Transcript Chapters 16-17-18-19

Homework Econ
Finishing Macro transition to Micro
Chapters 16-19

Bonus Homework Due Tuesday, March 7, 2006
• AP Packet V – We will be working on many of the
activities in the packet. Some will be for homework
credit.
Graphing Test! Not Adjusted! Total Points=100!
March 8th at the very earliest.
March 10th at the very latest.
Adam Smith
• Micro Economics
• The Laws of Supply
and Demand
formulated 1776
• Supply shifts outward
because of DIGTS!
• Equilibrium reached
through the invisible
hand of the market!
Wealth is based on the ability to produce goods & services!
David Ricardo Free Trade 1820’s
• Theories on Trade
• Comparative Advantage
• Trade is based on relative
opportunity cost.
• Countries specialize in
production of products
with the lowest
opportunity cost.
Wealth is increased through specialization and trade!
J. B. Say 1830’s
• Supply creates its own
demand!
• Aggregate supply is a
vertical line!
• Demand determines only
the price.
• Aggregate supply should
be increased to improve
standard of living!
Wealth is increased as output increases: “Supply creates Demand!
Classics and Keynes: AD-AS Interpretation
Classical Economics...
Classics and Keynes: AD-AS Interpretation
Classical Economics...
Laissez-faire
Classics and Keynes: AD-AS Interpretation
Classical Economics...
Laissez-faire
Vertical aggregate supply curve
Classics and Keynes: AD-AS Interpretation
Classical Economics...
Laissez-faire
Vertical aggregate supply curve
Stable aggregate demand
Classics and Keynes: AD-AS Interpretation
Classical Economics...
Laissez-faire
Vertical aggregate supply curve
Stable aggregate demand
• Quantity of money held by
households & businesses
Classics and Keynes: AD-AS Interpretation
Classical Economics...
Laissez-faire
Vertical aggregate supply curve
Stable aggregate demand
• Quantity of money held by
households & businesses
• Purchasing power of money is
determined by the price level
Classical Theory...
Price Level
AS
P1
AD1
Q1
Real Domestic Output
Copyright McGraw-Hill, Inc.
Classical Theory...
Price Level
AS
P1
P2
AD1
AD2
Q1
Real Domestic Output
Copyright McGraw-Hill, Inc.
John Maynard Keynes – 1930’s
• Father of Keynesian
Economics
• Macro economies my
be fine tuned!
• Fiscal policy may be
used expand aggregate
demand.
• Aggregate supply is
horizontal not vertical
An absence of Demand makes Supply meaningless!
Milton Friedman 1950’s –
2000’s!
• A limited role for
government!
• No Fiscal or Federal
Reserve interventions
• Simply grow the
money supply at 3-5%
to grow the economy!
Increasing Money Supply will increase NGDP!
MS * V = NGDP
VELOCITY: Stable or Unstable
Monetarists:
AP Test 2004
V is Stable...
VELOCITY: Stable or Unstable
V
Monetarists:
is Stable...
Greater money supply causes
spending and higher price levels
VELOCITY: Stable or Unstable
V
Monetarists:
is Stable...
Greater money supply causes
spending and higher price levels
Monetarists: Causes of Instability
VELOCITY: Stable or Unstable
V
Monetarists:
is Stable...
Greater money supply causes
spending and higher price levels
Monetarists: Causes of Instability
Inappropriate Monetary Policy
Alban W. Phillips
• Discovers and
explained the
relationship between
inflation &
unemployment!
• Discovered that they
may not exist
simultaneously!
Provide a Keynesian Trade Off Between Inflation & Unemployment!
Fine Tuning An Aggregate Economy Was Possible!
The Phillips Curve
The greater the rate of growth
of aggregate demand, the higher
will be the resulting inflation
rate and the larger the growth
of real output (and the lower the
unemployment rate).
Annual rate of inflation
(percent)
The Phillips Curve Concept
7
6
5
4
3
2
1
0
Phillips1958
1
2
3
4
5
6
Unemployment rate
(percent)
7
Annual rate of inflation
(percent)
The Phillips Curve Concept
7
6
as inflation declines....
5
4
3
2
1
0
1
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2
3
4
5
6
Unemployment rate
(percent)
7
Annual rate of inflation
(percent)
The Phillips Curve Concept
7
6
as inflation declines....
unemployment increases
5
4
3
2
1
0
1
Copyright McGraw-Hill, Inc. 1999
2
3
4
5
6
Unemployment rate
(percent)
7
“We’re all
Keynesians”
Fine Tuning
National
Economies is
Possible: G, T,
and Phillips
matter,
deficits don’t!
Stabilization Policy Dilemma
Policies to manage aggregate demand can
be used to choose a point on the Phillips
Curve, but such policies do not improve
the “unemployment rate-inflation rate”
tradeoff embodied in the curve .
Stagflation:
A Shifting Phillips Curve?
Can a Noble Prize be taken way?
Copyright McGraw-Hill, Inc. 1999
Aggregate Supply Shocks
• OPEC and Energy Prices
• Stagflation
• Misery Index 1970’s & 80’s
 Inflation +Unemployment
 12% + 8% = 20% in 1980
 2% + 6% = 8% in 2003-4
William E. Simon, chairman of the Federal Energy Administration,
urges the driving public to limit itself voluntarily to 10 gallons of
gasoline per week in Washington, D.C. on Dec. 20, 1973.
Scenes like this one in Martinez, Calif, were common Sept. 21, 1973 with Northern
California service station operators threatening to shut down over the weekend to
protest gas price restrictions. Motorist were rushing to fill their gas tanks.
Not only drivers of automobiles had to line up at this service station in
San Jose, Calif, March 15, 1974. A man who needed a refill for his
lawn mower got the same treatment. The owner of the service station
would not sell gas to people showing up with containers.
Cars line up in two directions on Sunday Dec. 23, 1973 at a gas
station in New York City. The gas station remained opened despite
President Nixon's plea for stations to close on Sundays.
This is an aerial View of the
Safeway gas station, on
Northern Blvd. and 36th street,
in the Queens section of New
York City on Feb. 8, 1974
during the energy crisis.
The pumps are here!
The line waiting for
Gas!
U.S. President Jimmy Carter
signs his energy proposals in the
Oval Office of the White House
in Washington, D.C.,
Wednesday, Jan. 26, 1977. At
left is his energy adviser James
Schlesinger. The proposals are
expected to help areas hit by the
gas shortage.
Aggregate Supply Shocks
Negative growth with rising prices!
Price Level
AS2
AS1
P2
P1
AD
o
Q2 Q1
Real domestic output
Natural Rate Hypothesis
doubts the existence of an inverse
relationship between inflation
and unemployment....
Two Variants
Adaptive Expectations Theory
Rational Expectations Theory
Long-Run Vertical Phillips Curve
Adaptive expectations implies a
long-run Vertical Phillips Curve at
the Natural Rate of Unemployment
Rational expectations implies that
the workings of the economy is
understood, and that fiscal and
and monetary policy will be
anticipated rendering the policy
ineffective
Annual rate of inflation
(percent)
The Phillips Curve Concept
Long Run
Phillips
Curve
7
6
5
4
3
2
1
0
Phillips1958
1
2
3
4
5
6
Unemployment rate
(percent)
7
Short Run
Phillips
Curves
Stagflation
• The 1970’s saw a tripling
of oil prices
• The 1970’s saw draught
and a series of massive
crop failures
• Aggregate supply shifted to
the left
• Neither Keynesian nor Fed
policy presents a good
solution!
David Stockman
Donald H. Rumsfeld, and Uncle
Richard B. Cheney
Arthur Laffer
That’s a voodoo economics
if you ask me!
Arthur Laffer
• Laffer’s curve became
the basis for
Reaganomics and the
Tax Cutting policies of
the Republican Party!
• Reagan’s tax cuts sent
deficits soaring in the
1980’s
Tax cuts stimulate growth shifting AS outward ending Stagflation!
Laffer Curve
Tax rate (percent)
100
Shows impact of tax rates
upon tax collections
0
Tax revenue (dollars)
Copyright McGraw-Hill, Inc. 1999
Laffer Curve
Tax rate (percent)
100
l
0
Tax revenue (dollars)
Copyright McGraw-Hill, Inc. 1999
Laffer Curve
Tax rate (percent)
100
m
m
l
0
Tax revenue (dollars)
Copyright McGraw-Hill, Inc. 1999
Laffer Curve
Tax rate (percent)
100
n
m
m
l
0
Tax revenue (dollars)
Copyright McGraw-Hill, Inc. 1999
Laffer Curve
Tax rate (percent)
100
n
m
m
l
0
Tax revenue (dollars)
Copyright McGraw-Hill, Inc. 1999
Supply-Side Economics
It’s All About Increased Output!
•Tax Cuts:
To stimulate Business Investment
To induce incentives to work
•Deregulation of Business
•Incentives to save and invest
• Laffer Curve as a Proof
Less tax evasion
Deregulation & Tax Breaks for
P
S
Small Business
S + Deregs
Tax Breaks
S rises
Price for
consumers
falls
Deregs
to business
S shifts
right
0
Tax credits
to producers
Or Deregulation
P
R
I
C
E
output
Output rises
D
Q
Supply-Side Economics
Micro Growth of Small Business Spurs Aggregate Growth
Price Level
AS1
AS2 = Sum all
Micro Supply
P1
P2
o
Stagflation
Can End As
Price Level
AD Falls and
RGDP,
Output, &
Q1 Q2
Employment
Real domestic output
Rise!
surplus
US National Debt Tops 8 Trillion 11/18/2005
No Loans
For College!
The Negative Effects:
1. No money left for businesses/consumers
2. Canceling effect: I down, C down,
3. i up = international $ up, M rises
4. AD collapses!
Real rate of interest, i
Deficits and Crowding Out
Sm1
10
8
6
0
Dm2
Dm1
Quantity of money demanded and supplied
R 10
i
8
R
6
0
PI2
MEI
PI1
Amount of planned investment, I
Criticisms of the Laffer Curve
• Taxes: Incentives and Time
• Who Benefits from Tax Cuts
• Position on Curve
Other Supply-Side Issues
• Deficits
• Industrial regulation
• Social regulation
• Reaganomics: success or failure
Are we presently growing
as a National Economy?
GROWTH of
Aggregate Supply?
Growth Economics
Two Economic Growth Definitions:
• An increase in real GDP occurring
over a period of time
• An increase in real GDP per capita
occurring over a period of time
Supplyside’s Goal:
Shift AS, LRAS, PPC right!
Growth Economics
Growth as a Goal
Ingredients of Growth:
Quantity & quality of natural resources
Quantity & quality of human resources
Supply or stock of capital goods
Technology
PRODUCTION POSSIBILITIES
Capital Goods
Q
Economic
Growth
C
A
b
a
B
D
Consumer Goods
Q
Determinants of Real Output
1- Size of employed
labor force
2- Average hours
of work
1- Technological advance
2- Quantity of capital
3- Education and training
4- Allocative efficiency
5- Other
Determinants of Real Output
1- Size of employed
labor force
2- Average hours
of work
Yields
1- Technological advance
2- Quantity of capital
3- Education and training
4- Allocative efficiency
5- Other
Copyright McGraw-Hill, Inc.
Determinants of Real Output
1- Size of employed
labor force
2- Average hours
of work
1- Technological advance
2- Quantity of capital
3- Education and training
4- Allocative efficiency
5- Other
Copyright McGraw-Hill, Inc.
REAL
DOMESTIC
OUTPUT
AD - AS Framework
LRAS1
LRAS2
Price Level
AS’2
AS’1
P2
P1
AD2
AD1
o
$5 Trillion
$12 Trillion
RGDP – OUTPUT - EMPLOYMENT
PRODUCTION POSSIBILITIES
Capital Goods
Q
Economic
Growth
C
A
b
a
B
D
Consumer Goods
Q
United States
Growth
Real GDP has increased
sixfold since 1940
Improved Products and Services
Added Leisure
Environmental Effects
Sources of Real U.S. National Income Growth
Increase in quantity of labor
33%
Increase in labor productivity
67%
Technological advance 28%
Quantity of capital
20%
Education and training
12%
Economies of scale
8%
Improved resource
allocation
8%
Legal-human environment
and other (Lawyers)
-9%
Causes Slowed Productivity
1- Labor Quality
Decline in experience
Less able workers
Slowing of rise in educational attainment
2- Technological Progress
3- Investment – 1990’s Bubble
Low saving rate
Import competition
Regulation
Reduced infrastructure spending