This looks so cool

1. This looks so cool EL FIN

2. OVERVIEW • This is it!!! • Fill in some gaps & details with those taking the macro AP test • You’ve got the gist of macro

3. Start at the Beginning • Day 1 we discussed the role of the gov’t • Why do they intervene in economy? • REGULATE THE BUSINESS CYCLE

4. How can they tell? • Use GDP as biggest indicator • Spent a lot of time here • Real versus nominal • CIGX & WIRP • GDP, GNP, NDP, NEW, etc. • Why does it really matter?

5. Cool Quote • “the government is charged with caring about all of us together, but none of use on our own” • Impossible for them to think about us individually • But it is the problems that affect us individually that makes GDP matter

6. Big 3 • Inflation, unemployment, growth • With a partner answer the following: • 1. How do you calculate inflation? • Need equation for market basket, CPI, & inflation • 2. Compare the 4 types of unemployment & define the natural rate • 3. Draw two separate graphs depicting growth • What needs to happen for economy to grow? What specifically can you do to encourage that growth? Draw the loanable funds graph.

7. These guys matter • Gov’t constantly trying to fight them all • Impossible to do so simultaneously • Why? • When will you see unemployment? • When will you see inflation? • The two are typically opposites

8. New Graph • Some Phillip guy figured it out • Phillips Curve shows tradeoff between the two • LRPC set at natural rate of unemploy • Can have a situation in which both increase • How?

9. Supply Shocks • Sudden changes in AS curve • Can go either way • Decrease in gas prices cause favorable • Natural disasters cause negative • AS shifts to the left…what happens? • Prices go up (inflation) • Output goes down (causing reduced output, which means people lose jobs) • STAGFLATION

10. We desire stability • No, actually we demand it • Get very unhappy when not stable • Blame gov’t • Can they really control it that much?

11. Big, big, big budget • This year Obama’s budget is $3.6t • Unparalleled amount of power/influence • But can they really do whatever they want? • NOPE for two reasons • 1. only “control” so much spending • 2. it involves Congress

12. Bad music kills ears • Most of gov’t budget is actually MANDATORY SPENDING • Same concept as homework • Things like safety nets • Can only control DISCRETIONARY • Relatively small portion of budget

13. Vote them all out? • Congress has all time low approval rating (positive signs of late) • Couldn’t pass bill for emergency unemployment benefits • How can they agree enough to “fix” the economy? • Luckily we have AUTOMATIC STABILIZERS

14. Auto pilot w/o sleeping • Some actions designed to kick in when needed w/o intervention necessary • When in recession, what fiscal policies need to happen? • Cut taxes & increase spending • That happens w/o trying • How?

15. Cruise Control at 105 • When economy hurting it needs help • We need help • People lose jobs or make less money their taxes go down • Likewise spending picks up • More people collect unemployment, food stamps, etc. • Taxes down & spending up w/o policy • Same works in reverse

16. Still need more help • Role of gov’t to stabilize business cycle • Can do so using FISCAL & MONETARY POLICY • Fiscal--taxes & spending • Monetary--control of money supply • RR, DR, OMO • Can use these guys to put economy where we want it

17. Need proof…look at picture • This is your ideal economy • Sorry, wrong picture

18. What does it look like?

19. LRAS is our goal • X marks where we are at • Vertical line is our goal • LRAS, potential GDP, natural rate of unemployment, full employment • Any deviation needs fixed

20. Have some choices • INFLATIONARY GAP • Economy OVERHEATED • RECESSIONARY GAP • Economy in a recession • ALL YOU NEED TO DO IS CLOSE THE GAP…HOW HARD IS THAT

21. They are sure trying • But why are they failing? • Who actually controls the economy? • Try as they might it is the CONSUMERS who control a larger portion of the economy

22. Still know what to do • Just b/c they can’t fix it doesn’t mean we don’t know what needs fixed • AS/AD graph shows us what needs done

23. Picture of fixing • X marks where we are…vertical marks where we want to be • Three options: • 1. Everything is good; E = V • 2. Recessionary Gap; V > E • 3. Inflationary Gap; E > V • Goal is to get E = V

24. Distance is easy • Distance btwn is what is needed • Do you need to stimulate economy by that entire amount? • No,no,no • Remember what happens when money is spent • Someone else earns it, who then spends it…etc.

25. Same as MS multiplier • The same thing happens here as creation of money process • Money is earned, spent, earned, spent, earned, spent forever UNLESS IT IS SAVED • SAVING, NOT SPENDING, MONEY IS ONLY THING TO LIMIT THIS PROCESS

26. APC, APS, MPC, MPS • Last big point of macro • APC = average propensity to consume • % of our income we spend • APS = average propensity to save • % of our income we save • As with micro, don’t focus on average but instead MARGINAL

27. MPC • Marginal propensity to consume • When given another $, amount that we spend • MPS: same thing but amount that we save • MPS + MPC = 1 • All money is saved or spent

28. Works same as RR • 1/RR is ms multiplier • Banks saving money is the same thing as us saving money (limits circulation process) • Expenditure multiplier then becomes • 1/MPS or 1(1-MPC)

29. Sample Recession • Say they want to stimulate the economy $200 billion • If the MPS is .2, how much should the gov’t increase spending to do so?

30. Spending is Spending • Doesn’t matter whether it is by consumers, gov’t, for investment, etc. • Spending counts the same • Changes in taxes work a little bit different • So does the multiplier when considering exports

31. Tax Multiplier • When the gov’t raises taxes they take money we would have spent…but also take money we would have saved • TAX MULTIPLIER ALWAYS SMALLER THAN SPENDING MULTIPLIER • Some of the money would have been saved • Likewise if the gov’t reduces taxes some of the money will be saved

32. End Result • Must reduce the value of the spending multiplier by amount of it actually spent • Spending multiplier = 1/MPS • Tax multiplier = (1/MPS) x MPC • Amount we spend of the change in taxes • Also written as MPC/MPS • Sometimes expressed as negative

33. Open Economy Multiplier • When we save money it leaves our “spending cycle” • Likewise when we buy imports it does the same thing • OE multiplier then combines effect of both savings & buying imports • OE = 1 / (MPS + MPi)

34. Practice • With a partner calculate each of the following multipliers: • Spending: MPC = .9 • Tax: MPS = .05 • Spending: MPS = .3 • Tax: MPC = .5 • OE: MPC = .2; MPi = .05

35. Part 2 • Now fix the economy • Recessionary gap of $500 billion…MPC = .10…how much should gov’t increase spending? • How much would they need to cut taxes? • If MPi .1, how much would they need to increase spending?

36. Another way to look at it • Keynesian Cross • GDP as a picture • Autonomous spending = necessary regardless of income • Slope of Consumption Function = MPC • HOW CAN THE KC BE USED TO EVALUATE WHAT NEEDS TO HAPPEN TO THE ECONOMY?

37. Bottom Line • Why does macro exist? • What’s the gov’t’s job (since GP)? • How can they do it? • What influence do we have? • Saving, velocity of money, MPC • Connect the dots and you get the whole picture.