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Fed Cartoon July 6, 2009

Posted by petrarcanomics in Cartoons, Role of Government.
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Fiscal Multipliers July 6, 2009

Posted by petrarcanomics in Role of Government.
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The spending multiplier formula is the one divided by the marginal propensity to save (MPS).

The tax multiplier formula is the marginal propensity to consume (MPC) over the marginal propensity to save (MPS). MPC + MPS must equal one.

Multipliers work by multiplying their value times the change in government spending or the change in taxes to calculate the overall effect of a  fiscal policy. The multiplier effect for taxes is smaller than the multiplier effect for government spending changes because of the leakage of savings involved with a change in tax policy.

For example, a government spending increase of four hundred billion dollars with a multiplier of 1/.25 would result in an increase in real national income or output of 1.6 trillion dollars.

For example, an expansionary tax cut of four hundred billion dollars times a multiplier of .75/.25 would result in an increase in real national income or output of 1.2 trillion dollars.

Bailout Cartoon July 6, 2009

Posted by petrarcanomics in Role of Government.
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Fiscal Policy July 6, 2009

Posted by petrarcanomics in Role of Government.
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Expansionary Fiscal Policies

Expansionary fiscal policies include government spending increases and/or decreases in taxes. Effective expansionary fiscal policies will cause a rightward shift in aggregate demand.

Contractionary Fiscal Policies

Contractionary fiscal policies include government spending decreases and/or increases in taxes that would decrease the level of overall spending and cause a leftward shift in aggregate demand.

John Maynard Keynes

Keynes sought out to solve the conundrum of the rapidly declining spending of the great depression era. Keynes’ solution was that government should literally deficit spend during such periods to make up for the lack of spending occurring in the private sector. He said that such spending during recessionary periods would not be inflationary because the short-run aggregate supply curve is horizontal in such times. Therefore an increase in aggregate demand would have little or no effect on price level.

Classicalist Viewpoint

Classicalist economists such as Jean Baptiste Say saw the short-run aggregate supply (SRAS) curve as closer to vertical. He believed that deficit spending would be largely inflationary. Say believed that supply would create its own demand because more workers would be employed to create that supply. Classicalists also believe that corrective actions by the government are largely detrimental to the long-term health of the economy. They also believe that automatic stabilizers in the economy such as increased  unemployment insurance payments as more workers are unemployed will help stabilize the economy.

Historical Economic Periods

The 1970s stagflationary period of rising unemployment and rising prices are a great example of what can be explained using the aggregate demand / aggregate supply model. For example, as oil prices tripled in the 1970s, short-run aggregate supply shifted to the left because oil was an essential input resource cost that rippled throughout the production of many goods and services in the economy. This SRAS shift to the left naturally increased price levels while at the same time decreasing output or real GDP in the economy. So the understanding of the aggregate demand / aggregate supply model is essential to explaining many historical economic periods.

See these Reffonomics pages for more info:

Aggregate Demand/Supply Model & Its Effect on Price Level and Output or Real GDP July 6, 2009

Posted by petrarcanomics in Markets: Supply & Demand, Role of Government.
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The aggregate demand aggregate supply model has price level on its vertical axis and output or real GDP on its horizontal axis.

Aggregate Demand

Aggregate demand is made up of consumption, investment, government spending, and net exports. It is negative sloping due to the interest rate effect, the real balances effect, and the foreign purchases effect. Aggregate demand shows the relationship between the average price level for all goods and services and the quantity of all goods and service people are willing to buy.

Short-run Aggregate Supply

Short-run aggregate supply is the total amount of goods and services that businesses are willing to produce over a range of price levels.

Long-run Aggregate Supply

Long-run aggregate supply is the amount of goods and services that can be produced when the economy is using all of its resources.

Price Level

Price level is an overall measure of prices on goods and services throughout the economy.


Output or real GDP is the quantity of overall goods and services that are being produced in the economy.

True Growth

True growth in the economy is depicted as a rightward shift in the long-run aggregate supply curve. Another way true growth can be depicted is an outward shift of the production possibilities curve (PPC). True growth in our economy can be achieved by increased productivity, newer or improved technologies, increases in resources, or increased education and training of workers or labor.

Macroeconomic Indicators That Measure Economic Performance July 6, 2009

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There are four types of unemployment: structural, cyclical, frictional, and seasonal.

  • Structural unemployment involves mismatches  between job seekers and job openings. Unemployed workers who lack skills or have poor education relative to the next best resource alternative.
  • Cyclical unemployment happens as a result of too little spending in the economy as would happen in a recession.
  • Frictional unemployment includes people who are temporarily between jobs, have quit one job to find another, or they could be waiting for the best job opportunity after graduating from high school or college.
  • Seasonal unemployment involves workers who are unemployed because their job doesn’t exist during certain parts of the year due to changes in the weather.

Unemployment rate = # of people seeking work / # of people in the labor force (both employed and unemployed) X 100

The natural rate of unemployment, or full employment, in the US economy is considered to be an unemployment rate of approximately five percent.

For more information on employment, see Reffonomics.


Inflation’s best measure in our economy is the consumer price index (CPI). The definition of inflation is the overall rising price levels in the economy. A healthy rate of inflation in the American economy is considered to be between +1 and +3 percent.

Deflation is a decrease in overall prices in the economy which is considered unhealthy to a growing economy because the declining prices usually lead to rising unemployment.

High inflation over 4% is considered unhealthy because of the many groups in society that are  hurt as a result of this level of rising prices.

The calculation of CPI is done by compiling the prices of a market basket of goods that consumers typically purchase. These market baskets establish an index which can be used to measure the trend of overall prices in an economy. The percentage growth in CPI is measured by the current year index being divided by a base year index times 100. % Growth CPI = current year index / base year index X 100

For more information see these pages on Reffonomics: Inflation and Price Level, Inflation Calculator, Price Level and CPI.

Gross Domestic Product

Gross domestic product is the best measure of all final goods and services produced in an economy. The percentage change in the growth of GDP is the best measure of economic activity to gauge the health of an economy. The total of goods and services for the current year can be divided by the goods and services produced in a base year divided by a price index and a population index to get the best measure of economic growth which is real GDP per capital.

There are also nominal economic measures which give you the hard dollar amount of production. There are also real measures which factor in inflation in economic indicators. For example, if nominal wages were to increase by 8% and if inflation as measured by CPI were to grow by 5%, then real wages would actually have increased  by only 3%. So real measures of the economy factor inflation to get a true picture of what has occurred in the economy.

Components of Spending

Gross domestic product has four components: consumption, investment, government, and net exports.

  • Consumption is the spending on final goods and services by consumers in the economy.
  • Investment by the business sector on resources such as land, labor, capital, and entrepreneurship.
  • Government spending
  • Net exports which is the difference between exports (positive to net exports) and imports (positive to net exports).

Business Cycles

Economies go through business cycles.

  • Expansionary phases are marked  by positive real GDP growth.
  • Peaks are achieved at the end of an expansionary phase.
  • Contractionary phases occur as the economy realizes negative real GDP growth after a peak.
  • A trough phase occurs at the bottom of a contractionary phase.
  • An expansionary recovery phase generally begins the next business cycle.

Market economies, while they are the most productive and efficient types of economies, go through the swings of business cycles.