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Unit 5:
Aggregate Demand and
Supply and Fiscal Policy
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Review
1. Identify the two types of tool boxes the
government has to fix the economy
2. Explain and give examples of
Expansionary Fiscal Policy
3. Explain and give examples of
Contractionary Fiscal Policy
4. Explain the Multiplier Effect
5. Explain how to calculate the spending
multiplier
6. Name 10 University Mascots
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Draw and Practice
Congress uses discretionary fiscal policy to the
manipulate the following economy (MPC = .9)
LRAS
Price level
AS
P2
AD1
1. What type of gap?
2. Contractionary or
Expansionary needed?
3. What are two options
to fix the gap?
4. How much needed to
close gap?
AD
-$5 Billion
$50FE $100
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Real GDP (billions)
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Draw and Practice
Congress uses discretionary fiscal policy to the
manipulate the following economy (MPC = .8)
LRAS
Price level
AS
P1
AD2
$800
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1. What type of gap?
2. Contractionary or
Expansionary needed?
3. What are two options
to fix the gap?
4. How much initial
government spending
is needed to close gap?
AD1
+$40 Billion
$1000FE
Real GDP (billions)
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Problems With
Fiscal Policy
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5 Problems With Fiscal Policy
•When there is a recessionary gap what two options does
Congress have to fix it?
•What’s wrong with combining both?
1. Deficit Spending!!!!
•A Budget Deficit is when the government’s expenditures
exceeds its revenue.
•The National Debt is the accumulation of all the budget
deficits over time.
•If the Government increases spending without
increasing taxes they will increase the annual deficit and
the national debt.
Most economists agree that budget deficits are a
necessary evil because forcing a balanced budget would
not allow Congress to stimulate the economy.
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US National Debt
US Debt Clock
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The Onion:
Government Stages Coup
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5 Problems with Fiscal Policy
2. Problems of Timing
• Recognition Lag- Congress must react to
economic indicators before it’s too late
• Administrative Lag- Congress takes time to
pass legislation
• Operational Lag- Spending/planning takes time
to organize and execute ( changing taxing is
quicker)
3. Politically Motivated Policies
• Politicians may use economically inappropriate
policies to get reelected.
• Ex: A senator promises more welfare and public
works programs when there is already an
inflationary gap.
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5 Problems with Fiscal Policy
4. Crowding-Out Effect
• In basketball, what is “Boxing Out”?
• Government spending might cause unintended
effects that weaken the impact of the policy.
Example:
• We have a recessionary gap
• Government creates new public library. (AD increases)
• Now but consumer spend less on books (AD decreases)
Another Example:
• The government increases spending but must borrow
the money (AD increases)
• This increases the price for money (the interest rate).
• Interest rates rise so Investment to fall. (AD decrease)
The government “crowds out” consumers
and/or investors
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5 Problems with Fiscal Policy
5. Net Export Effect
International trade reduces the effectiveness
of fiscal policies.
•
•
•
•
•
Example:
We have a recessionary gap so the government
spends to increase AD.
The increase in AD causes an increase in price
level and interest rates.
U.S. goods are now more expensive and the US
dollar appreciates…
Foreign countries buy less. (Exports fall)
Net Exports (Exports-Imports) falls, decreasing
AD.
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Review Activity
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Activity: Review Circles
You will be given one key concept to focus on.
You must understand it well enough to quiz
and help others remember it.
You must able to answer people’s questions
and give clear examples.
DON’T TEACH!!!!!!!!!!
QUIZ your partners. Make them work to
remember the concept.
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Review Circles
Odd numbers
Even Numbers
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List the 25 Concepts we have covered
1.
2.
3.
4.
5.
Aggregate Demand
Real Balance Effect
Interest Rate Effect
Foreign Trade Effect
Shifters of AD
(C,I,G,X)
6. Aggregate Supply
7. Shifter of AS (R.A.P.)
8. Short Run AS
9. Long Run AS
10.Two Types of Inflation
11.Ratchet Effect
12.Classic vs. Keynesian
13.Three Ranges of AS
14. Fiscal Policy
15. Discretionary vs. NonDiscretionary
16. Expansionary Policy
17. Contractionary Policy
18. The Car Analogy
19. Multiplier Effect
20. Calculating the
Spending Multiplier
21. MPC and MPS
22. Deficit Spending
23. Timing Problems
24. Crowding-Out Effect
25. Net Exports Effect
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