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3.4 Demand and Supply Side Policies

3.4 Demand and Supply Side Policies. 3.4.1 Shift in Aggregate Demand Demand Side Policies. Shifting the AD Curve (changes in any components) C, I, G, X-M Expectations Inflationary Wealth and Income Profit and Revenue Policy Overall Outlook. International Issues Exhange Rates

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3.4 Demand and Supply Side Policies

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  1. 3.4 Demand and Supply Side Policies

  2. 3.4.1Shift in Aggregate DemandDemand Side Policies • Shifting the AD Curve (changes in any components) C, I, G, X-M • Expectations • Inflationary • Wealth and Income • Profit and Revenue • Policy • Overall Outlook

  3. International Issues • Exhange Rates • Trading Partner’s Income • Relative Prices • Fiscal Policies • Taxes or Govt. Spending • Monetary Policies • Central Bank • Interest Rates and Money Supply

  4. AD shift without increase in LRAS is INFLATIONARY A to B to C B: Real wages drop, factor prices increase (causes supply shift) C: Inflationary result ADShort Run Vs. Long Run

  5. Overview of Demand Management • See Chart pg.380 • Overheating vs. Recessionary Economy • Problem: Fast rising inflation • Solutions: Monetary?? Fiscal?? • Problem: High Unemployment • Solutions: Mon.?? Fisc.??

  6. Govt. Budgets • Receipts – Expenditures • Which item under Receipts is the biggest future problem? • Surplus vs. Deficit • National Debt vs. Foreign Debt • Foreign = owed to other countries

  7. Built-In Safety Nets vs. Active Policies • Automatic-Stabilisers (Built-In Safety Net) • Progressive Taxes • Expansion: > % income paid = less disposable income= < Consumption = < AD • Recession: < % income paid = > AD • Social Benefits • Expansion: < Unemployment, Welfare = < Consumption = <AD • Recession: > social spending = >AD Both help to “soften” cycles, less volatile Don’t solve or prevent cycles Graphs pg. 383

  8. Discretionary Fiscal Policies (Active) • Govt. Spending • Expansion: Less spending < AD • Recession: More spending > AD • Focus on Unemployment • Surpluses (Boom) used for > Spending during bad times Does this really happen? • Taxes • Expansion: >Taxes =<C = <AD • Recession: <Taxes = >C = >AD

  9. Interest Rates and Monetary Policy • Definition: • Real Interest = Nominal – Inflation • Ex. 2% real = 5% nominal – 3%inflation • Central Bank • Interest Rates • Influence C and I • Inflation positively linked to interest rates • Review pg. 346 • Used to minimize inflation.

  10. Functions of Central Bank • Monetary policy- • interest rates, money supply • Lender of Last Resort • To commercial banks • Discount rate • Key for other rates • Affects bank profit and lending rates • Regulate Lending • Minimum reserve requirements

  11. What could the Central Bank (Fed) do to “tighten the money supply”? • When would the Fed do this? • Time Lags • Fed must try to be forward thinking • 2-6 quarters to influence inflation • Up to 2yrs to affect AD

  12. Relationship between Interest and Investment • Investment Schedule • Lower interest rates= Higher investment • 1. Opportunity Costs • Investment increases when opportunity costs fall • 2. Cost of Investment • Lower rates = lower cost of borrowing

  13. Supply and Demand for Moneypg. 388-389 • Demand for Money < Dm = shift left= lower r • Caused by factors other than price (r) • Ex. Income levels, price levels (inflation) • Supply of Money • Feds most common methods • Discount Rate • Affects lending ability • Open Market Operations • Buying and Selling of govt. debt • Bills and Bonds • Controls on Bank Lending • Reserve requirements

  14. Final note from text: • Basic Theory: • Change in Sm = Change in r • Vice Versa • Change in r = Change in Sm • Fed Can’t do Both simultaneously

  15. Exchange Rate Policies • Can be influenced by Fed (rate change) • Fed raises rates = greater demand for US currency = > currency appreciation = < X (US goods expensive) = >M (foreign goods cheaper) = <AD • Falling r = falling currency value • >exports • (U.S. goods cheaper for other countries) • < imports • (foreign goods more expensive) • More on this in 4.6

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