policy? 133 A. The federal government passes tax cuts to encourage firms to reduce air pollution B. The Federal Reserve cuts interest rates to stimulate the economy C. A state government cuts taxes to help the economy of the state D. The federal government cuts taxes to stimulate the economy

135 Which of the following would be classified as fiscal policy? 134 A. The federal government passes tax cuts to encourage firms to reduce air pollution B. The Federal Reserve cuts interest rates to stimulate the economy C. A state government cuts taxes to help the economy of the state D. The federal government cuts taxes to stimulate the economy

136 Which of the following best describes supply-side economics? 135 A. Labor productivity impacts aggregate supply B. Education impacts labor productivity which impacts aggregate supply C. Education impacts the incentive to work, save, and invest, and therefore aggregate supply D. Tax rates, particularly marginal tax rates, affect the incentive to work, save, and invest, and therefore aggregate supply

137 136 A. Labor productivity impacts aggregate supply B. Education impacts labor productivity which impacts aggregate supply C. Education impacts the incentive to work, save, and invest, and therefore aggregate supply D. Tax rates, particularly marginal tax rates, affect the incentive to work, save, and invest, and therefore aggregate supply Which of the following best describes supply-side economics?

138 Activities 30 /

139 138

140 139

141 140

142 141 Should We Worry About the National Debt?

143 If we took all of our nations income and paid off the national debt, how long will it take? A. More than 10 years B. Five years C. Two years D. One year E. Less than one year

144 If we took all of our nations income and paid off the national debt, how long will it take? A. More than 10 years B. Five years C. Two years D. One year E. Less than one year

145 Federal Budget 144 Deficit/Surplus Revenues > Expenditures surplus Expenditures > Revenues deficit A deficit (or surplus) is a flow variable Debt is a stock variable Government debt is sold by issuing bonds Treasury T bills to the public

146 The Federal Budget Deficit 145 Learning Objective 15.5 FIGURE The Federal Budget Deficit, 1901–2006

147 Reasons NOT to worry about the debt 146 The following work to reduce the figures 1. Take figures in relation to GDP 2. Adjust for state and local surpluses and debt owned by government Net public debt 3. Adjust for the cyclical component of the economy 4. Adjusting for capital outlays It is normal for capital outlays to grow in a growing economy 5. Adjusting for inflation

148 Federal Government Debt 147 Learning Objective 15.5

149 Current Debt 148 The current debt is $11.9 trillion dollars $4.4 trillion is held by government agencies Therefore, the U.S. net public debt is about $7.6 trillion Nominal GDP is about $14.2 trillion In other words, net public debt makes up 53.5% of GDP If we used all of the nations resources to pay off the debt alone, how long would it take to pay it off? About 7 months

150 Should we worry about the debt? 149 The cause of the debt is important to whether it is a burden Until the 1980s most debt was acquired because of war or recession These are taken to be good reasons to incur debt 1980s and 1990s and early 2000s have seen rising structural deficits due to expansionary policy Cause for concern for incurring debt

151 Reasons TO worry about the debt The ensuing inflation 2. Effects on Investment A deficit is negative saving Supply of national saving decreases Increasing the interest rate Some private investment is crowded out The I in GDP Leads to lower capital stock, K, in the future Lower productivity and standard of living

152 Reasons TO worry about the debt Borrowing from abroad About 40% of net public debt is held by foreigners The higher interest rates encourage more investment in the U.S. by foreigners The higher interest rates cause the dollar to appreciate Twin deficits 4. Growth of interest payments Opportunity cost

153 152 Should the Federal Government Have a Yearly Balanced Budget?

154 State of the Economy on Deficits 153 Larger deficits do not always mean the government has undertaken expansionary fiscal policy The same fiscal policies can lead to large or small deficits depending on the state of the economy With no change in policy: Recessions increase deficits Expansions decrease deficits

155 State of the Economy on Deficits 154 Recessionary Gap Tax revenues fall Transfer payments rise =>Deficits increase Under a yearly balanced budget, govt expenditures must: Decrease, making the gap worse

156 State of the Economy on Deficits 155 Expansionary Gap Tax revenues rise Transfer payments fall =>Deficits decrease Under a yearly balanced budget, govt expenditures must: Increase, making the gap worse boom the boom

157 State of the Economy on Deficits 156 Economists prefer using the structural deficit rather than the actual deficit Structural deficit is based on what expenditures would be if the economy were at full employment changes as policy changes, not as the economy changes If the goal is a balanced budget The structural deficit should be balanced over the business cycle

158 A recession tends to cause the federal budget deficit to _____ b/c tax revenues _____ and government spending on transfer payments _____. 157 A. Increase; rise; fall B. Increase; fall; rise C. Decrease; rise; fall D. Decrease; fall; rise

159 A recession tends to cause the federal budget deficit to _____ b/c tax revenues _____ and government spending on transfer payments _____. 158 A. Increase; rise; fall B. Increase; fall; rise C. Decrease; rise; fall D. Decrease; fall; rise

160 Macroeconomics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION, MISSISSIPPI STATE UNIVERSITY, & VIRTUAL ECONOMICS


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