ECO 106 Jessie’s Review Session Week 4 & 5 Material Reminder : MIDTERM REVIEW SESSION! Thursday 5:00-7:00pm 14 E Jackson Room 1325

Agenda Sit in a U-Shape!! Take Attendance Check In - How was this past week's homework assignment? Thoughts on midterm? Warm Up - MIDTERM ESSAY Miscellaneous (taken from multiple choice) Case I Case II I took all three of these from MyEconLab!! Midterm will be VERY similar. Case III Exit survey - http://tinyurl.com/JessieSI

WHY SLIDES? This weeks session will be different. We will all work together to solve these problems, then once we find answers, they will be shown on the slides. I will then share this document with all of you. Might be good to take notes (: WHOOOOOOOOO!

Warm Up How is fiscal policy supposed to help an economy? WHAT IS THE DIFFERENCE BETWEEN FISCAL AND MONETARY POLICY? Fiscal - GOVERNMENT : spending, borrowing, taxing (Executive & Legislative branch) Monetary - FRB : buying & selling securities, lending money to banks, paying interest on reserves How is fiscal policy supposed to help an economy? Was it in fact helpful in the “Great Recession” of 2008? Should it be reconsidered or reshaped in preparation for the next economic downturn that might affect the US economy?

GDP has decreased over the past 3 months GDP has decreased over the past 3 months. What should Obama and his advisors do? Use fiscal or monetary policy? Fiscal. Should the government use expansionary or contractionary policies? Expansionary. Which policies should be used? Increase gov. spending and decrease taxes.

Think, Pair, Share : Micro vs. Macro & Income Micro : Firms & Households at an individual level. Income is given, variables are constant. Macro : Looks at economy as a whole. Income needs to be found. Relationship between spending, income, and output. Behaviors are relatively constant. Use consumption function. WHAT IS THE CONSUMPTION FUNCTION? Keynes. Marginal Propensity to Consume. MPC = Change in Consumption/Change in Disposable Income

Let’s talk about Keynes, baby! https://humoresyamores.wordpress.com/2012/06/24/mises-laughing/ Theory of total spending in economy and its effects on output and inflation. Wanted to understand Great Depression. What was his plan to stimulate demand, and pull economy out of recession? Increase government expenditures & decrease taxes. Focuses on SHORT RUN.

Investment : What are the two parts? Explain. Desired - Fixed, with some inventory growth Undesired - Always inventories. Business must plan ahead. Think of Walmart. If their old inventory is piling up, and new comes… uh oh. What is the Keynesian Cross Model? The Keynesian cross diagram demonstrates the relationship between aggregate demand (shown on the vertical axis) and aggregate supply (shown on the horizontal axis, measured by output). True or False : We assume that firms decrease output in response to unwanted inventory accumulation. True.

What is the Spending Multiplier? Simple Spending Multiplier? SM: change in Y* = (1/(1-MPC)) * change in Id SSM: 1 / (1-MPC) What is the Multiplier effect? Draw it on the board (: Shows the flow of income, output, and consumption. The size of the multiplier depends upon household's marginal decisions to spend, called the marginal propensity to consume (mpc), or to save, called the marginal propensity to save (mps).

Total Savings = Public (T-G) + Private (-a+MPS)*(Y-T) Does the U.S. run a deficit or surplus? Which component of savings would that fall under? Deficit, Public. What percentage of government expenditure is on consumption? 28% Budget Deficit: Difference between what a government spends and what it collects in taxes (G-T) During the 1990’s the federal gov. budget went from deficit to surplus. Opposite in 2001… what contributes to recent budget deficit??? Lower tax rates. Increased medicare payments. War in Iraq.

CASE ONE : No taxes or government spending. This means that prices are held constant and quantities change in response to undesired inventory accumulation. So, what forces push output towards equilibrium? Changes in inventories (changes in production and income). If current output exceeds the equilibrium, inventories accumulate, encouraging businesses to cut back on production, moving the economy toward equilibrium. Similarly, if the level of production is below the equilibrium, then inventories run down, encouraging an increase in production and thus a move toward equilibrium. We want equilibrium output and income. To do that, we set Y = AE If there is no government spending or taxes, what do you set Y equal to? Y = Yd (disposable income) At equilibrium, what do we want to equal? National Savings & Desired Investment

CASE ONE : C=200+(⅘)*Y I=100 What is MPC? Definition and answer. ⅘ What is MPS? Definition and answer. ⅕ What is the equilibrium level of income and output? Y = 1500 What is the simple spending multiplier? Definition and answer. 5 By how much will equilibrium output (Y) increase if Investment increases by 40? 200 What will equilibrium savings equal at the (highest) new level of equilibrium income? 140

CASE TWO : Introduce a Government. T stands for ‘lump sum’ taxes and transfers. G stands for a constant amount of government spending. (There is no international trade.) Note that Yd=Y-T, where Yd is disposable (after tax and transfer) income. At Y* what should be equal? national savings = desired investment How do you find national savings again? S* = private saving + public saving

CASE TWO : C= 200 + (⅘) Yd, MPC=(⅘) Id= 100 constant desired investment | G= 200, constant government spending | T= 200, constant tax receipts Find Y* = 1700 By how much will equilibrium output rise if G increases by 40? 200 What is the simple tax multiplier? -4 So if taxes change by -40 how much will equilibrium Y increase? 160 By how much will equilibrium output increase if government spending and taxation increase by 40? 40

CASE THREE : Fiscal Policy with Fractional Taxation C= 100 + (¾)Yd, MPC=(¾) Id= 300 constant desired investment G= 2000 constant government spending T= 500+(⅓)Y, Assume that the GDP gap is 600 at your initial equilibrium. Find Y* = 4050 Find the Spending Multiplier 2 Suppose economy is operating below potential output by the amount of the GDP gap. By how much must government spending rise in order to bring the economy to full employment output? 300 What is the tax multiplier? -1.5 It’s always negative! How large a change in taxes is needed to bring economy into full employment? -400 ; We need a tax break of 400 to bring the economy to full employment.

Would you like to go over any additional HW problems? MIDTERM REVIEW SESSION IS ON THURSDAY 5-7pm in 14 E Jackson room 1325

MIDTERM LAYOUT ~ 20 multiple choice questions pulled from MyEconLab - Look over them all! Tax problem from Chapter 4 - We did this 2 weeks ago! Problem from Chapter 8 - We did this just now! (should be VERY similar) 2 longer questions from Chapter 9 - We did this just now! (should be VERY similar) Essay - WRITE IT OUT BEFORE MIDTERM!!! - We did this just now!

YOU CAN DO IT! Please fill out my exit survey with positive vibes (if you’re feeling them) and all that you would like Petar and I to focus on during our Midterm Review Session!!! Exit survey - http://tinyurl.com/JessieSI