ECO 2013, week 9 notes
ECO 2013, week 9 notes Eco2013
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This 4 page Class Notes was uploaded by Lauren Carstens on Friday April 8, 2016. The Class Notes belongs to Eco2013 at Florida State University taught by Joan Corey in Spring 2016. Since its upload, it has received 17 views. For similar materials see Principles of Macroeconomics in Economcs at Florida State University.
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Date Created: 04/08/16
Macroeconomics Chapter 11: The Keynesian View and Historical Perspective Classical vs. Keynesian 1. Classical Economics: belief that market and resource prices are flexible and allow the economy to self-correct fairly quickly o F.A. Havek o 1. Prices are flexible o 2. The economy is able to correct itself (fairly quickly) o 3. Says Law: idea that supply creates demand (production matters, not just having jobs or spending) The most productive thing for an economy is production o 4. People respond to economic calculation (Incentives matter) 2. Keynesian Economics: believe that market and resource prices are inflexible, and therefor, the market will not be able to quickly correct itself o John Maynard Keynes o 1. Prices are inflexible o 2. Economy can not correct itself We have to help it along o 3. Demand creates supply (spending matters) People are not going to produce things if people are not out there buying stuf o 4. People respond to animal spirits? People sometimes do things for reasons we don’t understand Sometimes do things impulsively o Reason for sticky wages and prices (what Keynes thought) Wages People don’t like lower wages Trade unions and large corporations enter into long- term contracts Bosses would rather fire people than lower wages during recession Prices It takes work for prices to change; it doesn’t happen immediately Menu costs: The costs of changing prices As a result, businesses produce the amount demanded at the existing price Marginal Propensity to Consume (MPC) The amount of additional income that is consumed MPC = additional consumption/ additional income o Ex: o For every dollar spent, you will spend $0.80 o Every time that $0.80 is spent, 80% of that will be spent The Expenditure Multiplier (M) o M = 1/ (1-MPC) o A change in expenditures will have a greater impact than the initial change o Note: For the multiplier to be efective, it must come from resources that otherwise would have been unemployed o In reality, the economy is poorer when you break a window because the money he has to spend on fixing the window, he could have spent on other goods We should focus on what is being produced Budget Deficits and Surpluses If we increase our budget deficit, our debt increases faster If we decrease our budget deficit, our debt increases slower Balanced Budget: government revenues (taxes) is equal to government expenditures o T=G Budget Deficit: Government is greater than government revenues o T < G Budget Surplus: Government revenue is greater than government spending o T > G Changes in the size of the deficit or surplus can have two main sources o 1. A reflection of the state of the economy Recession: People make less money, the amount of taxes collected goes down. People collect more government benefits so the government spending goes up. Budget deficit Expansion: People’s income goes up, so their taxes go up. Fewer people collect government benefits so government spending goes down. budget surplus o 2. Discretionary Fiscal Policy Deliberate changes in tax policy and/ or government expenditures designed to afect the budget deficit or surplus Keynesian view of fiscal policy Expansionary Fiscal Policy: o 1. Increasing government expenditures and/or o 2. Reducing tax rates o Designed to bring the economy out of a recession by increasing aggregate demand o Drawback: Expansionary policy will increase the size of the budget deficit Restrictive Fiscal Policy o 1. Decreasing government expenditures and/ or o 2. Raising tax rates o Designed to bring the economy down from an expansion by decreasing aggregate demand o Restrictive policy will reduce the size of the budget deficit Keynesians believed in the use of counter-cyclical policy, rather than balancing the budget o Counter- Cyclical Policy: A policy that moves the economy in the opposite direction form the forces of the business cycle o Recession: expansionary policy Worry about balancing the budget over a long time because we’ll be able to pay back the deficits when we have surplus o Expansion: restrictive policy Use surplus in the good times to pay back the deficits and have the economy balance over a large number of years Timing Problems of Fiscal Policy Efectiveness of fiscal policy is reduced by the following timing problems o 1. Our ability to forecast a recession/expansion is extremely limited Recognition lag o 2. Change in fiscal policy requires legislative action, which takes a long time (republicans and democrats working together??) Administrative lag o 3. A change in fiscal policy will not have an immediate impact on the economy Impact lag o If timed incorrectly, fiscal policy will increase (rather than reduce) economic instability
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