Test Questions 3 Chapter 10 12 13 What are the 4 spending groups the percentage of each group to RGDP and the factors that spending depends on Consumer Spending 70 of RGDP Income Wealth Real interest rates Expectations Consumer confidence Investment Spending 10 of RGDP Real interest rate RGDP Expectations Business confidence Government Spending 25 of RGDP Based on the budget Net Export Spending 5 of RGDP foreign income exports Domestic income imports Why is the demand curve downward sloping a Real Balance Effect Price goes down your income goes further so you buy more purchasing power increases Interest Rate Effect at lower prices we need less money so we have a lower b demand for money so lower interest rates given a constant supply of money from the FED so more borrowing and spending even if we spend our own money in the bank c Foreign Effect at lower prices our goods are less expensive so everyone buys from the US The aggregate supply curve shows the level of output that a firm will be What does the AS curve tell you willing to produce at different prices What does the AD curve tell you do at different prices The aggregate demand curve shows the amount of buying consumers will Why is the AS curve upward sloping The aggregate supply curve is upward sloping because as price level goes up a firm is willing to produce more product and as price level goes down firms are not willing to produce as much product Why is the AD curve downward sloping The aggregate demand curve is downward sloping because as price level goes up consumers are not willing to buy as much product and as price level goes down consumers are willing to buy more What factors shift the AS curve new technology regulations changes in productivity changes in cost of production taxes changes in the four areas of spending What factors shift the AD curve What does the AS AD model determine Consumer Investment Government Exports The AS AD model determines the RGDP of an economy as well as the Price Index which they will be at If the economy is at equilibrium income is it also at full employment Why or why not If the economy is at equilibrium income it is not necessarily at full employment All that equilibrium tells you is that aggregate supply aggregate demand and what the RGDP and Price Index is at that point Full employment on the other hand entails maximum production The space between the equilibrium point and full employment is the inflationary gap What is Fiscal Policy The government s role in the economy government spending and taxes Why is spending so important especially in its relationship to RGDP One persons spending is another persons income Once we get income we have more money and so we spend more When the government spends money people make income spend the income etc RGDP is increased by all of this because RGDP is just income or expenditure WHERE SPENDING GOES RGDP GOES Explain how the multiplier effect works What does the multiplier depend on Why would the multiplier effect be important to President Obama The multiplier effect is the cycle described above It has to do with how much we spend and how much we save An example of it in its works is I spend 90 of 1 90 cents spent 10 cents saved Next guy spends 90 of 90 cents 81 cents spent 9 cents saved NEXT guy spends 90 of 81 cents 73 cents spent 8 cents saved This is important to President Obama because if he decides that government will spend 1 someone will spend 90 cents and the multiplier process begins Is there a limit to the multiplier effect 1 1 mpc or 1 mps MPC Marginal Propensity to Consume spending behavior with an increase in income MPS Marginal Propensity to Save saving behavior with an increase in income What are the two ways of filling the RGDP gap through spending and what are the differences Government Spending raise the debt infrastructure is better once the recession is over goes to unemployed gives more people work it has to work unless no one spends any of their income not so easy to pass politically because of the debt multiplier is larger Decreasing Taxes raises the debt by a little more than G Does not go to unemployed goes to already employed No infrastructure improvement no guarantee that it will be spent people already working are more likely to save then those who aren t working Smaller multiplier Easier to pass than increased spending Hard to reverse raising taxes later is NOT COOL How much does government spending have to change to fill the RGDP gap Change in RGDP k change in government spending Y k G How much do taxes have to go down to fill the RGDP gap Change in RGDP k mpc change in taxes Y T k mpc The change in taxes would have to be GREATER than the change in government spending because it does not have a first round of spending from the government MPC is factored in we miss the first 1 spend and skip right to the person who got the income spending 90 cents Why does the budget automatically go into deficit when the economy goes into recession Tax revenues fall because people are out of work and government spending rises because social programs kick in SS UE Medicade Medicare people can then spend this money This decrease in taxes and increase in spending offers as a brake on the recession so that it does not go deeper into recession What are the costs of the national debt Monetizing the debt inflation printing new money causing inflation Foreign held debt the interest payment goes overseas Crowding Out government borrows a lot raises interest rates discourages others from borrowing and investing and Distribution of Income The wealthy lend the gov money poor pay taxes the taxes go to the rich for interest payments that they owe them Should we have a Balanced Budget Amendment No If you have to comply with the balanced budget act then you need to increase taxes or decrease spending which moves the aggregate demand curve to the left and brings us further into deficit This is a Contractionary Fiscal Policy A decrease in spending and an increase in taxes from previous levels would cause a decrease in total spending aggregate demand a decrease in the price and a decrease in RGDP output The dollar value of the debt has never been higher so what Debt to GDP ratio is what really matters This is because with a higher debt to GDP ratio the BURDEN of the debt is higher What causes the business cycle The business cycle fluctuations in RGDP over time is a response to the fluctuating changes in spending Where spending does RGDP follows