Recent Changes

Balance the budget over the life of the business cycle( during the recesion we use contractionary fiscal policy and during the contrctionary we use expansionary, it assumes that the size of the expansion is equal to the contractionary, but that is not necessarily the case)
Problem: No guarantees that the size of the recessionary gap will equal the expansionary gap. It is difficult for the government to reign in spending and increase taxes during the expansionary periods.
What are the three theories on fiscal policy? According to each theory, what should scal
policy be used to do? What is the problem associated with each theory?
1. Countercyclical
Countercyclical scal policy is used to close recessionary or expansionary gaps.
Countercyclical scal policy can cause the crowding eect. That is, government spending
crowds out investment spending. This is because the government funds spending by
selling bonds. The more bonds sold (or the more government debt), the higher the
interest rates, which cause a decrease in the number of loans because it is too expensive
for rms to borrow.
2. Balanced Budget
Balanced budget scal policy uses automatic stabilizers rather than discretionary scal
policy.
Balanced budget scal policy can cause a pro-cyclical eect. Eorts to balance the
budget during a recessionary period can push the economy further into a recession.
3. Cyclical Balanced Budget
Cyclical balanced budget scal policy attempts to balance the budget over the business
cycle. Countercyclical policies can then be used to close recessionary and expansionary
gaps.
The problem with cyclical balanced budget policies is that we do not know how long the
business cycle will last. In order to be able to balance the budget over the business cycle,
the length and magnitude of the recessionary gap needs to be equal to the expansionary
gap, which is not always the case.
(1): Dr. S. Powers, "Fiscal Policy" notes, slide 28, April 4, 2012
(2): Dr. S. Powers, "Fiscal Policy" notes, slide 29, April 4, 2012

Bank run
When people go to the bank and to get money but the bank has run out of money. bank reserves and the BOC are set up to fix this problem. The BOC instil confidence in the people, if the banks run out of money, the boc will borrow them.
What is a bank run and how is it resolved?
A bank run is when a bank runs out of cash. Banks not only hold people's money they also
make money by providing loans. If a number of people choose to withdraw their money
simultaneously then the bank my not have the cash on hand necessary to meet people's
demand. In this case, chartered banks can borrow from other chartered banks (at the
overnight target rate) or from the Bank of Canada (at the bank rate) to meet the needs of the
bank's customer
(
9

AD=C+I+G+(X-IM)
{http://www.pcecon.com/notes/noteimages/ADAS/AD.gif} (2)
The aggregate demand curve is downward sloping because of these 3 effects below:when prices goes up, these 3 cause real gdp to go down and when prices fall, real GDP increases
real balance effect: prices go down > value of saving goes up > savings goes down > so consumption spending goes up > AE goes up > real GDP goes up
interest rate effect: prices go down > interest rates go down > so investment spending goes up > AE goes up > real GDP goes up
foreign trade effect: prices go down > export spend goes up, import spending goes down > net exports goes up > AE goes up > real GDP goes up
The aggregate demand curve is downward sloping because as the price level drops the quantity of goods and services people are willing and able to buy increases.
Endnotes:

government spending
export spending
If economy is steady:
Y = C + I + G + (X - Im)
Leakages = Injections
S + T + Im = I + G + X
Net export = X - Im
REFERENCE:
Dr. Stephanie Powers, "Circular Flow"(Lecture, Donald School of Business, Red Deer AB, Winter 2012)

(2): "Demand for Goods and Services in the Economy", www.pcecon.com, accessed April 11, 2012,
http://www.pcecon.com/notes/ADASdefinitions.html.
downward sloping. Except:
real balance effect-effect: prices go down>down > value of saving goes up > savings goes down>so consumptionsdown > so consumption spending goes up ( its movement along the AD curve; it does not shift it)> AE goes up > real GDP goes up
interest rate effect-effect: prices go down>interestdown > interest rates go down>down > so investment spending goes up > AE goes up > real GDP goes up
foreign trade effect-effect: prices go down.down > export spend spending goes down>netdown > net exports goes up' these three causesup > AE to go up, Prices down , our economy grows.goes up > real GDP goes up
Dr. Stephanie Powers, "Aggregate Demand", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)

Classical and Keynesian Views of Aggregate Supply
Classical
theAccording to classical/neo classical, they did not use demand and supply model. AS is vertical and = Poential GDP. In the long run, the economy will be t full employment. Therefore AS is the total of all final goods and services when all resources are utilized. According to neo-classical theory, increase in AD will only lead to inflation(prices go up). The only way to grow the economy is to increase the amount of natural resources, capital goods, technology and the quantity and quality of workers. they also said no govt intervention because it will only drive up prices. because when D goes up, prices goes up -> interest up -> D goes down.
If wages goes up => unemployment to go up => income will go down => demand will go down.
the classical has of labour.
Keynesian
ASBecause of rubber barons(monopoly) and labour unions, wages and prices were sticky (in flexible).
AS is a horizontal line.line(flat line). changing demandAD will make grow and prices will not change. Changes have little to no impact on inflation, Aggregateprices(inflation).Aggregate demand will increases economic of the two.two.because as the real GDP gets bigger the supply curve gets steeper.( sometimes classical economists are right and sometimes Keynesian economist is right)
price level
/
/ (
/------------------------------
Real GDP
Dr. Stephanie Powers, "Aggregate Supply", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)

GDP Gap and Aggregate Demand and Aggregate Supply
Aggregate supply and potential GDP shift by the same amount
the AD , P increases and AS increase but P down, the economy GDP= Potential GDPGDP( here is no cyclical unemployment)
Recessionary gap
Towhen the potential GDP > actual GDP. There is cyclical unemployment
To close this the min wage.wage (supply siders). to increase the money supplysupply. Alfred MArshal is to be blmed for theses graphs. the down side is high unemployment
Expansionary gap
Potential GDP< Actual GDP
to close this gap you need to decrease AS or AD. to do this you need to do the opposite of the recessionary gap.
will lower pricesprices. the down side is inflation. How to close this gap; raise biz taxes, increase minimum wage( will decrease AS) . To decrease AD; increase interest rate, decrease money supply and lower government spending.
what happens to potential GDP if wages fall; it stays the same. if new technology is implemented, it shifts it outward. Increas in technology, natural resources, real capital and quality and quantity of labour cause potential GDP to increase shift outward. The economy does not achieve full employment equilibrium when potential GDP shifts as a result of increase in technology, it creates a surplus and recessionary gap.
Dr. Stephanie Powers, "Aggregate Demand", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)

4.Change in technology - less capital -> AS to go down
5.Change in quality and quantity of labour - less quality and quantity of labour -> AS to go down
No 1. cost of production shifts only the AS curve
Note no 2 to 5 are factors that lead to economic growth and they also cause shift in the potential GDP.( increase in the last 4 will cause an increase to potential GDP0
Potential GDP is independent of prices because it shows the amount we can produce if we use all our resources.

4.Change in technology - less capital -> AS to go down
5.Change in quality and quantity of labour - less quality and quantity of labour -> AS to go down
Note no 2 to 5 are factors that lead to economic growth and they also cause shift in the potential GDP.( increase in the last 4 will cause an increase to potential GDP0
Potential GDP is independent of prices because it shows the amount we can produce if we use all our resources.
( Morris, Alan J., and Sayre, John E. Principles of Macroeconomics: 6th Edition. United States: The McGraw-Hill Companies, 1942.)