Economics Notes

Factors of Production September-08-08 6:06 PM

Human resources-labour->wages Natural resources-land -> rent Entrepreneurship-> profit Technology-capital-> interest

Brief Review

1. Basic economic problem faced by both society and individuals is that the human wants are unlimited. 2. Economic resources can be categorized as natural, human, capital. 3. Micro concentrates on ways consumers, and businesses act on certain markets, while macro concentrates on the broader whole. 4. Economic models contain casual relationships between variables and simplifying instructions

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September-09-08 8:40 AM

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What is an Economy? September-15-08 8:34 AM

An economy can be best be described as a self-sustaining system in which many independent transactions (often triggered by self-interest) create flows of money and products.

AN ECONOMY... • • • • •

Is a very complex or intricate system Is dynamic of subject to movements and exchanges Consists of interdependent people, groups, and institutions, each performing specialized roles Involves a series of independent transactions motivated by economic goals Involves numerous transactions that create 2 circulars flows ( money moves in one direction while goods and services more in opposite direction.

The 3 Basic Economic Questions What to produce? • What goods and services should our society produce, and in what quantities? • What is worth producing and what is not? • What are we giving up in order to produce these goods and services

• • • •

How to produce? By whom, with what resources, and in what way should these goods be produced? How can out limited resources be used most efficiently? Should products be made in small, privately owned factories or in large, state owned corporations? How much automation should be used? How much manual labour?

For whom to produce for? • How will total output be shared among the different members of society? • Who will get which goods and services? Will products be shared equally? • On what basis should decisions concerning distribution be made? Although every economy attempts to answer these questions effectively, the way each question is answered will help identify the type of economic question. Economists define the economic system as the set of laws, institutions, and common practises that help a nation determine how to use scarce resources to satisfy as many of its people's needs and wants as possible. The 3 ECONOMIC SYSTEMS THAT HAVE EMERGED ARE: 1. TRADIONAL 2. COMMAND 3. MARKET

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Economic Systems September-09-08 9:11 AM

1. What are the possible advantages for the society of the market system? Some of the advantages for market system include: - The consumer and business decide on what to produce, how to produce, and who to sell to, not the government - Reduce unemployment due to higher volume of sales, and restrictions; more money enters the entrepreneurs pockets. - More competition with no protection for smaller industries

2. What are the possible disadvantages for the society of the market system?

-

Some of the disadvantages for the market system include: Unequal distribution of wealth; rich get richer, poor get poorer Business control the market, the government has very little say Less consumer protection Less worker protection, regulation

3. What are the possible advantages for the society of the command system? Some of the advantages for the command system include: - Regulation of workers and wages; no unfair treatment - Everyone is equal, no rich or poor 4. What are the possible disadvantages for the society of the command system? Some of the disadvantages for the command system include: - Government can't allocate resources quickly due to having not enough knowledge on how much people need to survive - Wages are not in-line with the amount of work or expertise required; a farm worker making as much as a doctor - Limits personal freedom - You don't own any possessions, land, or anything, the government owns it all.

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Modern Mixed Economy September-17-08 8:55 AM

Modern Mixed Economy MARKET

USA

Sweden

Canada

Korea

COMMAND

Traditional Mixed Economies Mongolia

India

Myanmar

TRADITIONAL

Modern Mixed Economy: is one that combines both the use of markets and significant government presence in economic decision-making. - Includes a private sector. Economic activity dominated by markets. Traditional Mixed Economies: Where, market driven industries, such as mining, co-exist with a traditional sector. Public + traditional sector.

Canada: A Mixed Market Economy September-17-08 9:02 AM

• • • •

The Canadian economy contains elements of traditional and command economies. The Canadian economy is classified as a mixed economy Our country's economy includes both private enterprise and state-owned enterprise. The Canadian system tries to integrate the best features of all 3 economic types, E.g. Land ownershipCanada allows for state-owned or CROWN LAND - features of command economy. It also permits private ownership if land - feature of market economy

Conflicting Goals September-17-08 9:21 AM

Strategies to keep prices stable often have an adverse effect on employment rates + national production. Governments can promote price stability by raising interest rates in order to control the amount of money in circulation as it becomes more expensive to borrow money for investment: Businesses hire fewer workers + production levels either remain constant or begin to decline. Increases in employment +production as the opportunity cost of stable prices.

Tangible Resources1. Land a. Natural resources Unit 1 Page 7

a. Natural resources b. Water c. soils 2. Labour a. Skilled workers 3. Capital a. Facilities b. Equipment c. Machines d. money Intangible Resources1. Knowledge a. Science b. Technology c. experience 2. Entrepreneurship a. Management b. Direction c. Risk taking 3. Environment a. Work ethic b. Politic stability c. Economic stability

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Production Possibility Curve September-25-08 8:35 AM

1. The choices that a country has to make about the use of scarce resources available and the associated sacrifice of1 product for the other. (OPPORTUNITY COST) a. The PPC can illustrate the various combinations of goods or services that are possible if an economy uses all of its available resources (PRODUCTION POSSIBILITIES) b. What a country produces with its limited resources is an important question. It doesn't matter how big you are but how you use your resources that countsi. Does this country operate at full capacity ii. Does it utilize the best available technology? iii. Is it producing at full potential? c. The curve is based on assumption that the country only produces two goods. d. If it devotes all its resources to making one product, it will not be able to make any of the other one.

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PIZZA

COKE

2. The PPC curve is concave to the origin because: a. Along this curve, an economy uses all of its available resources. b. It shows the inverse relationship between the 2 products. 3. Opportunity cost is the cost of something in terms of what must be given up in order to obtain it. (sacrifice) 4. The combination of products measured shows an inefficient use of available resources, misallocation of resources 5. Economic scarcity - limited amount of natural resources (THE LAW OF SCACRCITY).it shows the maximum amount of goods available. a. Economic choices- choices of individuals are endless for each decision made by a producer, the concept of the PPC could be used in order to map out the various options. b. Economic tradeoffs- the economy must sacrifice some of the goods to be produced for more of the other goods that are produced. 6. "LAW OF SCARCITY"; it is based on the number of choices that are available to an individual. The PPC is not fixed because of the number of choices that individuals are faced with, and the decisions that a producer makes (TECHNOLOGICAL CHANGES). 7. Law of increasing relative cost- the increase in the relative cost of producing more of item A, measured by the numbers of another item B, that could be produced with the same resources. 8. Relative Cost - Cost of producing one item, A, expressed in terms of the numbers of another item, B, which must be given up in order to produce A. (OPPORTUNITY COST).

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Review Quiz September-29-08 8:15 PM

1. The PPF illustrates scarcity in that we can only produce at maximum efficiency given the total number of resources available to produce them. Because we cannot attain outside of the PPF, this shows we are limited and thus show scarcity. 2. By producing closer to the PPF we can gauge how efficient production is, and vice versa if we are producing farther away. 3. For every x or y quantity that we produce more of, we must forego an amount of the opposite x or y. Thus as we move along the PPF, for every quantity of X we produce we must give up some of Y. 4. The PPF illustrates opportunity cost since for every X value we produce, a Y value must be foregone in order to produce it. This is the opportunity cost as we move along the PPF. 5. Opportunity cost is a ratio because the decrease of quantity of one good is divided by the increase of production in another good. 6. As the production of product X or Y increases so does the opportunity cost, which explains the outward bow of the curve.

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Laws of ... September-30-08 8:51 AM

Law of increasing relative costs - The increase in the relative cost of producing more of item A, measured by the numbers of another item, B, that could be produced wit the same resources.

Relative Cost - cost of producing one item, A, expressed in terms of the numbers of another item, B, which must be given up in order to produce A Law of Diminishing Returns - The eventual decline in the rate of extra outputs produced that occurs when one input used in production of the output is held constant and the others are increased. Input - a productive resource such as labour

2 Variables - fixed, variable Law of increasing returns to scale - the increase in the rate of extra outputs produced when all inputs used in production are increased and no inputs are held constant 2 Variables / inputs

1.3 Practise Questions

1. Production Scenario Coconuts Fish

a) b) c) d) e) f)

Opportunity Cost

a

24

0

b

20

1

4

c

12

2

8

d

0

3

12

4, 8,12 Yes because the cost is increasing for each quantity of fish It would bow outwards since the opportunity cost is increasing That he has no misallocated resources, and producing at maximum efficiency. Full capacity. We would be outside the PPF given if he is at maximum efficiency. The amount of fish captured would increase, meaning the curve will extend further. 2.

a) 1/600 b) 1/300

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Gross Domestic Product October-21-08 8:21 AM

By : DYNAFROM WANG National income accounts - accounts showing the level of total income and spending in the Canadian economy Gross Domestic Product - the total dollar value at current prices of all final goods and services produced in Canada over a given period. Income approach - a method of calculation GDP by adding together all incomes in the economy - money flow Expenditure approach - a method of calculating GDP by adding together all spending in the economy real flow Product Current Price (p) Annual Output (Q) Total Dollar Value (PxQ) Lasers

$1000

3

$3000

Milk

2

1000

2000 GDP = $5000

GDP Identity - Gross domestic product calculated as total income is identical to GDP calculated as total spending. GDP expressed as total income = GDP expressed as total spending The Income Approach - INCOME COMPONENTS OF GDP - wages, profit, interest, and rent. - GDP is the sum of 7 categories ○ Wages and salaries  Largest income category representing 50% of GDP; payment to workers. ○ Companies profits  Represents all corporate earnings declared to the government, profits paid as corporate income tax  Retained Earnings -profits kept by business for new investment ○ Interest income  Interest paid on business loans ○ Proprietors' incomes and rents  Sole proprietors and partnerships earnings ○ Indirect Taxes  PST, not included in main income components of GDP, value is included in expenditure approach  Direct taxes are taxes taken away from your income, indirect = gst, pst, gas tax ○ Depreciation  Durable assets considered a cost of doing business and shows up in both approaches. ○ Statistical Discrepancy  GDP figures are estimates, discrepancies between the approaches are known as statistical discrepancy, to balance the two figures, STAT can divides the difference between the two approaches. IE 1.4B in 2005, half of that 0.7B was added to lower the estimate of GDP, and HALF 0.7B was deducted from the higher GDP estimate  Difference between actual and estimated

Unit 2 Page 13

GDP October-23-08 8:21 AM

Consumer expenditure

C

Investment expenditure

I

Government expenditure G Export expenditure

X

Import expenditure

M

Savings

S

Taxes

T

Income

Y

Disposable income

Yd

Y = $100 - (taxes, other deductibles) = T = $90 = YD Yd = 90 - (spend + save) Y= C + S + T Injections Leakages I

S

G

T

X

M

If injections are greater then leakages than the circular flow will increase causing the economy to expand, causing output and employment to increase.

CIRCULAR FLOW

Unit 2 Page 14

GDP = C + I + G + (X-M) GDP EXPENDITURE APPROACH

Final Product - products that will not be processed further and will not be resold Intermediate Products - products that will be processed further or will be resold CONSUMER EXPENDITURE APPROACH -

1) 2) 3) 4) 5)

DISPOSABLE INCOME CONSUMER CONFIDENCE (FUTURE EXPECTATIONS) MARGINAL TIME PREFERENCE AVAILABILITY OF CREDIT ADVERTISING a. DURABLE GOODS - GOODS THAT ARE CONSUMER OVER TIME b. NON-DURABLE GOODS - GOODS THAT ARE CONSUMED JUST ONCE

BUSINESS INVESTMENT DEPENDS ON: 1) BUSINESS CONFIDENCE (FUTURE EXPECTATIONS) 2) RATE OF INTEREST (MARGINAL EFFICIENCY OF INVESTMENT) 3) RATE OF RETURN ON INVESTMENT (PROFITS) GOVERNMENT EXPENDITURE DEPENDS ON: 1) ELECTION PROMISE 2) ANTI-CYCLICAL BEHAVIOUR 3) TAX REVENUE

NET EXPORT EXPENDITURE DEPENDS ON: 1) QUALITY OF PRODUCTS 2) PRICE OF CANADIAN VS FOREIGN GOODS 3) VALUE OF CANADIAN CURRENCY VS FOREIGN CURRENCY CATEGORIES OF PRODUCTS FINAL PRODUCTS - PRODUCTS THAT WILL NOT BE PROCESSED FURTHER AND WILL NOT BE RESOLD INTERMEDIATE PRODUCTS - PRODUCTS THAT WILL BE PROCESSED FURTHER OR WILL BE RESOLD DOUBLE COUNTING - THE PROBLEM OF ADDING TO GDP THE SAME ITEM AT DIFFERENT STAGES IN ITS PRODUCTION VALUE ADDED - THE EXTRA WORTH OF A PRODUCT AT EACH STAGE IN ITS PRODUCTION; A CONCEPT USED TO AVOID DOUBLE COUNTING IN CALCULATING GDP

EXPENDITURE EQUATION: C + I + G + (X-M) EXLUDED PURCHASES: FINANCIAL EXCHANGES - GIFTS OF MONEY BETWEEN FAMILY MEMBERS ARE NOT COUNTED IN GDP SECOND-HAND PURCHASES - EXCLUDED BECAUSE THEY HAVE ALREADY BEEN COUNTED AT THEIR FIRST SALE

PERSONAL CONSUMPTION (C) LARGEST PORTION OF GDP 55% PERSONAL CONSUMPTION - HOUSEHOLD SPENDING ON GOODS AND SERVICES DURABLE GOODS - GOODS THAT ARE CONSUMER OVER TIME NON-DURABLE GOODS - GOODS THAT ARE CONSUMED JUST ONCE GROSS INVESTMENT (I)

15-25% OF THE GDP GI = inventory + (capital stock - depreciation) = NI GROSS INVESTMENT - PURCHASES OF ASSETS THAT ARE INTENDED TO PRODUCE REVENUE INVENTORIES - STOCK OF UNSOLD GOODS AND MATERIALS CAPITAL STOCK - THE TOTAL VALUE OF PRODUCTIVE ASSETS THAT PROVIDE A FLOW OF REVENUE = Gross - Net DEPRECIATION - THE DECREASE OF VALUE OF DURABLE REAL ASSETS OVER TIME

Unit 2 Page 15

NET INVESTMENT - GROSS INVESTMENT MINUS DEPRECIATION PERSONAL SAVINGS - (S) FUNDS SAVED BY HOUSEHOLDS GOVERNMENT PRUCHASES (G) GOVERNMENT PURCHASES - CURRENT GOVERNMENT SPENDING ON GOODS AND SERVICES TRANSFER PAYMENTS - GOVERNMENT PAYMENTS TO HOUSEHOLD OR OTHER LEVELS OF GOVERNMENTS

NET EXPORTS EXPORTS (X)- FORIEGN PURCHASES OF CANADIAN GOODS AND SERVICES IMPORTS (M)- CANADIAN PURCHASES OF GOODS AND SERVICES FROM THE REST OF THE WORLD

NET EXPORTS - EXPORTS MINUS IMPORTS

Gross National Product = GDP + Investment Income Received from non-residents - Investment income paid to non-residents. (IIR - IIP) = Net investments from non-residents VALUE ADDED - the extra worth of a product at each stage in its production; a concept used to avoid double counting in calculating GDP

Unit 2 Page 16

8.1 Practise Questions October-30-08 8:32 AM

1. a. b. c. d. e. f. g. h.

Yes, expenditure - personal consumption Yes, expenditure - gross investment Yes, expenditure - personal consumption Yes, income - interest income Yes, expenditure - government spending Nope Yes , expenditure - government spending Yes, expenditure - export

a. b. c. d. e.

162B = 29 + 76 + 25 + 17 + 38 185B 11.5B 173.5B 9B

2. -

Unit 2 Page 17

GDP vs Real GDP October-29-08 7:39 PM

Self Test 2 1. (6000 / 1) x (100 / 140) = 4285.7143 , 285.7143/4000 = 0.0714 Which means a total increase of 7% 2. (5800 / 1) x (100 / 160) = 3625 , -575 / 4200 = 0.1369 which means a decrease of 13%. Self Test 3 1. -

a. When the person buys a good or service from other people and are reported then it counts. b. Legal bets are counted in the GDP. State lotteries are also counted. c. None 2. They should be included into GDP because illegal production is still a sale of a good or service and is still a form of production which is included in the definition of GDP. 3. Some physical benefits includes a higher quality of life in general, more production, nature of the workforce. Self Test 4

1. GDP / Population 2. 3.55x greater. 3. 5000000000000/250000000 = 20000 per capita GDP.

CASE STUDY 1. 2. 3. 4. 5.

GDP is everything bad in an economy. Less leisure time, downsizing of the middle-class, and the reduction of community and civic needs. Crime, pollution, commuting, family breakdown expenditures. Good marriages, friendly communities, clean water, leisure time, and wild places. -

GPI

GDP

Not real representation of economy Makes economy look like it's growing Looks bad for economy

Universal standard

Better economic policies

Shows prosperity

GNP a) b) c) d)

INCOME BASED EXPENDITURES -854B EXPENDITURE - = 490+157+184+(67-27) 872B Minus or add the difference on either approaches and it's the same value. =9b It is contracting since there is more expenditures then there is income. = GI - DEPR = 78 GNP =855B which is lower then GDP which means more dependencies of foreign investment

2. -

3. a. Diamond, since it can't be processed any further, only refined. Generally cut and sold as is. b. Oil, it must be processed and filtered, and then sent to a distribution plant. c. Water, can be sold as is, or is potentially filtered and then bottled and etc. 4. -

a. Y Unit 2 Page 18

a. b. c. d. e. f. g. h. i. j. k.

Y y n y y y n y y y n

a. b. c. d.

Understates since leisure time has decreased Overstates Overstates since income is not distributed evenly Understated since there is more efficiency.

5. -

Unit 2 Page 19

Inflation + CPI November-07-08 8:21 AM

Deflation - a general decrease in the level of prices. Hyperinflation - a situation in which prices increase rapidly and inflation is out of control.

CPI Consumer Price Index - a measure of price changes for a typical basket of consumer products. Item weights - the proportions of each good in the total cost of the basket of consumer goods used to calculate CPI Base Year - the survey year used as a point of comparison in subsequent years

Nominal versus Real Income Cost of living - the amount consumers must spend on the entire range of goods and services they buy. Nominal Income - income expressed in current dollars Real Income - income expressed in constant base-year dollars Real Income = Nominal Income CPI (In hundredths)

Limitations of CPI Consumer Differences - Individuals needs vary between individuals Changes of Spending Patterns - Changes in consumption patterns can skew CPI Product Quality and New Products - TV's and medicine, tries to adjust but difficult

THE GDP Deflator GDP Deflator - an indicator of price changes for all goods and services produced in the economy Nominal GDP - Gross Domestic Product expressed in current dollars REAL GDP = Nominal GDP GDP Deflator (In hundredths)

Inflation's Effects Incomes - Cost Of Living Adjustment Clause - Provisions for income adjustments to accommodate changes in private levels which are included in wage contracts. - Full Indexed Incomes - nominal incomes that automatically increase by the rate of inflation - Partially indexed incomes - nominal incomes that increase by less than the rate of inflation - Fixed incomes - nominal incomes that remain fixed at some dollar amount regardless of the rate of inflation

Borrowing and Lending - Nominal interest rate - the interest rate expressed in money terms - Real Interest rate - the nominal interest rate minus the rate of inflation Real Interest Rate = Nominal interest rate - inflation rate - Inflation Premium - a percentage built into a nominal interest rate to anticipate the rate of inflation for the loan period Unit 2 Page 20

the loan period Nominal Interest Rate = Desired real interest rate + Inflation Premium

Unit 2 Page 21

Check Your Understanding November-05-08 9:30 AM

4. 1990 = 13.4 B

a) b) c) d) e) f)

1. Unemployed since they are looking for a job. Frictional. Not in labour force. Unemployed, frictional. Employed, still got a job. Not in Labour Force, discouraged worker. Employed, but is a underemployment.

2. a. b. c. d. e. f.

Cyclical Frictional Structural - Replacement Seasonal Structural - Technological Cyclical

3. Hidden unemployment is workers who are employed but are not utilizing their skills, discouraged workers, which leads to misleading unemployment rates. They have no effect on employment data, but if counted they will effect it negatively. 4. - The GDP GAP is at its minimum when the unemployment rate is below the full employment rate. It is also at it`s highest when unemployment rate is too high.

1990

13.4B

1992

50.76

1994

43.9212

1996

34.98

1998

18.76

2000

-3.1476

Negatives = 0. No loss in national Production.

Unit 2 Page 22

Monitoring Employment November-03-08 9:00 AM

Employment Rate = ( number employed / labour force )x 100 Unemployment Rate consists of those who are not working and are available for work = (Unemployed / Labour Force) x 100 Categories - Under 15 and those institutionalised - Homemakers - Labour force who are employed

Pop = total population LF = labor force = U + E LFpop = labor force population p = participation rate = LF / LFpop E = number employed e = rate of employment = E / LF U = number of unemployed u = rate of unemployment = U / LF Pasted from

Seasonally Adjusted Rate - eliminates short-term or seasonal unemployment Participation Rate - Labour force includes both the unemployed and employed, with the exception of military, students, and homemakers, the labour force is expressed as a percentage of the total employable population. = Total Labour Force / Total Employable Population x 100

Limitations of Employment Data Underemployment - Workers who are not at work at jobs that utilize their skills. Discouraged Workers - those who would like to work but have stopped looking because they believe nothing is available for them Hidden unemployed - underemployed, and discouraged refered to as hidden since they are not counted in the official unemployment rate

Types of Unemployment 6 MONTHS UNEMPLOYED, AFTER IS DISCOURAGED Frictional Unemployment - refers to short-term unemployment of those workers who presently between jobs or who are entering Seasonal Unemployment - is the result of climatic changes that may leave workers unemployed for specific periods of the year. Structural Employment - direct result of structural changes in the economy, ie industries disappearing. Such as  Technological Unemployment -the structural unemployment is identified the cause.  Replacement Unemployment - one of the costs that Canada and other industrial nations will face in moving to a global economy such as downsizing and structural employment Unit 2 Page 23

will face in moving to a global economy such as downsizing and structural employment changes Cyclical Unemployment - caused by upward swings and downward swings, caused by economic decline. Inadequate Demand Unemployment - declining demand during periods of economic slowdown, bank of Canada can contribute by raising interest.

Full Employment Full Employment - highest reasonable expectation of employment, referred to as the natural employment rate which includes frictional and structural unemployment and excludes cyclical and seasonal (unemployment rate is between 6-7%)

Costs of Unemployment Potential Output - GDP that can be potentially outputted with full employment Actual Output -The GDP that the economy actually outputs. - Chronic unemployment can hurt both individual and the Canadian economy as a whole. There are human and economic costs associated with joblessness, especially unemployment lasting for extended periods of time. Cost of unemployment for the entire economy, is reflected by the GDP GAP. GDP GAP = GDP x ((unemployment rate - full employment) x2 ) 100 (Loss in National Production) OKUN`s LAW: When potential output exceeds actual output, the greater the GDP gap, for every 1% gain in unemployment, 2% gap in GDP

88

Unit 2 Page 24

9.1 Practise Questions November-07-08 8:30 AM

1. a. -

2006

2007

12.50

11

12.50

14.3

25.0

25.3

2. 0.25 / 12.50 x100 = 0.0002 b. 2006 = 23.75 2006 = 26.75 (DIFFERENCE / BASE x 100) c. 12.6% 2. Year

Nominal GDP GDP DEFLATOR REALGDP

2004

205.344

97.458

210.7

2005

234.3

100

234.3

2006

245.9

101.34

249.19

2007

258.7

102.944

251.3

2008

275.19

105.438

261.4

Unit 2 Page 25

9.2 Practise Questions November-12-08 9:11 AM

1. (MILLIONS)

Unemployed members of labour force

2.3

Total population 15 years of age and over

58.9

Participation rate

64

Workers with full-time job

21.4

Part-time workers who do not wish to have full time jobs 4.2 Part-time workers who wish to have full time jobs

3.5

Total population less then 15 years of age

14.6

a. Labour force b. Labour force population c. Official unemployment rate

2.

Using the information in the table derive an estimate of this economy unemployment that includes underemployment.

Unit 2 Page 26

Business Cycles and Employment Patterns November-18-08 8:37 AM

• • • •

Globalization has led to increased replacement unemployment as jobs migrate to China High EI benefits act as a disincentive to permanent employment Automation has created technological unemployment as workers continue to be replaced by machines Greater economic freedom and worker mobility means frictional unemployment Fluctuations in the economy refer to business cycle

PEAK

• • • •

Expansion: rising prices Lower unemployment Rising production Rising incomes

• • • •

Recession/contraction Decreasing prices Increasing unemployment Decreasing production Lower income TROUGH

During first phase of expansion also known to be recovery mode. 2 consecutive business quarters with negative GDP growth = recession. Stagflation - periods of economic stagnation where production slows down and both unemployment and inflation rates increase

CHECK YOUR UNDERSTANDING 1. During high levels of GDP growth, there is higher employment due to more jobs created. During a contraction, jobs are loss due to lowering production. 2. ALREADY DID 3. The business cycle occurs since it is the general trend for the economy. As the economy contracts for 2 quarters the economy is in a recession and a extended recession is a depression. 4. Cost-push is from operating expenses, and demand-pull is from excessive demand ie. Jordan wants 1000 milkshakes, and a milkshake costs 1000 to make. 5. As inflation rises, unemployment declines and vice versa due to higher prices. 6. Supply was not able to keep up with demand.

Unit 2 Page 27

Aggregate Demand November-24-08 8:21 AM

Aggregate Demand - the relationship between the general price level and total spending in the economy. - made up of spending by C, I, G, and (X-M). Real Expenditure - total spending in an economy, adjusted for changes on the general price level, is calculated by using the GDP deflator Aggregate Demand Curve

Price Level

Real GDP

Demand Curve - relationship between the general price level and total spending in the economy expressed on a graph Demand Schedule - shows relationships between general price level and total spending in the economy expressed in a table Price Low = Demand High Amount Spend by an Entire Economy is Determined by: 1. Wealth Effect: - when price level rises, the real value of households financial assets decreases. Because consumers feel they have less wealth, they spend less on consumption items. As a result of this wealth effect, real expenditures drop Real Value of Financial Assets = Nominal value financial assets / price level 2. Foreign Trade Effect - with changes in the price level, expenditures on imports change in the same direction, while expenditures on exports change in the opposite direction. a. When the price level in Canada rises, Canadian exports become more expensive for foreigners sales in foreign markets fall - decreasing in export expenditures. b. Products imported into Canada become cheaper relative to higher- priced domestic products import expenditures by Canadian rise. c. Foreign Trade Effect - Net exports (X-M)

Changes In Aggregate Demand

1. Consumption a. Disposable income b. Wealth (wealth effect)

Unit 3 - Fiscal Policy Page 28

b. Wealth (wealth effect) c. Consumer expectations d. Interest rates 2. Investment (limited to planned investment) a. Real rate of return - constant dollar extra profit provided by a project each year, slated as a percentage of the projects initial cost. b. Investment Demand - the relationship between interest rates and investments c. Investment Demand Schedule - relationship between interest rates and investments expressed in a table d. Investment Demand Curve - the relationship between interest rates and investments expressed on a graph Investment Influenced by: 1) Interest rates 2) Business expectations 3. 4. 5. 6.

Government Purchases Net Exports Foreign Incomes (FDI) Exchange Rates

Shifts in Aggregate Demand Curve

Aggregate demand increases and the AD curve shifts to the right, with the following: 1. An increases in consumption due to: a. A rise in disposable income b. A rise in wealth unrelated to a change in rice level c. A expected rise in prices or incomes d. A fall in interest rates 2. An increase in investment due to: a. A fall in interest rates b. An expected rise in profits 3. An increase in government Purchases 4. An increase in net exports due to: a. A rise in foreign incomes b. A fall in value of the Canadian dollar

Aggregate demand decreases and the AD curve shifts to the left with the following: 1. An decrease in consumption due to: a. A fall in disposable income b. A fall in wealth unrelated to a change in rice level c. A expected fall in prices or incomes d. A rise in interest rates 2. An decrease in investment due to: a. A rise in interest rates b. An expected fall in profits 3. An decrease in government Purchases 4. An decrease in net exports due to: a. A fall in foreign incomes b. A rise in value of the Canadian dollar

10.1 Practise Questions a) b) c) d)

Shift to right, rise in disposable income (CONSUMPTION) Shift to left Shift to left, net exports Shift to right, investment, consumption Unit 3 - Fiscal Policy Page 29

d) Shift to right, investment, consumption e) Shift to left, net exports f) Shift to left, investment

Unit 3 - Fiscal Policy Page 30

Aggregate Supply November-24-08 9:18 AM

Aggregate Supply - relationship between the general price level and real outputproduced in the economy AS-> Sellers - sell at highest price at lowest cost Aggregate Supply Schedule : relationship between general price level and real output expressed in a table Aggregate Supply Curve : expressed on a graph

Aggregate Supply Curve

Changes in Aggregate Supply (AS) (these are variable that change total output at all price levels) 1. Input prices: a. Short run decrease in AS : a decrease in total output at al price levels, with no change in potential output b. Short Run increase in AS: an increase in total output at all price levels, with no change in potential output. 2. Resource Supplies: a. Over the long term, supply of resources in an economy (human and capital) tend to grow. With such an increase, businesses tend to produce more real output at every price level. - More input over a long period of time increase AS. b. Long Run Increase In AS: an increase in total and potential output at all price levels. c. Long Run Decrease In AS: a decrease in total and potential output at all price levels. 3. Productivity: a. Labour Productivity: Quantity of output produced per worker in a certain period of time. b. Labour Productivity = Real Output / Total Hours Worked c. Increases in productivity are largely due to technological progress. Causes the AS to shift to the right.

Price Level Potential Output (MAX EFFICIENCY)

Real GDP

Aggregate Supply Curve SHORT RUN

SHIFTS IN THE AS CURVE Aggregate supply increases, with the AS curve shifting to the right, and potential output staying the same with the following: 1. A decrease in input prices due to a. A fall in wages b. A fall in raw material prices

Price Level Potential Output (MAX EFFICIENCY)

Aggregate Supply increases, with the AS curve shifting to the right and potential output increasing with the following: Real GDP

2. An increase in supplies of economic resources due to a. More labour supply b. More capital stock c. More land d. More entrepreneurship 3. An increase in productivity due to technological progress 4. A change in government policies: a. Lower taxes b. Less government regulation

Aggregate supply decreases, with the AS curve shifting to the left, and potential output staying the same with the following:

Aggregate Supply Curve LONG RUN

Price Level Potential Output (MAX EFFICIENCY)

1. A increase in input prices due to a. A rise in wages b. A rise in raw material prices Aggregate Supply decreases, with the AS curve shifting to the left and potential output increasing with the following: 2. An decrease in supplies of economic resources due to a. less labour supply b. less capital stock c. less land d. less entrepreneurship 3. An decrease in productivity due to technological decline 4. A change in government policies: a. higher taxes b. more government regulation

10.2 Practise Questions 1. -

a. b. c. d. e. f. g.

Long-run, shift to right, increase in resources Shift to left, long run, government policy Shift to left, long-run, input prices Shift to right, short run Shift to left, long run Shift to left, long run Shift to right, long run

Unit 3 - Fiscal Policy Page 31

Real GDP

Unit 3 - Fiscal Policy Page 32

Equilibrium November-26-08 9:04 AM

-An economy`s equilibrium price level and real output occur at the intersection of the AD and AS curves.

Inventory Changes - Inventory increase ○ At this price level - real output exceeds real expenditures - more is produced than is purchased in the economy ○ Businesses have an unintended increase in inventories - surplus - which represents a positive unplanned investment. As a result of this surplus, prices of individual decrease, pushing down the general price level. ○ Lower prices - cause businesses to decrease output (since real outputs and unemployment are inversely related, this causes a rise in the unemployment rate ○ This trend continues until equilibrium SURPLUS

Price Level 160

AS

B (EQUILIBRIUM)

AD SHORTAGE 700

Real GDP

- Inventory Decrease ○ Suppose price levels are below equilibrium levels-expenditures exceed production ○ Expenditures exceed production-creates a shortage ○ This leads to an unintended decrease in inventories - negative unplanned investment ○ Particular products are in short supply, prices rise ○ Buyers response - decrease spending ○ Higher price level causes businesses to raise real output- unemployment falls Role of Unplanned Investments Unplanned investment is - +ve- when price level is above equilibrium value - -ve - when price level is blow equilibrium value

Unit 3 - Fiscal Policy Page 33

Injections And Withdrawals December-01-08 8:29 AM

Injections and Withdrawals Injections - add to main income spending stream in economy (I,G,X) Withdrawals - outward flows of funds. Divert funds from the income-spending stream (Savings, Taxes, M)

Investments and Savings -

Most funds are borrowed by businesses for investments Companies keep a portion of their profits to reinvest Governments also borrow money - more government borrow, the less ends up with businesses Foreign flows

Government purchases and taxes - Usually government purchase exceeds taxes - To make up - governments borrow funds in financial markets - Recent years - T >G, governments - use these excess funds to pay off some of their outstanding debts.

Exports and Imports - Money spend on imports > exports - Foreign lenders typically provided funds to Canadian financial markets, with lending by foreigners being greater than borrowing by foreigners - This surplus of lending by foreigners has helped make up the shortfall in net exports

Total Injections and Withdrawals - Total injections. I (I-Planned investments) + g + x - Total withdrawals: S + T + M - When total injections exceed total withdrawals, flows into the income-spending stream > flows out. This implies that real output and spending in the economy expand - When total withdrawals exceed total injections, flows into the income-spending stream are less than outflows. The income-spending stream falls and slows down. This implies that real output and spending in the economy contract. - Equilibrium : Total injections = total withdrawals

AS

Price Level (GDP DEFLATOR)

Recessionary Gap

AD

Potential Output

Real GDP

Unit 3 - Fiscal Policy Page 34

Equilibrium VS Potential Output Recessionary Gap - is the amount by which equilibrium output falls short of potential output - If equilibrium output is below its potential level, unemployment is above the natural unemployment rate. (The difference between the equilibrium output and potential output is the RECESSIONARY GAP. Inflationary Gap- is the amount by which equilibrium output exceeds potential output - If equilibrium output is above its potential output, unemployment is temporarily below the natural unemployment rate - When equilibrium output > potential output - inflationary GAP AD3 AS AD 1 PRICE LEVEL

AD2

Inflation Gap Recessionary Gap

Equilibrium REAL GDP

10.3 Practise Questions 1. -

a. Surplus, Inflation gap, economy expands b. Recessionary gap, deficit 2. -

a. IGX, STM b. Yes 3. a. Below b. Above c. Higher

Unit 3 - Fiscal Policy Page 35

The Canadian Economy with an Increase in Government Spending December-03-08 8:18 AM

AS AD1

Income Price AD0

Equilibrium 2 Y1 P1 Y0 P0

Full Employment, Full Output Equilibrium 1 Q0 E0

Q1 E1

OUTPUT EMPLOYMENT

Economic Model : How will a change in government spending effect the economy. At the point the economy is in equilibrium where the out level is Q0, Employment E0, Income level Y0, Price Level P0

Now lets assume there is an increase in government spending. How will this effect the graph? As G ↑, AD ↑ AD1 Because AD = C+I+G+X-M This will cause curve to shift to the right.

-

Now there will be an new equilibrium where AD1 crossing the AS at that point the economy is in equilibrium where the Output level increases from Q0 to Q1 Employment increase from E0 to E1 Income Level increase from Y0 to Y1 Price Level increases from P0 to P1

In conclusions: As G ↑ AD ↑ Q ↑ Employment ↑ Y ↑

P↑

Unit 3 - Fiscal Policy Page 36

The Canadian Economy with an Increase in Personal Income Rates December-03-08 8:34 AM

AS AD0 Income Price AD1

Equilibrium 2 Y0 P0 Y1 P1 Full Employment, Full Output Equilibrium 1 Q1 E1

Q0 E0

OUTPUT EMPLOYMENT

Economic Model: How will an increase in personal income tax rates effect the economy To start we must show some kind of connection between tax rate and aggregate demand. This is now a direct relationship like government spending was. Now lets assume there is an increase in personal income tax rates how will this affect the graph?

Recall: YD = Y-T T = f(Y) T = t1Y Therefore: If T1 ↑ T2 ↓ YD C = F(yd)

C= ↓ As C ↓ AD ↓ to AD1: Because AD = C+I+G+X-M This will cause the curve to shift to the left. Now there will be an new equilibrium where AD1 crossing the AS at that point the economy is in equilibrium where the: • • • •

Output level decreases from Q0 to Q1 Employment decreases from E0 to E1 Income level decreases from Y0 to Y1 Price level decreases from P0 to P1

In conclusion AS t ↑ Yd ↓ C ↓ AD ↓ Q ↓ Employment ↓ Y ↓ P ↓

Unit 3 - Fiscal Policy Page 37

Ranges on the AS Curve December-03-08 8:39 AM

Ranges on the AS Curve AS AD1 Income Price

Classical Range

AD0

Y1 P1 Y0 P0

Intermediate Range Keynesian Range

Full Employment, Full Output

Q0 E0

Q1 E1

OUTPUT EMPLOYMENT

• Keynesian Range: is known as the horizontal section of the aggregate supply curve. It is referred to as the Keynesian section because there is substantial unemployment level occurring at that point. Recall John Maynard Keynes came to fame in the time period of the great depression. • Intermediate range : In the intermediate section of the aggregate supply curve there is a direct relationship between employment and income levels. • Classical range : is known as the vertical section of the aggregate supply curve. In this section, classical economists' concern themselves with the belief that the economy will operate at full employment which will result in full output

Unit 3 - Fiscal Policy Page 38

Phases of the Business Cycle December-03-08 9:01 AM

Business cycle is divided into the major phases: - Expansion - Contraction

Expansion - Is a period of increase in consumer confidence and economic activity. It is made up 3 smaller stages known as ○ Recovery  Is the first part of an expansionary phase. Consumer confidence starts to increase a little people start to replace small items such as clothes and small appliances. This results in business starting to replace or increase their inventory levels. Businesses start to increase their output hiring more employees.  Unemployment is decreasing while inflation is occurring ○ Boom  Is the second part of an expansionary phase. Consumer's confidence starts to increase at a faster pace buying more and more consumer goods. As businesses start to hire even more people national incomes rise an unemployment levels fall. People now start to buy consumer durable goods such as cars, houses. Resulting in businesses to start increase their construction levels on homes, factories and stores. Businesses now also start to buy new equipment and machines increasing their efficiency levels. This results in workers receiving higher pay. Prices increase.  Unemployment levels fall approaching full employment, inflation increases at very high rates ○ Peak  Occurs when expansion reaches a climax. Output starts to standstill and level off. Consumer confidence starts to decline to the point where people start to stop their buying.

Contraction - Is a period of decrease in consumer confidence and economic activity. It is made up of 3 smaller stages known as  Recession □ Is the first part of a contractionary phase. Consumer's confidence starts to decrease a little. People start to stop buying large items such as cars, major appliances and houses. This results in businesses starting to reduce their output of these items (inventory levels). Businesses start to decrease their hiring they may even start to lay off some of their employees. Workers might have to take wage cuts. Resulting in prices going down. □ Unemployment is increasing while inflation is dropping  Depression □ Is the second part of a contractionary phase. Consumer's confidence starts to decrease at a faster pace buying less of all consumer goods. Now businesses have to try to get rid of their inventory levels on their shelves. Businesses decrease or slow their production levels to a very low level. Business try to cut cost so they start to lay off even more people national incomes fall as unemployment levels rises. This results in an even lower level of confidence in people. Resulting in even less buying. Prices must fall even lower; companies start to go bankrupt. □ Unemployment levels increase approach Keynesian range, inflation becomes non existent prices start to fall  Trough □ Contraction reaches a minimum. Output starts to standstill and level off. Consumer confidence starts to level off at a low point to the point where people start to stop their savings, they have to buy a little.

Unit 3 - Fiscal Policy Page 39

Conclusion - If I+G+X =S+T+M - a country is in a state of economic equilibrium were the economy is not growing or contracting. - Therefore, periods of contractions: - (I+G+X) < (S+T+M) - And period of expansion: - (I+G+X) > (S+T+M) - These are not periods of equilibrium

Unit 3 - Fiscal Policy Page 40

Stabilization Policy December-05-08 8:44 AM

Definition: A government policy designed to lessen the effects of the business cycle. Goal: Is to keep the economy as close as possible to its potential output. Natural unemployment exists inflation is restrained Two Categories: - Expansionary policies - Contractionary policies

Expansionary Policies - Our government policies designed to reduce unemployment and stimulate output - When total output is below its potential, policy-maker want to eliminate the recessionary gap

Contractionary Policies - Our government designed to stabilize prices and reduce output - The economy is booming, policy makers want to cut the inflationary gap - (to stabilize prices and bring the economy back down to its potential output)

Fiscal Policy - "Fiscal" - budgetary - Definition: Government stabilization policy that uses taxes and government purchases as its tools: budgetary policy - Governments have an extensive impact on the economy through taxation and government purchases. The government's annual budget sets out what the government will tax and spend. - The budget becomes an instrument of stabilization policy - Fiscal Year: the 1-month period to which a budget applies

Discretionary Fiscal Policy - Is when the government takes deliberate actions through legislation to alter spending or taxation policies in order to influence the level of spending and employment - Discretionary fiscal policy occurs when the federal government takes on an active role in the economy by increasing or decreasing government spending or tax policy. - Non-discretionary fiscal policy is active accounts or stabilizers that are set up to operate even when the government does not takes on an active role in the economy.

Uses of Fiscal Policy FISCAL POLICY OPPOSITE OF BUSINESS CYCLE if POLICY IS CONTRACTIONARY then BUSINESS CYCLE IS AT EXPANSIONARY EXPANSIONARY FISCAL POLICY 1. Expansionary Fiscal Policy: i. Government policy that involves increasing government purchases, decreasing taxes, or both to stimulate spending and output. 1) This would entail a tax cut, an increase in government spending, or both 2) To stimulate economic growth and lower employment (PST - 8%, GST - 5% was 7%) ○ Expansionary discretionary Fiscal Policy i. The economy is in an economic contraction. Most likely it is in recession. AT this time the government will enact policies to reduce the recessionary gap and spur economic growth Unit 3 - Fiscal Policy Page 41

government will enact policies to reduce the recessionary gap and spur economic growth ○ Increased Government Spending i. The government increase spending which should increase aggregate expenditure ii. As G + AD + Q + Employment + Y + P + (+ = increases) ○ i. Decrease taxes ii. The government will reduce personal or corporate taxes which should increase aggregate expenditure iii. As T - C + AD + Q + Employment + Y + P + iv. These two policies could also be run together at the same time 2. Contractionary Policy: a. Government policy that involved decreasing government purchases, increasing taxes, or both to restrain spending and output b. The economy is in an economic expansion. Most likely it is in a boom. At this time the government will enact policies to reduce the inflationary gap and spur stable but slower economy growth c. Decreased Government Spending i. The government decreases spending which should decrease aggregate expenditure ii. As G - AD - Q - EMPLOYMENT - Y - P iii. Increase Taxes iv. The government will increase personal or corporate taxes which should decrease aggregate expenditure v. At this point the teacher will try to involve students the below analysis vi. As T + C - AD - Q - EMPLOYMENT - Y - P vii. These two policies could also be ran together at the same time d. Automatic Stabilizers: i. Certain elements in the economy tend to stabilize our growth. These items were up to set up to automatically work when the economy grows too fast or contracts too fast. The government established them. ii. During a boom, these stabilizers will try to decrease Y, P, Q, and employment iii. During a recession, these stabilizers will try to increase Y, P, Q, and employment iv. In a period of contraction, net tax revenues .(taxes minus transfers and subsidies) decrease. v. During a period of expansion, NET TAX REVENEUE increases

Examples of Stabilizers: a) Income Tax: a. The Canadian income tax system is a progressive system, meaning as incomes increase people pay a higher total tax and also a higher tax rate. So in a boom as incomes go up the government automatically collects more taxes from its people. b. As incomes decrease people pay a lower total tax rate and also a lower tax rate. So in a recession as incomes go down the government automatically collects fewer taxes from its people, giving them more to spend. b) Social Security Payments (welfare): a. During a recession as people lose their jobs and become unable to find work. The can collect welfare, so that they still have money to live with. b. During a boom when people start to find work they are automatically cut off of welfare. They have less money to spend. c) Price Support Programs: a. This is a program implemented by the federal government of Canada that is used to give farmers aid. When farm output starts to receive a lower price. The government will use some artificial means (grants) of increase the price farmers receive. These way farmers receive enough money to continue their operations. They do not go out of business. When there are booms and farm product prices go up, the price programs do not work.

Unit 3 - Fiscal Policy Page 42

The Spending Multiplier December-09-08 8:19 AM

- Multiplier effect - the magnified impact of a change on aggregate demand; price level stays constant, change in spending at one price value. - Marginal Propensity to Consume - the effect on domestic consumption of a change in income MPC = Change in consumption on domestic items / change in income - Marginal Propensity to Withdraw - the effect on withdrawals 0 savings, imports, and taxes - of a change in income MPW = change in total withdrawals / change in income 1 = MPC + MPW

MULTIPLIER EFFECT - Is the magnified impact of any spending change on aggregate demand. It assumes that the price levels stays the same. - The multiplier effect is the change in spending at one price level multiplied by a certain value to give the resulting change in AD Consumption Function - Calculates the amount of total consumption in an economy. It is made up of autonomous consumption that is not influenced by current income and induced consumption that is influenced by the economy's disposable income level

C = Yd

C = Autonomous consumption + MPC / Yd Consumption

Disposable Income

Marginal Propensity to Consume - Measures the rate at which consumption is changing when disposable income is changing. In a geometric fashion the MPC is the slope of the consumption function - Is the effect on domestic consumption of a change in income: MPC = change in consumption on domestic items change in income

Unit 3 - Fiscal Policy Page 43

Marginal Propensity to Withdraw (SAVE) - Withdrawals: savings, taxes, imports - Is the effect of a change in income on withdrawals. It is the change in total withdrawals as a proportion of the change in income. - Marginal propensity to save : measures the rate at which savings is changing when disposable income is changing MPW = Change in total withdrawals Change in Income Consumption

C = 50 + .85YD - This equation means that out of every extra dollar in disposable income 85 cents is spent on consumption. Therefore the MPC = .85, the MPS = .15. Disposable Income, Consumption and Savings YD

C

MPC

S

MPS

100

135

200

220

.85

-20

.15

300

305

.85

-5

.15

400

390

.85

10

.15

500

475

.85

25

.15

-35

- As income levels increase people tend to consume by the same percentage - That is the rich in society spend at the same rate as the poor

The Spending Multiplier - Is the value by which the initial spending change is multiplied to give the total change in the output. (The shift in the AD curve) a) Total change in Output = i. Initial change x spending multiplier b) Spending Multiplier = i. Total change in output (shift in the AD curve) Initial change in spending c) Spending Multiplier = i. 1 MPW - Average propensity to Consume is the ratio between a person's total and disposable income and his/her total consumption - Average Propensity to Save is the ratio between a person's total disposable income and his/her total savings

Marginal Propensity - Marginal Propensity to Consume is the ratio between a person's change in disposable income and his consumption - Marginal Propensity to Save is the ratio between a person's change in disposable income and his change in savings APC = C / Yd

APS = S / Yd

Benefits of Fiscal Policy

Unit 3 - Fiscal Policy Page 44

1. Regional focus - some part of the country may be more effected than others by the business cycle 2. Impact on spending - when the first spending is assured by the government - multiplier effect

Drawbacks of Fiscal Policy 1. Policy Delays: a) Recognition Lag - is the amount of time it takes policy makers to realize that a policy is needed b) Decision Lag - is the period that passes while an appropriate response is formulated and implemented c) Impact Lag - is the time that elapses between implementing the policy and having its effect on the economy 2. Political Visibility: a) Discretionary Fiscal Policy - highly visible elements of government activity. 3. Public Debt: a) Is the total amount owed by the federal government as a result of its past borrowing b) Public Debt Charges - is the amounts paid out each year by the federal government to cover the interest charges on its public debt.

11.2 Practise Questions 1. a) 1 million b) 0.33 c) 1/MPW 2. -

a) SM = 1.67, shift to left by 6667 -(MPC x change in T) x 1 / mpw b) SM = 1.25, shift to right by 6250 c) 3750 d) -66666.666667

Unit 3 - Fiscal Policy Page 45

Impact of Fiscal Policy - Budget Surpluses and Deficits December-11-08 9:03 AM

Budget Surplus - Surplus Budget : occurs when the government's revenues exceed their expenditures = T > G - Budget Surplus = government revenues - government expenditures)

Budget Deficit - Deficit Budget: occurs when the government's expenditures exceed their revenues. = G > T - Budget deficit = government expenditures - government revenues)

GDP - The size of a governments surplus or deficit in relation to the economy's overall GDP gives an indication of what type of discretionary fiscal policy is an operation, as well as the built in effects of automatic stabilizers.

Balanced Budget Balance Budget - occurs when the government's revenues equals their expenditures. = T= G - Is where the government's expenditure and revenues are equal

Debt - Debt: is the total amount of money the federal owes. - The government debt represents the sum of all its past budget deficits and any surpluses.

Surpluses - Budget surpluses are related to discretionary fiscal policy. - Surpluses are more likely the result of built in factors

Deficits - Deficits sometimes indicate active expansionary policies that increase government expenditures or reduce revenues - Deficits come about as a result of automatic stabilizers

Fiscal Policy Guidelines 1. Annually balanced budgets a. Is the principle that government revenues and expenditures should balance each year. 2. Cyclically Balanced Budgets a. Is the principle that government revenues and expenditures should balance over the course of one business cycle (which is not necessarily one fiscal year) b. The deficits from periods of contraction should roughly equal the surpluses from periods of expansion 3. Functional Finance a. Is the principle that government budgets should be geared to the yearly needs of the economy b. Policy makers should concern themselves primarily with correcting fluctuations caused by the business cycle.

Unit 3 - Fiscal Policy Page 46

Economic Application Questions December-14-08 7:00 PM

1. a. -= Interest Rate Total Investment 11

100M

9

150M

7

200M

5

250M

3

300M

1

350M

b. =

Investment

Interest Rate

c. 250Million since there is 50M worth of investment for each 2% decrease in interest rates

1. a. b. c. d. e. f.

Shift to the right, consumption. Shift to the left, investment Shift to the left, consumption, Shift to the right, government purchases Shift to the right, increase net exports Shift to the right, increase net exports

A, D, E, F

B, C Price Level

Real GDP

Unit 3 - Fiscal Policy Page 47

3. a. b. c. d. e. f.

Shift to left, short run Shift to right, long run Shift to right, long run Shift to left, long run Shift to right, short run Shift to right, long run

Aggregate Supply Curve SHORT RUN

Price Level Potential Output (MAX EFFICIENCY)

Real GDP

Aggregate Supply Curve LONG RUN

Price Level Potential Output (MAX EFFICIENCY)

Real GDP

4. a. -

140 AS0

130

Price Level

120

110

100 AD0 180

200 220 240 260

280

300

Unit 3 - Fiscal Policy Page 48

Real GDP

Equilibrium price level is 120, and real output is 240B

b. If 140, there is a surplus, if at 110 it is a shortage. c. =

140 AS0 130

Price Level

120 AD 1 110

100 AD0 180

200 220 240 260

280

300

Real GDP

The aggregate demand has shifted to the left. Two causes could be a rise in taxes, or fall in incomes.

d. 140 AS0

AS1

130

Price Level

120 AD 1 110

100 AD0 180

200 220 240 260

280

300

Real GDP

Unit 3 - Fiscal Policy Page 49

Shift to right, a decrease in government regulations, lower taxes.

5. A fall in injections results in lower income-spending since it effects (I,G,X) which conversely affects aggregate demand by decreasing inventory resulting in shortages. Spending in economy contracts since there is more withdrawals then injections due to lower flows of income -spending. This can be found on AS and AD since it incorporates IGX, S,T,M 6. Wage increases are only bad shortly but you can ease them by raising prices. But on the other hand, a change such as a low supply of land available could effect you for the long run since there is no immediate solution. 7. Since a decrease when you are beyond your output would only lead you to your equilibrium, whereas a decrease when you are below your potential output leads you into lower spending. Recessionary Gap.

1. a. 1982-1984,1986-1988, 1991-1994, 1996-1997, 1998-1999, 2001-2002, 2003-2004 since annual percentage change in GDP b. 1984-1986, 1988-1991, 1995-1996, 1997-1998, 1999-2001, 2002-2003, 2004-2005negative percentage c. Peak 5.8 @ 1984 d. Troughs -2.9 @ 1982 2. a. i. People buy a lot ii. People don't buy a lot b. i. People buy a lot ii. People don't buy a lot c. i. Plenty ii. None d. i. Plenty ii. None e. i. None ii. Plenty f. i. Loads of raises ii. Good luck eating out of a garbage can g. i. Plenty ii. None 3. Contractions: Luxury goods, essential goods, farming, gold Expansions: Luxury goods, housing, retail 4. a. b. c. d.

Recessionary gap Inflationary gap Inflationary Gap Recessionary Gap

Unit 3 - Fiscal Policy Page 50

Chapter 11 December-15-08 8:23 AM

1. a) Inflationary gap, increase taxes; ad shift to left b) Recessionary gap, tax cut, increase in government spending; ad shift to right c) Equilibrium real output = equilibrium 2. a) MPC = 0.35 MPW = 0.65 SM = 1.54 b) MPC = 0.25 MPW = 0.75 SM = 1.34 c) MPC = 0.4 MPW = 0.6 SM =1.67 3. a) Low income cause smaller change in tax revenues. This dampens decreases in net tax revenues during periods of falling incomes and also dampens increases in net tax revenue when incomes are rising. Therefore, automatic stabilizers become less effective and the statement is true. 4. a) 0.4 + 0.3 (0.6) + .05 (.60) = 0.6 .61 b) MPW = .61 MPC = .39 c) 1.64

90

5. 270

(BAR GRAPHS) 800 800 + 270 1070 + 90

810

6. a) b) c) d)

SM = 1.54, shift to the right, 3.076B SM = 1.81, shift to the left, 9.0 B SM = 1.43, shift to left, 4.285B SM = 1.6, shift to right, 6.400B

7. a) MPW = 0.55 MPC = 0.45, SM =1.82 b) Shift to left, 14.56 B

Unit 3 - Fiscal Policy Page 51

Roles of the Bank of Canada November-24-08 8:22 AM

1. Regulate Economic Activity: - The governor of the Bank of Canada (Mark Coolly) and the minister of finance (Jim Flaherty) set the monetary policy of Canada, The Bank of Canada can use monetary policy to help stimulate the economy during a recession or to try and slow the economy during a period of boom.

Interest Rates High interest rates are better known as tight credit or tight monetary policy. Low interest rates are better known as loose credit or easy monetary policy. During period of easy monetary policy Canadians tend to start spending more. During periods of tight monetary policy Canadians tend to save more. Money Supply The Bank of Canada can also increase of decrease the money supply available in Canada to Canadians to try and affect their spending habits.

The Canadian Economy with Tight Monetary Policy AS AD0 Income Price AD1

Equilibrium 2 Y0 P0 Y1 P1 Full Employment, Full Output Equilibrium 1 Q1 E1

Q0 E0

OUTPUT EMPLOYMENT

Economic model : how will a tight monetary policy effect the economy. To start we must show some kind of connection between money supply and Aggregate Demand. At this point the economy is in equilibrium where the : Out level is Q0, Employment E0, Income Level Y0, Price Level P0 Now lets assume there is a decrease in money supply. How will the affect the graph? M ↓ then C ↓

Therefore As C ↓ AD ↓ to AD1 because AD = C + I + G + X + M This will cause the curve to shift to the left Now there will be a new equilibrium where AD 1 crossing the AS where the point in the economy is in equilibrium where the output level decreases to Q1, employment decreases to E1, Income Level decreases to Y1 and Price level decreases to P1.

Unit 4 - Monetary Policy Page 52

decreases to Y1 and Price level decreases to P1. M ↓ C ↓ AD ↓ Q ↓ EMPLOYMENT ↓ Y ↓ P ↓

The Canadian Economy with an Easy Monetary Policy

AS AD1

Income Price AD0

Equilibrium 2 Y1 P1 Y0 P0 Full Employment, Full Output Equilibrium 1 Q0 E0

Q1 E1

OUTPUT EMPLOYMENT

Economic Model: How will a change in interest rates effect the Economy. At that point the economy is in equilibrium where the output level is Q0, employment level E0, income Y0, price level P0.

Now lets assume there is a decrease in interest rates how will the effect the graph? As R ↓ S ↓ C ↑ AND THEREFORE AD ↑ TO AD1 BECAUSE AD = C + I + G+ X + M

This will cause the curve to shift to the right. Now there will be an new equilibrium where AD1 crossing the AS at that point the economy is in equilibrium where the: • • • •

Output level increases from q0 to q1 Employment increases from E0 to E1 Income level increases from Y0 to Y1 Price level increase P0 to P1

In conclusion As R ↓ S ↓ C ↑ AD ↑ Q ↑ Employment ↑ Y ↑ P ↑

2. Fight Inflation: The B of C is set up to keep an eye on inflation. The B of C is truly set up as a watch dog to make sure inflation rates do not go up that much. Currently Canada has a policy to maintain inflation below 2-3% per year. In the late 80's and early 90s B of C wanted inflation to be 0. Again B of C can use interest rates or money supply to try and maintain control of inflation. To control inflation they will use tight money policy by increasing interest rate or decreasing money supply. See graph one. 3. Regulation Foreign Exchange Rates : Canada has a floating exchange rate. This means the value of the Canadian currency is decided on the world market. It is determined by the supply of the Canadian dollars and the demand for Canadian dollars. However, at times the B of C feels that it is in the best

Unit 4 - Monetary Policy Page 53

dollars and the demand for Canadian dollars. However, at times the B of C feels that it is in the best interest of Canadians to regulate this activity. If the Canadian dollar falls too much this might create a panic in Canadians, so B of C steps in to prevent huge drops. Also B of C also realizes that if the Canadian dollar increases too much in value this will hurt Canadian Export market so they don't allow huge gains either. For this reason Canada does not have a free float. It has a dirty float. Example:

Dirty Float the Canadian Exchange with the Bank of Canada Intervention

S0 S1

Prices of one Canadian Dollar in terms of US E0

E1

D0

Q0

Q1

As S0 = D0 The exchange is E0 at this exchange the Bank of Canada feels the exchange is too high and will hurt the Canadian export sector, therefore they get involved and try to increase the supply of Canadian dollars which will bring the exchange rate down to E1 which is more acceptable exchange rate. 4. Regulates the Banking System: the B of C is also known as the banker's bank. The B of C is the central bank in Canada, and it holds some deposits from the Chartered banks in Canada (RBC, CIBC, BMO, TD, HSBC). The B of C also sets the laws and rules that regulate the Chartered Banks, Trust companies, Mortgage companies, and credit unions. Some of the laws that are created deal with cash reserves if the banks, lending policies of bank, service charge policies, who can become a chartered bank and etc. 5. Government's Bank : The B of C is also known as the Government of Canada's Bank. The government deposits its money with the B of C. The bank of Canada issues government bonds to be sold. It looks after the Canadian Mint, printing of Canadian money. It also covers the paying of government expenses and the collection of government revenues.

12.1 Practise Questions

1. As a means of exchange, bartering requires coincidence of wants which leads to discrepancies, whereas money, it can be exchanged for anything. As a store of purchasing power, bartering cannot be liquidated easily, and therefore is lacking. As a measure of value, bartering a product or service has no/over 9000 set values, which no standard is established. 2. M1 = 20B + 34B = 54B, M2 = 20B + 34B + 164B = 208B, M2+ = 20B+157B+34B+164B+215B+15B

Unit 4 - Monetary Policy Page 54

Money Supply January-12-09 8:40 AM

M1 - is the money stock consisting of non-bank holdings (money in people's pockets and money at companies) of currency plus demand deposits in banks of people and businesses. This does not include currency held by banks or owned by the bank of Canada

M1b - this is M1 plus all chequable deposits M2 - Is defined as M1b plus all notice deposits in a bank and personal term deposits. This does not include corporation term deposits. M2a - consists of M2 plus deposits at trust companies, mortgage companies, and shares in credit unions M3 - consists of M2a plus corporation term deposits plus Canadian foreign currency deposits • • • • • • •

Currency held outside of banks is 37B Demand deposits of individuals and businesses is 92B Personal saving deposits at chartered banks is 349B Non-personal notice deposits at chartered banks is 51B Deposits at trust and mortgage companies is 8B Deposits at credit unions and caisses populaires is 115B Deposits at other financial institutions is 113B

Quantity theory of Money: P= M +V Q P is equalled to the consumer price level Q is equalled to the quantity of goods and services in the economy. V is the velocity of money (this is a measure of how fast money is spent in the economy). M is the money supply Transaction Velocity Approach M*V = P*T M is the money supply P is the general price level of consumer goods V is the velocity of money T is the number of transaction in the economy

13.2 Practise Questions 1. a. Expansionary b. Increase money supply, shift AD to the right, more consumption and investment 2. a. 2% b. Decrease?

13.3 Practise Questions 1. a. Bonds + 10000 b. Decrease 500 Unit 4 - Monetary Policy Page 55

b. Decrease 500 c. 9500 d. 475 2. a. b. c. d.

-2000 -200 1800 9000

Bond Sales Person A

Scotia Bank

100000 Cash reserve of eg. 10% ($10000)

Unit 4 - Monetary Policy Page 56