Shifts caused by taxes o Two modern approaches Life Cycle Hypothesis permanent

Shifts caused by taxes o two modern approaches life

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Shifts caused by taxes o Two modern approaches: Life-Cycle Hypothesis, permanent income hypothesis ▪ Current consumption levels are based on Expected Lifetime income levels Effects of tax cuts depend on their term o Permanent – will increase spending (shift consumption intercept up) o Temporary – will either not increase spending, or increase it imperceptivit y Explanation: - Because you expect to earn a surplus of income over your current spending, you are okay borrowing against that (i.e. student loans, mortgage, etc.) -
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Later in life, when you retire, you earn less than your spending amount, so you use up your savings from earlier in life Average Propensity to Consume (APC) = Household Spending/Household Consumption o Decreases with higher income levels, although the difference is probably not as large as in reported figures b/c: ▪ When people report their income, they often don’t include transfer payments (unemployment, disability, etc.) Transfer payments would lower income (denominator) for lower income families ▪ High-income people tend to understate their consumption levels Lowers the spending (numerator) for higher income families o APC v. MPC ▪ MPC determines how much spending results from a redistribution of income High APC doesn’t necessarily imply a high MPC ▪ Can’t assume that MPCs are necessarily larger for poorer households Low-income households might use additional income to pay off debt, work less hours, etc. Economy has achieved a spending balance when the amount of GDP produced (Y) equals C + I + G + X Graph of the Spending Balance model starts with the expenditure line o This line’s graph plots desired spending as a function of Y Finding the point of spending balance o Graphical method: draw a 45-degree line, Spending = Y ▪ The point of the spending balance is the point where the expenditure line intersects the 45-degree line o Algebraic method – solve the spending equation for Y Multipliers o Shifts in autonomous spending will have a multiplied effect on Y o Only important in the context of the EFM o Multiple = 1/(1-mpc)
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Deriving the Aggregate Demand Curve (refer below for diagrams) o Aggregate demand story starts with a change in the inflation rate ▪ Once you get this inflation rate, go over to the monetary rule curve and see what that inflation rate implies in terms of R Spending (C, I, and X) depends on R o After you figure out the R, draw this curve on the spending balance model and you will be able to see the value of Y ▪ Y = change in spending x multiplier ▪ Connecting the dots yields the aggregate demand curve o Shifts in the AD Curve ▪ Anything that shifts the Monetary Rule curve will shift the AD curve. If the monetary rule curve shifts down, then the spending line will shift up, and the AD curve will shift right. ▪ Anything that shifts the expenditure curve besides a change in R If the expenditure curve shifts up, then the AD curve will shift right No action occurring on the monetary rule curve The Inflation-Adjustment Line (IA) IA curve = graphed on same set of axes used for the aggregate demand curve o Horizontal axis (x) = GDP (Y)
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o Vertical axis (y) = inflation (@) o
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