Eco 202 ch 35 monetary fiscal aggregate demand
26
Chapter 35 Monetary Policy Fiscal Policy and Aggregate Demand
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Transcript of Eco 202 ch 35 monetary fiscal aggregate demand
Chapter 35 !
Monetary Policy Fiscal Policy
and Aggregate Demand
Key Termstheory of liquidity preference fiscal polices multiplier effect crowding-out effect automatic stabilizers !
Economic Cycle
Aggregate Demand
Wealth Effect Interest-Rate Effect
Exchange-Rate Effect
John Maynard Keynes (1883 - 1946)
!
Father of Macroeconomics !
The General Theory of Employment,
Interest and Money !
The ideas of economists and political philosophers are more powerful than commonly understood; indeed the world is ruled by little else.
Theory of Liquidity Preference
Interest rates adjust to bring money supply and money demanded into
balance
Interest Rates
Nominal = Real + Inflation !
If inflation is zero, then nominal = real
Money Supply
Discount Rate Bond Market Reserve Ratio
Interest Rate
Quantity of MoneyMD1
Money Market
MD2
r1
r2
Money Supply
Money Demand
Quantity fixed by the Central
Bank
Equilibrium Interest
Rate
Liquidity Theory1. Money Supply is fixed by central bank with policy tools (Debt Instrument Market, Discount Rate, Reserve Requirement)
2. Money Demand - Liquidity - Interest rate is the opportunity cost of holding money.
3. Equilibrium pressures
Interest Rate
Quantity of Money
Money Market
r2
Money Supply
Money Demand
Quantity fixed by the Central
Bank
r1
r3
Money Demand
Interest Rate
Quantity of Money
Money Market
r
Money Supply
r1
r3
Interest Rate
1. Price level increases 2. Increases demand for money 3. Increases interest rate 4. Reduces quantity demand of output
Money Market
r2
Money Supply
Money Demand
Quantity fixed by the Central Bank
r1
Price Level
P2
Aggregate Demand
OutputY2
P1
Y1
Aggregate Demand
Fiscal Policies
Level of government spending and taxing
Multiplier Effect
Additional shifts in aggregate demand due to expansionary government
spending
Marginal Propensity to Consume MPC
New income = spend + save How much do you spend?
75 percent Then you will be saving 25 percent
Marginal Propensity to Consume plus
Marginal Propensity to Save equals one
!
MPC + MPS = 1 1- MPS = MPC 1- MPC = MPS
Earn Spend Total Spending
1 100.0 75.0 75.0
2 75.0 56.3 131.3
3 56.3 42.2 173.4
4 42.2 31.6 205.1
5 31.6 23.7 228.8
6 23.7 17.8 246.6
7 17.8 13.3 260.0
8 13.3 10.0 270.0
9 10.0 7.5 277.5
10 7.5 5.6 283.1
11 5.6 4.2 287.3
Multiplier !
1/(1-MPC) !
Remember 1-MPC = MPS
Therefore Multiplier
also 1/MPS
MPC MPS Total Spending
1.00 0.00 infinite
0.90 0.10 10.00
0.80 0.20 5.00
0.75 0.25 4.00
0.60 0.40 2.50
0.50 0.50 2.00
0.40 0.60 1.67
0.30 0.70 1.43
0.25 0.75 1.33
0.10 0.90 1.11
0.50 0.50 2.00
Multiplier !
1/(1-MPC) !
Remember 1-MPC = MPS
!
Therefore Multiplier
also 1/MPS
Multiplier Effect
1. Works with C, I, G, and NX 2. Goes both ways
Where does the money come from?
Tax Borrow
Reduces Income Increases interest
Crowding-Out can be larger than the
Multiplier
Aggregate Demand shifts left
Crowding-out Effect
Offsetting aggregate demand when fiscal
expansion raises interest rates and reduces spending
Price Level
Quantity of Output
PL
Y3 Y1 Y2
Government Spending Multiplier Effect
Government Spending Crowding-Out Effect Taxes & Borrowing
Automatic Stabilizers
Changes in fiscal policy that stimulate aggregate demand
when the economy goes into a recession
Physical Financial Human Intellectual Cultural Total
Saudi Arabia
Qatar
U.A. E.
Jordan
Kuwait
Iraq
Egypt
Capital Analysis Scale 1-10 each category 1=lowest, 10=highest
