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USC ECON 205 - Consumption and Investment and Government Response

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ECON 205 2nd Edition Lecture 23 Outline of Last Lecture I. Review of the Fiscal ClifII. New Classical and Supply Side EconomicsIII. Keynes’ MacroeconomicsIV. GDP Growth and InflationV. Currency Overvaluation and the Trade DeficitPractice QuestionsOutline of Current LectureI. Consumption function and Investment II. Types of UnemploymentIII. Economic GrowthIV. Types of InflationV. Government Economic ActionsCurrent LectureI. Consumption Function and InvestmentThe slope of the consumption function is the marginal propensity to consume. Therefore, the marginal propensity to save is the slope of the savings function. The multiplier is equal to the reciprocal of the marginal propensity to save. Lastly, the marginal propensity to save added to the marginal propensity to consume is one.The major diference between the consumption and investment functions is the consumption function is stable while the investment one is volatile. This is why investment is the main source of the business cycle. Behind investment is rate of return on investment. The rate of investmentis related to the marginal efficiency of capital and income. We pay interest to get current gratification, and we have to postpone our payment by interest. II. Types of UnemploymentStructural unemployment is a mismatch between supply and demand, especially in certain industries (such as aerospace engineering). Cyclical unemployment is caused by economic cycles, while seasonal unemployment is unemployment by seasons (like farming). Lastly, frictional unemployment is the unemployment rate for people who are between jobs.III. Economic GrowthThe theoretical aspect of economic development is that some countries grow, while others do not. Some economists believed that it was a permanent situation, that rich countries would always stay wealthier than poorer nations. However, we now talk about convergence, that ofpoorer countries catching up to richer countries. Since trade is a major aspect of economic development, we include trade in economic calculations. - A closed economy is a model that only includes consumption, investment, and government expenditures. An open economy, however, includes net exports as well. IV. Types of InflationNormal inflation is the 1-3% that occurs each year. Cost-push inflation is when the costs of production increase, such as labor unions, leading to higher prices. Demand-pull inflation is when the aggregate demand is increased due to government expenditures (or even the private or exporting sector). The costs of production are labor, capital, rent and resources (land). V. Government Economic ActionsThe policy of the government should be to reach full employment, stabilize prices, and promote adequate growth of GDP. However, many economists believe that there is a natural rate of unemployment, approximately 6%. If unemployment rises over that percentage, the government should undertake countercyclical measures.Some automatic countercyclical measures are unemployment benefits, money given for some weeks to unemployed persons, and welfare benefits like food stamps. Other discretionary measures are emergency bailout measures that lend money to certain industries that earn interest for the


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