ECON 101 Lecture Notes - Lecture 3: Deflation, Fiscal Policy, Disinflation
30 Apr 2018
School
Department
Course
Professor
Economics 101
Lori Leachman
Part 3 • Lecture
• Macroeconomics - study of entire economic system, focus on how gov. uses discretionary policy
o Discretionary - policy that can change whenever gov. wants
o Fiscal policy - taxes, spending, budget - short term
▪ Done by executive & legislative branches - lot of politics
▪ Full employment, economic growth, price stability, optimal external balance
o Monetary policy - interest rates, money supply - affect inflation
▪ Done by Federal Reserve (Central Bank)
▪ Price stability, economic growth, full employment, optimal external balance
• Government Objectives & Goals
o Full employment (around 4.5%) - maintain frictional level of unemployment; not zero
o Price stability - little/no inflation (less than or equal to 2%)
▪ Inflation - persistent upward movement in price level (price of all goods)
▪ Deflation - downward movement in price level - very problematic - debt burden
▪ Disinflation - smaller and smaller inflation rates
o Economic Growth - measured by real GDP (gross domestic product)
o Optimal External Balance
▪ BP = balance of payments = (x - m) + (Ad - FA)
• x - m = trade balance; goods & services trade
o x = exports, m = imports
• Ad - FA = money flow; financial account
o Ad = domestic assets that foreigners buy (i.e. stocks purchased by
foreigners), FA = foreign assets that we buy (real estate in other
countries)
• If Ad - FA > 0 (borrowing from world; outflow) < 0 (lending to world; inflow)
• If x - m > 0 (trade surplus) < 0 (trade deficit)
• BP = 0 = deficit and borrowing = 0 (U.S.) - LONG RUN ALWAYS
• Optimal for US (industrial country) - trade surplus and lending to world
o Currently the opposite
• Optimal for developing country - imports capital goods - trade deficit and
borrowing from world - build up capital to produce in future (investments)
• Four Sectors of Economy
o C: Consumption - single largest spending component (65-70%)
o I: Investment - 2 parts: business spending & inventory investment (disequilibrium) (10-15%)
o G: Government - consolidated government and includes federal, state, local gov. (30%)
o Xn: Net Exports - less than 0 (we import more than export)
• Economic Assumptions
o Rationality: people prefer more to less of good
o Efficiency: people want most for least cost
o Nothing is free: everything has a cost
▪ Direct cost: what you pay
▪ Transaction costs: time/info/subscription/transfer costs/fees
▪ Opportunity costs: costs of next best alternative; what you give up
▪ Optimal decision making takes on board all costs
o The best economic decisions are made with marginal analysis (reconsidering at all steps)
o Risk = prob of bad event * cost if the event occurs
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