III - Unemployment and fiscal policy ( Unit

14 )
Monday, 12 September 2022 14:20

- Non-durable goods = Consumed in less than 3y ( usually only one time ) ex : food
- Durable goods = goods used repeatedly over time ( over 3y lifespan = easily postponed ) ex : bicycles

I. The transmission of shocks : the multiplier process

Variation of Investment and consumption affects the whole economy :
• Direct effect ( ex : change own’s spending due to a change in income )
• Indirect effect ( ex : change of spending affects others’ income )
=> The Indirect effect amplify the Direct effect of a shock to aggregate demand.

Multiplier process : mechanism through which the direct and indirect effect of a change in autonomous
spending affects aggregate output ( production )

II. The multiplier model including the government and net exports.
Aggregate demand AD = C + I + G + ( X - M ) ( consumption + investment + Government spending
+ net exports )
• Consumption :
○ Fixed amount c0 : autonomous consumption ( independent of current income )
○ Variable amount c1: positively depends on current income
+ MDP of households with little health = close to 0.8 ( depends a lot on income )
+ MDP of wealth households = close to 0.0
○ Proportional tax t on income : income net of tax (= disposable income )
• Investment : depends on interest rate and profit rate

• Government spending : exogenous

• Net exports : exogenous

A goods market equilibrium : the output = aggregate demand ( Y = AD )

==> multiplier model : fall in demand —> fall in production and in income
—> further ( smaller ) fall in demand —> further fall in production…
Multiplier = sum of all these successive drops in production

IV. Investment spending

With profits a firm can :
• Dividends = increase emoloyees’ salaries or owners’ dividends
• Saving = buy financial assets or pay off existing debt
• Investment abroad / at home = build new productive capacity
( depends on owner’s impatience, financial and investment profitability )

V. Fiscal policy : How governments can dampen and amplify fluctuations

To dampen fluctuations in the economy :
- The size of the government ( ex : WWII )
- The government provides unemployment benefits : helps households smooth consumption. ( same
for other social transfers )
- The government can intervene by using fiscal policy ( spending or taxes )
- Improving their budget position ( = austerity )

VI. The government’s finances

1. Revenues : Taxes ( income, spending, alcohol, petrol… )
2. Expenditure / expenses : spendings on health, education, defense, public infrastructures, and social
security
3. Primary deficit when G > T : may rise public debt ( measured by debt-to-GDP-ration )

V. Aggregate demand and unemployment

Labour market model = how labour is employed in goods production
=> equilibrium : wage and price setting curves intersect