CIA4U0 Analyzing Current Economic Issues

1. CIA4U0Analyzing Current Economic Issues Chapter 10: The Business Cycle and Fiscal Policy Topic 1: Introduction to Fiscal Policy Topic 2: Aggregate Demand & Supply P 217-223

2. Fiscal Pol., Agg. Demand & Supply Topic Overview • Introduction • Aggregate Demand • Aggregate Supply • Equilibrium Output & Price Level • Changes in Aggregate Demand • Changes in Aggregate Supply

3. Fiscal Pol., Agg. Demand & SupplyIntroduction • Fiscal Policy-The set of Government taxation, spending and borrowing policies used to try to stabilize the economy • Made up of: • Unemployment rate • CPI • GDP • Production Possibility Curve • Market equilibrium (product, labour, capital) • Aggregate— “the total of”

4. Aggregate Demand & Supply Aggregate Demand (AD) • …is the total demand for all goods and services produced in a society at all price points • Quantity-Real GDP • Price is the chain Fisher index (a type of price index that is used for this purpose) • Graph looks very similar to a single product demand curve

5. Aggregate Demand & Supply Aggregate Demand (AD) • Recall: GDP = C + I + G +(X – M) • Economy must always be growing • That means real GDP must be growing (consumption after inflation) • For GDP to grow, that means one or more of C, I, G or X must grow

6. Aggregate Demand & Supply Aggregate Supply (AS) • …is the total supply of all goods and services provided at all price points • Also uses the chain Fisher Volume index • The supply curve is generally similar to a single product supply curve • Goes from low left to high right

7. Aggregate Demand & Supply Aggregate Supply (AS) • Differences: • It will be flat (very elastic) at low quantities • This is because inputs (resources/labour) are sitting idle and wages are low so there is little demand and little competition • Line starts to curve upwards as we produce more at higher prices—competition for inputs starts putting some pressure on prices • At high quantities, inputs become scarce, bidding for them causes prices to rise much faster • We don’t produce much more because of limited inputs

8. Aggregate Demand & Supply Equilibrium Output & Price Level • … is the point at which the AD and AS curves intersect • Full employment (FE) equilibrium occurs when the two curves intersect at the beginning of the upwards curve of the AS curve • Demand above this point causes inflation • Demand below this point causes a recession

9. Aggregate Demand & Supply Equilibrium Output & Price Level • A Recession is characterized by: • High unemployment • Low inflation • Low GDP growth • Inflation is characterized by: • High inflation • High employment • High levels of GDP growth

10. Aggregate Demand & Supply Changes in Aggregate Demand • All about the GDP equation (C, I , G, X, M) • What gives consumers more (or less) money to spend • What gives companies more (or less) money to invest • What policies cause government to spend more (or less)—fiscal policy

11. Aggregate Demand & Supply Changes in Aggregate Demand (4) • Changes in Consumption (C) • Has 4 possible uses: • Consumption of domestic output (60% of GDP) • Taxes • Savings • Consumption of imports • If the last 3 go down, consumption goes up (good) and visa versa (bad)

12. Aggregate Demand & Supply Changes in Aggregate Demand (4) • Changes in Investment (I) • Tied to: • Expected profits • Profits expect to be high/consistent, investment will increase (good) • Interest rate • Some investments are made with borrowed money • If interest rates are lower, firms are more willing to invest (good)

13. Aggregate Demand & Supply Changes in Aggregate Demand (4) • Changes in Government spending (G) • Transfer payments—direct payments one government pays to other governments or individuals to alleviate social problems • Other government spending-training programs, investment, expansion, business grants, business development • All of these things put money into people’s pockets which fuels demand (good)

14. Aggregate Demand & Supply Changes in Aggregate Demand (4) • Changes in Foreign Trade (X - M) • 3 factors: • Canadian Inflation-as the prices of our output go up, the more we buy from outside (bad) • Foreign Income levels-as they go up, demand for our stuff increases (good) • Value of the Canadian $ - as the value of our dollar goes up, our exports become more expensive, decreasing demand for our output (bad)

15. Aggregate Demand & Supply Changes in Aggregate Supply (3) • Changes in the price of inputs: • Labour • Land • Capital • As these costs go up, supply will go down • Only the elastic (flat) and curved parts of the curve will move up and to the right • The inelastic part (vertical) cannot move

16. Aggregate Demand & Supply Changes in Aggregate Supply (3) • Changes in amount of available inputs • Increases in the amount of • Labour • Resources • Capital • Makes it possible to produce more • Lowers the price for these things • Causes the whole curve to “expand” (flat part goes downward, vertical part goes sideways)

17. Aggregate Demand & Supply Changes in Aggregate Supply (3) • Changes in efficiency • Makes it possible to produce more to be more efficient in doing it • Lowers the prices of outputs • Increases supply • Causes the same effect on the curve as a change in the amount of inputs