SP - Stabilization Policies Overview

Stabilization Policies

Introduction

Public policy can affect the economy’s output, price level, and level of employment, both in the short run and in the long run. Students should learn to analyze the impacts of fiscal policy on aggregate demand and on aggregate supply, as well as on the economy’s output and price level, both in the short run and in the long run. 

Module Lessons Preview

In this module, we will study the following topics:

Fiscal Policy: Changes in taxes and government spending designed to affect the level of aggregate demand in the economy are called fiscal policy.

Phillips Curve: When inflation increases, the unemployment rate decreases, and when inflation decreases, the unemployment rate increases. A graphic representation of this trade-off is known as the Phillips Curve.

Inflation, Unemployment & Taxes: Can we use the fiscal policy to help fight inflation, unemployment and taxes? What role does the government play?

Crowding Out: Crowding out occurs when the government borrows to pursue expansionary fiscal policy and such government borrowing replaces private borrowing and spending.

Government Debts & Deficits: A budget deficit occurs when the government spends more than it collects in taxes and borrows to cover the difference. It does this by issuing bonds. The sum of past deficits is the debt. The debt incurs annual interest charges.

 

Key Terms

Aggregate - total

Aggregate Demand (AD) - Curve that shows the amount of real output (Real GDP) that buyers collectively desire to purchase at each possible price level - Demand for all goods combined (aggregate)

Aggregate Supply (AS) - Level of real domestic output producers will produce at a given price level

Short Run (SRAS) VS Long Run Aggregate Supply (LRAS) - SRAS is when input prices (usually nominal wage) do not match price level changes. LRAS is when input prices (usually nominal wages) do match price level changes

Recessionary Gap - When SRAS and AD are not in equilibrium. SRAS/ AD equilibrium is the left of LRAS. Economy is operating below full capacity and unemployment is above NRU.

Inflationary Gap - When SRAS and AD are not in equilibrium. SRAS/ AD equilibrium is the right of LRAS. Economy is operating above full capacity and unemployment is less than NRU.

Average Propensity to Consume (APC) - (consumption)/ (income). The percentage of total income consumed

Average Propensity to Save (APS) - (saving)/ (income). The percentage of total income saved. APC + APS = 1

Marginal Propensity to Consume (MPC) - Tells us how much more you will consume if you earn an additional dollar. (Change in consumption) / (change in income). Falls as an individual becomes more wealthy.

Marginal Propensity to Save (MPS) - Tells us how much you will save if you earn an additional dollar. (change in saving) / (change in income). Rises as an individual becomes more wealthy.

Spending Multiplier - Consumption increases as income increases. In other words, one person’s consumption becomes another’s income (there is a multiplier effect). Tells us how any change spending (government, investment, exports, consumption) can ultimately change AD and GDP. 1/ (1 – MPC)

Taxing Multiplier - -MPC/ (1-MPC)

Sticky Wages and Prices - When workers’ earnings don’t adjust quickly to changes in labor market conditions. Can slow the economy’s recovery from a recession. When demand for a good drops, its price typically falls too.

Stagflation - when you experience high inflation and high unemployment at the same time.

Productivity - the rate of output per unit of input.

Potential GDP - the level of output that an economy can produce at a constant inflation rate. Although an economy can temporarily produce more than its potential level of output, that comes at the cost of rising inflation.

Supply Shock - an event that directly alters the firms’ costs, and as a result, the prices they charge. Shifts the economy’s aggregate supply curve and as a result, the Phillips curve.

Phillips Curve - illustrates the short-run relationship between inflation and unemployment.

Short Run VS Long Run Phillips Curve - inflation and unemployment are unrelated in the long-run. As a result, the long-run Phillips curve is vertical at the natural rate of unemployment.

 

IMAGES CREATED BY GAVS