Lec- Week 5

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University of Toronto Scarborough
Economics for Management Studies
Iris Au

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. www.notesolution.com 2 Full-Employment Level of Output and Output Gaps Full-employment level of output, Y FElong-run level of output 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 is calFEd 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). www.notesolution.com 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) www.notesolution.com 4 Recessionary or Deflationary Gap It occurs when the equilibrium level of output (Y*) is less than the full-employment level, i.e., Y* FEY . This means that the economy is producing less output than Y = AE C Excess AE = AE 0 c Y Supply A B 45 Y www.notesolution.com
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