Week_5_-_Fiscal_Policy__AS-AD_Model_Revised

Week_5_-_Fiscal_Policy__AS-AD_Model_Revised - 1 ECMA06...

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1 ECMA06 – Fiscal Policy and the AS-AD Model Fiscal Policy as an Automatic Stabilizer and the AS-AD Model Outline Discuss the concepts like inflationary gap, deflationary gap, and full-employment level of output. Relationship between budget balance and national debt. The link between budget balance and output gaps. The use of fiscal policy to smooth out business cycles. Develop the AS-AD model –bringing price into the model.
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2 Full-Employment Level of Output and Output Gaps Full-employment level of output, Y FE It is the level of output consistent with “full employment” 1 . When the economy is operating at its normal pace (not too fast and not too slow), then we can say that the economy is at its full employment. The unemployment rate at Y FE is called the non-accelerating inflation rate of unemployment (NAIRU) or natural rate of unemployment (NRU). 1 You can interpret the term “full employment” as “Good/productive” workers find it “easy” to find a job. “Young/inexperienced” workers find it “easy” to find their first job. “Old” workers are not forced out of the labour force if they lose their jobs (i.e., no discouraged workers).
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3 ECMA06 – Fiscal Policy and the AS-AD Model Full employment DOES NOT mean that everyone is working because Frictional unemployment – unemployment that results from the turnover in the labour market as workers move between jobs. Structural unemployment – long-term and chronic unemployment arising from imbalances between the skills and other characteristics of workers in the market and the needs of employers. The labour market is dynamic (people constantly move in and out of the labour market). There are frictions in the economy (some industries/regions expand while some industries/regions contract)
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4 Recessionary or Deflationary Gap It occurs when the equilibrium level of output (Y*) is less than the full-employment level, i.e., Y* < Y FE . This means that the economy is producing less output than is normally associated with full employment. AE Y = AE AE = AE 0 + c Y Y 45 ° Y Y* Y FE When the economy has lots of unemployed workers, we say we are in a recession Recessionary gap. If the gap is large enough, there will be pressure for prices to fall Deflationary gap.
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5 ECMA06 – Fiscal Policy and the AS-AD Model Inflationary Gap It occurs when the equilibrium level of output (Y*) is greater than the full-employment level, i.e., Y* > Y FE . This means that the economy is producing more output than is normally associated with full employment. AE Y = AE AE = AE 0 + c Y Y 45 ° Y Y FE Y* The economy is “too hot”! The economy overheats there will be pressure for prices to rise Inflationary gap.
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6 Endogenous Budget Balance In this section, we connect the notion of output gaps with the notion of endogenous budget balance. Our Extended Model – the Budget Balance Again
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This note was uploaded on 12/21/2011 for the course ECONOMICS ECMA06 taught by Professor Dr.atamazaheri during the Spring '10 term at University of Toronto.

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Week_5_-_Fiscal_Policy__AS-AD_Model_Revised - 1 ECMA06...

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