Unit 7

»»»Balance of payments

Measure of money inflows and outflows between the United states and the rest of the world (ROW)
    -inflows are referred to as credits
    -outflows are referred to as debits
The balance of payments is divided into 3 accounts
    -current account
    -capital/financial account
    -official reserves account

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»»Double entry bookkeeping

-every transaction in the balance of payments is recorded twice in accordance with standard accounting practice
    - EX. US manufacturer, John Deere, exports $50 million worth of fan equipment to Ireland
    A credit of $50 to the current account ($50 million worth of farm equipment or physical assets)
    A debt of $50 to the capital/financial account (+$ 50million worth of euros or financial assets)
**the two transactions offset each other. Theoretically, the balance payments would always equal zero... Theoretically

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» current account-Balance of trade or net exports
    -Exports of goods/services - imports of goods/services
    -Exports create a credit to the balance of payments
      -Imports create a debt to the balance of payments

-Net foreign income
    -Income earned by US owned foreign assets -income paid to foreign held US assets
    -EX interest payments on US owned Brazilian bonds- interest payments on German owned US treasury bonds

-Net transfers (tend to be unilateral)
    -foreign aid > a debit to the current account
    - EX Mexican migrant workers send money to family in Mexico

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» capital/financial account

-the balance of capital ownership
-includes the purchase of both real and financial assets
- direct investment in the United States is a credit to the capital account
    -EX the Toyota factory in San Antonio
-Direct investment by US firms/individuals in a foreign country are debits to the capital account
    - EX the Intel factory in San Jose, Costa Rica
-purchase of foreign financial assets represents a debit to the capital account
    EX Warren buffet buys stocks in petrochina
- purchase of domestic financial assets by foreigners represents a credit to the capital account
    - the United Arab Emirates sovereign wealth funds purchases a large stake in the NASDAQ

What causes capital/financial flows?
- differences in rates of return on investment
- ceteris Paribas, savings will flow toward higher returns

Relationship between current and capital account
- remember double entry bookkeeping?
- the current account and the capital account should be zero each other out
-that is... if the current account has a negative balance (deficit), then the capital account should then have a positive balance (surplus)

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Official reserves
-the foreign currency holdings of the United states federal reserve system
- when there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments
- when there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments
-the officials reserves zero out the balance of payments

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Credit vs debits

Credit: additions to a nation's account
Debits: subtraction to a nation's account

How to calculate the following:
1. Balance on trade
    - (merchandise and service exports) - (merchandise on service imports)
2. Trade deficit occurs when the balance on trade is negative (imports > exports)
    Trade surplus occurs when the balance on trade is positive ( exports > imports)
3. Balance on current account:
    Balance on trade (exports & imports) + net investment income + transfer payments
4. Official reserves
    -nationally
          (change^) in CA [current capital] + (change^) in FA [capital amount] + (change^) in official reserves = 0

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»» foreign exchange (FOREX)

- the buying and selling of currency
    EX in order to purchase souvenirs from France, it is first necessary for Americans to sell (supply) they dollars and but (demand) euros
- the exchange rate (e) is determined in the foreign currency markets
    EX the current exchange rate is approximately 77 Japanese yen to 1 US dollar
- simply put. The exchange rate is the price of a currency
- do not calculate the exact exchange rate

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» changes in exchange rates

-exchange rates (e) are a function of the supply and demand for currency
    -an increase in the supply of a currency will decrease the exchange rate of the currency
    - a decrease of the supply of a currency will increase the exchange rate of the currency
    -an increase in demand of a currency will increase the exchange rate of the currency
    -a decrease in the demand of a currency will decrease the exchange rate of a currency

»» Appreciation and depreciation (supply of dollars)

-Appreciation of a currency occurs when the exchange rate of that currency increases (e^)
-Depreciation of a currency occurs when the exchange rate of that currency decreases (ev)
EX: if German tourists flock to America to go shopping, then the supply of euros will increase and demand for dollars will increase. This will cause the euro to depreciate
and the dollar to appreciate

» exchange rate determinants

-consumer tastes
-relative income
-relative price level
-speculation

» demand $ - exports and capital inflows
When the US exports goods/services to other countries, they need our dollar to compete the transaction.
    -they demand our money, they need to supply theirs

» supply $ - imports and capital outflows
When we import goods/services from other countries, we need their money to complete the transaction
    - we demand their money, we need to supply ours

EXAMPLE GRAPH

***TIPS 
- always change the D line on one currency graph, the S life on the other currency's graph
- move the lines of the two currency graph in the same direction (right or left) and you will have the correct answer
- if D in one graph increases, S on the other will also increase
- if D moves to the left, S will move to the left on the other graph 

Fixed exchange rates
It is determined by government policies

flexible (floating) exchange rates
It is set by market forces with little or no government intervention


»» Absolute advantage v. Comparative advantage
» absolute advantage : faster, more effective
» comparative advantage: lower opportunity cost

» the same country can have an absolute advantage in two products
» only one country can have a comparative advantage at one product

Comparative output (item A):
Opposite product/product you're looking for (B/A)

Unit 5/6

From short run to long run

»»AS curve doesn't shift in response to changes in the AD curve in the short run
    I.e. -nominal wages doesn't respond to price level wages
          - workers may not realize impact of the changes on may be under contract
»» long run - period in which nominal wages are fully responsive to previous changes in price level

-when changes occur in the short run they result in either increased our decreased producer profits -not changes in wages paid
-in the long run increases in AD result in a higher price level, as in the short run, but as workers demand more money the AS curve shifts left to equate production at the original output level, but now at a higher price
- in the long run, the AS curve is vertical at the natural rate of unemployment (NRU), or full employment (FE) level of output. Everyone who wants a job has one and no one is enticed then into or out of the market.
- demand - pull inflation will result when an increase in demand shifts the AD curve to the right temporarily increasing output while raising prices
- cost-push inflation results when an increase in input costs that shifts the AS curve to the left. In this case the price level increase is not in response to the increase in AD, but instead the cause of price level increasing

»»  the Phillips curve

Represents the relationship between unemployment and inflation
The trade off between inflation and unemployment only occurs in the short run
Each point on the Phillips curve corresponds to a different level of output

»Long run Phillips curve (LRPC)

-It occurs at the natural rate of unemployment
-It is represented by a vertical line
-There is no trade off between unemployment and inflation in the long run
    -The economy produces at the full employment output level
    -The nominal wages of workers fully incorporate any changes in price level as wages adjust to inflation over the long run
-LRPC will only shift if LRAS curve shifts
Because of the long run Philips curve exists at the natural rate of unemployment (NRU), structural changes in the economy that effects UN structural changes in the economy that effects UN will also cause the LRPC to shifts
      -increase UN shift LRPC >
      -decrease UN shift LRPC <

-The three of unemployment that make up LRPC
Frictional
Structural
Seasonal

» the short run Philips curve (SRPC)

-Phillips is assumed to be stable in the short run because the SRAS curve is stable
-If there is an increase our decrease in AD you shift up or down along the SRPC
- if SRAS increases it will shift to the right, but the SRPC with shift to the left
- if SRAS decreases it will shift to the left, but the SRPC will shift to the right

»» supply shocks 

-rapid and significant increase in resource cost which causes the SRAS curve to shift this producing a corresponding shift in the short run PC curve

»» misery index

-a combination of inflation and unemployment in any given year
-single digit mystery is good

» stagflation occurs when high unemployment and high inflation happens at same

»disinflation when inflation decrease over time

» supply- side economics or reagonomics

-support policies that promote GDP growth by arguing that high marginal tax rates along with current system of transfer payments price discentives to work, invest, innovate, and underage entrepreneurial ventures
- the supply side economist tend to believe that the AS curve shifts to the right thus creating the trickle down effect

»» meaningful tax rates

-amount proof on the last dollar earned it on each additional dollar earned
-by reducing marginal tax rates supply sides believe that you would encourage more people to work longer foregoing leisure time for extra income

»»laffer curve

-Trade offs between tax rates and tax revenues
- 3 criticism
    -where the economy is actually located in the curve is difficult to determine
    -tax cuts also increase demand which can fuel inflation
    - empirical evidence suggest they impact of tax rates on incentives to work, invest, and save are small

>>Economic Growth and Productivity 

• Economic Growth Defined
  • Sustained increase in Real GDP over time
  • Sustained increase inReal GDP per Capita over time
• Why Grow?
  • Growth leads to greater prosperity for society
  • Lessens the burden of scarcity
  • increases the general level of well-being
• Conditions of Growth
  • Rule of Law
  • Sound legal and Economic Institutions
  • Economic Freedom
  • Respect for Private Property
  • Political and Economic Stability
    • Low inflationary Expectations
  • Willingness to sacrifice current consumption in order to grow
  • Saving 
  • Trade
• Physical Capital
  • Tools, machinery, factories, infrastructure
  • Physical Capital is the product of investment
  • Investment is sensitive to interest rates and expected rates of return
  • It takes capital to make capital
  • capital must be maintained
• Technology and productivity
  • Research and development, innovation and invention yield increases in available technology
  • More technology in the hands of workers increase productivity
  • Productivity is output per worker
  • More Productivity = economic growth
• Human Capital
  • People are a country'e most important resource. Therefore human capital must be developed
  • Education
  • economic freedom 
  • the right to acquire private property
  • incentives
  • clean water
  • stable food supply
  • access to technology
• Hindrances to Growth
  • Economic and political instability 
    • High inflationary expectations
  • Absence of the rule of law
  • Diminished private property rights
  • negative incentives
    • the welfare state
  • Lack of savings
  • excess current consumption
  • Failure to maintain existing capital
  • Crowding out of investment
    • government deficits and debt increasing long term interest rates
  • Increased income inequality and populist policies
  • Restrictions onFree international Trade

Unit 4

Color Coordination

Money
Federal Reserve Bank
Balance sheet
Fiscal Policy
Loanable funds


1. Uses of money
-As a medium of exchange, trading
-Unit of account, establishes economic worth (P » worth (quality))
-Store of value, money holds value over a period of time

2. Types of money
-Commodity money, goods: chicken, beans, shoes. 
     It gets its value from the type of material from which it is made.
-Representative money: IOU, paper money that is backed by something tangible
- fiat money: it is money because the government says so
*America uses fiat money

3. Characteristics of money
- Durability
- portability
- divisibility
- uniformity
- scarcity
- acceptability

4. Money supply
- M1 money; consists of currency in circulation. 
     »Currency is coins and paper money. 
     »Checkable deposits (demand deposits) or checks.
     » traveler's checks
- M2 money; consists of M1 money plus 
     »savings accounts
     »money market accounts
     »deposits held by banks outside the US

»»Fractional reserve banking: it is the process by banks of holding a small portion of their deposits in reserve and loaning out the excess
1. Banks keep cash on hand (required reserves) to meet depositor's need
2. Banks must keep reserved deposits in their vaults or at the federal reserve bank
3. Total reserves, total funds held by a bank,
    *TR = (required reserves) RR + ER (excess reserves, reserves beyond those that are required )
4. Banks can legally lend only to the extent of their excess reserves
5. Reserve ratio = required reserves divided by total reserves.  *RR / TR
     ***typical required reserve ratio = 10%, set by the Fed

»»Significance of a fractional reserve system
1. 
2. Required reserves do not prevent bank pennants because banks must keep their required reserves (fdisd)
3. Reserve requirements gives the Fed control over how much money banks can create


»»Functions of the Fed (federal reserve bank)
1. To control the money supply through monetary policy (circulation of currency and adjusting the interest rate)
2. Issue paper money
3. Serve as a clearing house for checks
4. Regulate banking activities
5. Serve as a bank for banks

»»»Balance sheet:
A statement of assets and claims summarizing the financial position of a firm or a bank at some point in time
 *A balance sheet must balance at all times
»»Assets vs liabilities
»Assets:
     -What you own
     -Reserves:
          - required reserves (RR) - % required by Fed to keep on hand to meet demand
          - excess reserves (ER) - % reserve over and above the amount needed to satisfy the minimum reserve ratio set by Fed
     -Loans and firms, consumers, and other banks (earns interest)
     -Loans to government = treasury securities
     -Bank property - (if bank fails, you could liquidate the building / property)

»Liabilities + owner's equity or network:
     -What you owe
     -Claims of non owners
     -Demand deposits ($ put into bank)
     -Times deposits (CDs)
     -Loan firms: federal reserve and other banks
     -Shareholders equity - (to set up a bank, you must invest your own money in it to have a stake in the banks success or failure)

100% reserve banking have no impact on size of money supply

In a fractional-reserve bank system, banks create money

»»  the required reserve ratio
-The % of demand deposits that must be sure as vault cash or kept on reserve as federal funds in the bank's account with the federal reserve.
-The required reserve ratio determines the money multiplier (1/reserve ratio )
     -decreasing the reserve ratio increased the rate of money creation in the banking system and is expansionary
     -increasing the reserve ratio decreases the rate of money creation in the banking system and is Contractionary
-Changing the required reserve ratio is the least used tool of monetary policy and is usually held constant at 10%

»»The monetary (money) multiplier
-The money multiplier shows us the impact of s change in demand deposits on land and eventually the money supply
-The money multiplier indicates the total number of dollars created in the banking system by each 1$ addition to the monetary base (bank reserves & currency in circulation)
-To calculate the money multiplier, divide 1 by the required reserve ratio
     Money multiplier = 1/reserve ratio
          EX: if the reserve ratio is 25%, then the multiplier = 4

»»The four types of multiple deposit expansion question
-Type 1: calculate the initial change in excess reserves
     Aka the amount a single bank can loan from the initial deposit
-Type 2: calculate the change in loans in the banking system
-Type 3: calculate the change in the money supply
*sometimes type 2 and type 3 will have the same result (ie no federal involvement)
-Type 4: calculate the change in demand deposits 


»»Fiscal policy
-Controlled by congress
     1. Tax or
     2. Spend
»»Monetary policy
-Controlled by Fed reserve bank
     1. OMO (open market operation - feds can buy or sell bonds/securities) a referred monetary tool because it's flexible
     2. Reserve requirement
     3. Discount rate; it is the interest rate charged by the Fed for over night loans to commercial banks *it doesn't change money supply directly
     4. Federal fund rate; it is the interest rate charged by one commercial bank for overnight loans to another commercial bank

»»»The Fed has several tools to manage the money supply by manipulating the excess reserves held by banks, a practice known as monetary policy
»»The federal tools of $ policy
» expansionary (easy $) - wants to increase money supply
- monetary policy options;
    -open market operation (OMO): buy back bonds from the public
     -Required reserves: decrease reserve ratio
     - discount rate: decrease discount rate
     - Federal funds rate: decrease federal fund rate
»» Contractionary (tight $) - wants to retract money supply
     -OMO: sell bonds to the public
     -RR: increase reserve ratio
     - discount rate: increase discount rate
     -Federal funds rate: increase federal fund rate

»» money creation process
- $ multiplier = 1/RR
- multiple deposit expansion
- Banks create money by making loans
EX: RR = 20%, loan = $500, Q: total money created
1/.2 = 5 x loan, 500 = 2500 money created « potential loans
**assumption: no excess reserves

»»Loanable funds market
- the market whee savers and borrowers exchange funds (Qlf) at the real rate of interest (r%)
- the demand for loanable funds, or borrowing comes from households, firms, government and foreign sector. The demand for loanable funds is in fact the supply of bonds
- the supply of loanable funds, or saving comes from households, firms, government and foreign sector. The supply of loanable funds is also the demand for bonds.

»Changes in the demand for loanable funds
-demand for loanable funds= borrowing (I.e. supplying bonds)
- more borrowing = more demand for loanable funds »
-less borrowing= less demand for loanable funds «
EX: -government deficit spending= more borrowing= more demand for loanable funds therefore DLF » and r%^
- less investment demand= less borrowing= less demand for loadable funds therefore DLF « and r% v

»Changes in supply for loanable funds
-supply of loanable funds= saving (I.e. demand for bonds)
- more saving = more supply in loanable funds »
- less saving= less supply in loanable funds «
EX: -government budget surplus = more saving= more supply of loanable funds therefore SLF » and r%  v
-decrease in consumer's MPS = less saving= less supply of loanable funds therefore SLF « and r%^

Review:
-Required reserves = amount of deposit X required reserve ratio
-Excess reserves = total reserves - required reserve
-Maximum amount in a single bank can loan= the change in excess reserves caused by a deposit
-The money multiplier = 1/required reserve ratio
-Total change in loans = amount single bank can lend X money multiplier
-Total change in the money supply= total change in loans + $ amount of Fed action
-Total change in demand deposit = total change in loans + any cash deposited

Unit 3

AGGREGATE DEMAND

Aggregate demand (AD) - Shows the amount of real GDP that the private, public, and foreign sector collectively desire to purchase at each possible level
» The relationship between the price level and the level of real GDP is inverse

»»Three reasons why AD is downward sloping
» real-balances effect
     -When the price level is high households and businesses cannot afford to purchase as much output
     -When the price level of low households and businesses can afford to purchase more output

» interest-rate effect
     -A higher price level increases the interest rate which tends to discourage investment
     -A lower price level decreases the interest rate which tends to encourage investment

» foreign purchases effect
     -A higher price level increases the demand relatively cheaper imports
     -A lower price level increases the foreign demand for relatively cheaper US exports


»»Shifts in aggregate demand
There are two parts to a shift in AD
-a change in C, Ig, G and/or Xn
-a multiplier effect that produces a greater change than the original change in the four components
- increases  In AD = AD >
- decreases in AD = AD <

»»Determinants 
»Consumption - households spending is affected by:
-consumer wealth
More wealth = more spending AD shift >
Less wealth = less spending AD shift <

-consumer expectations
Positive expectations = more spending AD shift >
Negative expectations= less spending AD shift <

- households indebtedness
Less debt = more spending AD shift >
more debt = less spending AD shift <

-taxes
Less taxes = more spending AD shift >
More taxes= less spending AD shift <

»Gross private domestic investment
Investment spending is sensitive to:
-The real interest rate
Lower real interest rate = most investment AD >
Higher real interest rate = less investment AD <

-Expected returns
Higher expected returns = more investment AD >
Lower expected returns= less investment AD< 

Expected returns stress influenced by:
Expectations of future profitability
Technology
Degrees of excess capacity (existing stock of capital)
Business taxes

» government spending
More government spending AD >
Less government spending AD <

» net exports
Net exports are sensitive to:
-exchange rates (international value of $)
Strong $ = more imports and fewer exports = AD <
Weak $ = fewer imports and more exports = AD >

-relative income
Strong foreign economics = more exports = AD >
Weak foreign economics = less exports = AD <

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AGGREGATE SUPPLY

Aggregate supply - the level of real GDP (GDP r) that firms will produce

Long run
- Period of time where input pieces are completely flexible and adjust to changes in the piece level
-In the long run, the level of real GDP supplied is independent of the price level
-Measuring potential output
     -Obsessing to see if all resources are used efficiently
-There is no pressure to raise or lure factor prices when on point b or equilibrium
- inefficient or under utilizing our resources on point a, factor prices are pressured to fall
- over utilizing at point c, factor prices are pressured to rise

»»Shifts in LRAS
Technology
Economic growth
Capital
Entrepreneurship
More resources available


Short run
Period of time where input prices are sticky and do not adjust to changes in the price level
In the short run the level of real GDP supplied is directly related to the price level

Long run aggregate supply (LRAS)
-the long run aggregate supply on LRAS marks the level of full employment in the economy (analogous to PPC)
***vertical at full employment

Change in SRAS
-An increase in SRAS is seen as a shift to the right.
-A decrease in SRAS is seen as a shift to the left
-The key to understanding shifts in SRAS is per unit cost of production
     Per unit production cost = total input cost / total output

»»Determinants of SRAS 
Input prices
-Increases in resource prices = SRAS <
-Decreases in resource prices = SRAS >

Productivity
- Productivity = total output /total input
-more productivity = lower unit production cost = SRAS >
-lower productivity = higher unit production cost = SRAS <
Legal institutional environment

Keynesian range
-The followers of the Keynesian view believed in a horizontal AS curve because when the economy is below full employment AD shift outward.
-Increase in real GDP, Unemployment drops but the price level is constant, So demand creates is own supply

Classical range
-In the long run the AS curve is vertical because the only effects of an increase in AD is when we're already at full employment. Thus you have an increase in the price level and supply creates its own demand SA's law

Intermediate range
-AS off between the classical and Keynesian range when this occurs AS shifts outward price level and real GDP increases


As PPC increases real GDP decreases, inverse

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AD AND AS MODELS

The equilibrium of AS and AD determines current output (GDP r) and the price level (PL) 
Equilibrium - when all three lines intersect: LRAS, SRAS, and AD

Full employment equilibrium exists where AD intersects SRAS and LRAS at the same point

Recessionary gap
A recessionary gap exists when equilibrium occurs below full employment output. SRAS and AD intersects and shifts left but LRAS doesn't

Inflationary gap
An inflationary gap exists when equilibrium occurs beyond full employment output. SRAS and AD intersects and shifts to the right, while LRAS doesn't.

Changes (^) in AD
-When a determinant increases then AD shifts to the right, GDPr increases and PL increases, unemployment rate decreases and inflation rate increases.
-When a determinant decreases then AD shifts to the left, GDP r decreases and PL decreases, unemployment rate increases and inflation rate decreases.

Changes (^) in SRAS
-when a determinant decreases then AS shifts to the right, GDP r increases and PL decreases, unemployment decreases and inflation rate decrease
-when a determinant increases then AS shifts to the left, GDP r decreases and PL increases, unemployment increases and inflation rate increases

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INVESTMENT DEMAND

Investment
Money spent on expenditures on:
New plants (factories)
Capital equipment (machinery)
Technology (hardware and software)
New homes
Inventories (goods sold by producers)

»»Expected rates of return
How does business make investment decisions?
-cost/ benefit analysis
How does business determine the benefits?
-elected rate of return
How does business count the cost?
-interest costs
How does business determine the amount of investment they undertake?
- compare expected rate of return to interest cost
If Expected return > interest cost, then invest
If elected return < interest cost, then do not invest

»»Real (r%) vs nominal (n%)
Nominal is the observable rate of interest. Real subtracts out inflation (pi%) and is only known ex post facto.
How do you compare the real interest rate (r%)?
r% = i% - pi%
What then, determines the cost of an investment decision?
The real interest rate (r%)

Investment demand curve (ID)
Shape: downward sloping
Why? - when interest rates are high, fewer investments are profitable; when interest rates are low, more investments are profitable
-conversely, these are few investments that yield high rates of return, and many that yield low rates of return

Changes in r% cause changes in Ig. Factors other than r% may shift the entire ID curve.

»»Shifts in investment demand ID:
cost of production
Business taxes
Technological change
Stock of capital
Expectations

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CONSUMPTION AND DEMAND

Disposable income DI:
Income after taxes or net income

»»Two choices
With disposable income, households can either
-Consume (spend money on goods and services)
-Save (not spend money on goods and services) 

»»Consumption
Household spending
The ability to consume is constrained by:
-The amount of disposable income
-The propensity to save
»»Do households consume if DI = 0?
-Autonomous consumption
-Dissaving 

»» saving
Household not spending
The ability to save is constrained by:
-the amount of disposable income
-the propensity to consume
»» do households save is DI = 0?
NO

PAC average propensity to save and APC average propensity to consume
APC + APS = 1
APC > 1 then dissaving
-APS then dissaving

»»MPC and MPS
marginal propensity to consume
Change in C / change in DI
% of every extra dollar earned that is spent

Marginal propensity to save
Change in S / change in DI  
% of every dollar that is saved
MPC + MPS = 1

»»determinants of C and S
Wealth 
Expectations
Household debt
Taxes


»»The spending multiplier effect
An initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending, or aggregate demand

Multiplier = change in AD / change in spending
Multiplier = ^ AD / ^ C, Ig, G, or Xn

Why does this happen?
Expenditures and income flow continuously which sets off a spending increase in the economy

The spending multiplier can be calculated from the MPC or the MPS
Multiplier = 1/1-MPC or 1/MPS
Multipliers are (+) when there is an increase in spending and (-) when there is a decrease

»»Tax multiplier
When the government taxes, the multiplier works in reverse because now money is leaving the circular flow
     -MPC/1-MPC or -MPC/MPS
If there is a tax cut, then the multiplier is +, because there is now more money in the circular flow

Step 1: calculate the MPC and MPS
Step 2: determine which multiplier to use, and whether it's + or - 
Step 3: calculate the spending and/or tax multiplier
Step 4: calculate the change in AD

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FISCAL POLICY

Fiscal policy - Changes in the expenditures or tax revenues of the federal government
     2 tools of the fiscal policy:
Taxes - government can increase or decrease taxes
Spending - government can increase our decrease spending
Fiscal policy is enacted to promote our nation's economic goals: full employment, price stability, economic growth

Deficits, surpluses, and debt
-Balanced budget: revenues = expenditures
-Budget deficit: revenues < expenditures
-Budget surplus: revenues > expenditures
-Government debt: Sum of all deficits - sum of all surpluses

-Government must borrow money when it runs a budget deficit
Government borrows from:
Individuals


»»Fiscal policy two options
Discretionary fiscal policy (action)
Expansionary fiscal policy - think deficit, recession
Contractionary fiscal policy - think surplus, inflationary period

Non-discretionary fiscal policy (no action)

Discretionary
-increasing or decreasing government spending and/or taxes in order to return the economy to full employment. Discretionary policy involves policy makers doing fiscal policy in response to an economic problem

Automatic
- unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation. Automatic fiscal policy takes place without policy makers having to respond to current economic problems

Contractionary fiscal policy - policy designed to decrease aggregate demand
- strategy for controlling inflation
-inflation is countered with Contractionary policy
     -decrease government spending Gv
     - increase taxes T^

Expansionary fiscal policy - policy designed to increase aggregate demand
- strategy for increasing GDP, combining a recession, and reducing unemployment
-recession is countered with expansionary policy
     -increase government spending G^
     - decrease taxes Tv


Progressive tax system - average tax rate (tax revenue/GDP) rises with GDP

Proportional tax system - average tax rate remains constant as GDP changes

Regressive tax system - average tax rate falls with GDP

the more progressive the tax system, the greater the economy's built in stability.

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