Economics and Statistics

  You are in charge of the government budget for the year 2021. You are told that schools and public roads need to be updated, and you estimate an appropriate budget in order to carry out the task. Describe what will happen in the short run to the economy, and what type of inflation do we see? Describe the supply side effect from this policy, explain what happens in the long run. Assume that there is no crowding out effect. First, note that updating public infractures, assuming taxes stay the same, will require an increase in government spending, which will also have an impact on the investment and consumption level in the economy (remember the spending multiplier?). Therefore, the aggregate demand curve will shift to the right. This will cause inflation (i.e positive change in the price level) and a higher output in the short-run.  Note that if we were to assume a large crowding out effect, the short run aggregate supply curve would shift to the left (increase in production c...

  As a reminder, in the long run, wages and prices are considered variables in the economy. Thus in periods of economic expansions, workers will demand higher wages due to the pressure on the labor market (higher demand), increasing costs to firms, shifting the SRAS to the left. They opposite effect happens during periods of economic contraction. Expansionary policies have no direct effect on the long run level of full employment. It can be the case that a positive demand side policy also has a positive supply side effect.  Expansionary monetary policy, and its effect on the LRAS: lower interest rates implies more investment which implies more capital (i.e machines), making the workers more productive, leading to economic growth (i.e increasing the level of output in the long run). More investment does shift the AD to the right but so do the LRAS and SRAS curves. Contractionary demand side policies can have an impact on the long run level of full employment if and on...

  Fiscal Policy: government spending and taxation, aimed at expending or contracting the level of macroeconomic activity in a nation. A tax increase (decrease) will raise (lower) households' disposable income, leading to more (less) consumption. Furthermore, firms will increase (decrease) the number of investment as they get to keep a larger (smaller) share of their profits. An increase (decrease) in government spending affects the variable G that defines the aggregate demand. Government spending also leads to a change in household income, affecting the level of consumption. Tax multiplier: just like any multiplier so far, it is just the sum of a converging geometric series: Say the MPC is equal to 70%, then it must be the case that the MPS is 30%. Thus, the tax multiplier, t, is equal to about -2.32. In other words, for every dollar that goes to tax revenue, total spending decreases by about 2.32 dollars. Note that a tax decrease would be negative, and thus have a positi...