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CIA4UZ (October 13 Test) (LEVEL OF OVERALL ECONOMIC ACTIVITY (5 Macro…

- - - - New Classical: minimal gov't intervention in allocation of resources; perfectly inelastic representing full employment
      - Keynesian
        
        Perfectly elastic: producers can raise levels of output w/out raising average costs b/c of spare capacity
        
        Increasing: spare capacity used up, FoP's become increasingly scarce, producers bid for these factors → higher costs, CPI increases
        
        Inelastic: output cannot be increased w/out increase in quantity/quality of FoP's
  - - - Investment in human capital: education creates positive externalities, underprovided (merit good) in pure market system → increase in quality of labour
      - Research and development: stay up-to-date with modern developments and develop new production techniques → gov'ts can offer tax incentives or finance them in public research facilities → improvement in quality of capital
      - Provision/maintenance of infrastructure: large scale capital necessary for economic activity to take place (roads, electricity, water supply, etc.)
      - Direct support for businesses/industrial policies: improving nature of competitive industries through anti-monopoly laws, helping small firms ecome established, growing export companies
      - Subsidies
    - - Reduction in household income taxes: higher taxes disincentive to work (people prefer to substitute more work for leisure time rather than pay higher taxes on extra income) → reduction will incentivize people to increase productivity
      - Reductions in corporate taxes: more money available for investment (increase capital stock), R&D; incentivized to produce more efficiently
        
        Effects
        
        More investment = increase in short-run AD
        
        Firms produce more efficiently (opportunity cost of paying taxes reduced); willing to produce more at each price level
        
        Disadvantages
        
        Lower gov't revenue, less income for funding of underprovided merit goods which may decrease LRAS (argument that this effect cancels out with increased productivity)
        
        More investment = increase in AD = inflation → if exceeds target inflation rate, consumer purchasing power goes down, stakeholders will reduce spending and money flow goes down
      - Labour market reforms
        
        Reduction in trade union power: reduce ability to negotiate high labour costs → lower costs of production and increase number of workers
        
        Reduction/elimination of minimum wage: decreased cost of labour → increase in AS
        
        Reduction in unemployment benefits: encourage unemployed people to take available jobs
      - Deregulation: reducing/removing federal restrictions -
        the undoing of governmental regulation on certain markets; rules/restrictions on operations may increase costs of production
        
        Increased competitiors e.g. firms currently producing at profit maximization point in monopoly diagram → aims to increase output and lower price so that there is more incentive to innovate/be perfectly competitive (ATC cuts MR and MC at its lowest point)
        
        Example: deregulation in Canadian electricity market -- all companies use same infrastructure → incentive to innovate, costs decrease, increased competition; cost of production for other firms who use electricity also goes down → increases AS
      - Privatisation: sale of public gov't-owned firms to private sector → much more efficient (nationalized firms function based on political decisions, not economic)
        
        Problems with public firms (political reasons so MC does not necessarily equal MR)
        
        Underproduced merit goods if left up to market
        
        Stakeholders want to see short-term benefits (may lead to increased inflationary pressure, exports decrease b/c prices less competitive and imports increase)
        
        Benefits
        
        Pay off debt
        
        Increased quality of management
        
        Economic mindset, cut costs and gov't waste, more efficient use of FoP's
        
        Example: privatised health care - better equipment, shorter waiting lines, driven towards profit maximization; can have benefits but can be argued that b/c clinics wish to increase profit, they may not focus so much on diagnosing accurately
      - Policies to increase competition: ex. enforcing anti-monopoly laws: increase efficiency and productive potential
- - - - Deflationary gap: level of AD not sufficient to buy up potential output in the perfectly inelastic region
        
        If operating in perfectly elastic region, AD can increase such that CPI will not change despite an increase in output (due to spare capacity; producers employ FoP's w/out increase in costs)
        
        If AD moves into increasing region, FoP's become scarcer, prices bid up
        
        Operating at full employment: increase in AD will create inflationary gap (no increase in output and increase in CPI) → impossible for economy to produce further given existing FoP's
      - Extension of LRAS
        
        Economy operating below full employment level: no effect (AD not sufficient to buy up potential)
    - - Increase in AD may increase output in short-run (AD=SRAS1) -- inflationary gap where equilibrium @ level of output that exceeds potential output
        
        Ex. paying existing workers overtime wages (labour is the only variable factor of production)
        
        Firms competing for increasingly scarce labour and capital → increase in AD - increase in CPI and increase in costs to produce
        
        Firms willing to supply higher level of output due to higher prices in short-run, but higher costs of production ultimately results in no gain → SRAS shifts leftwards to full employment but @ higher CPI
      - Decrease in AD -- deflationary gap: Fall in price levels means cheaper costs of FoP's → SRAS shifts rightwards until it reaches long-run equilibrium but @ lower CPI
      - Increase in LRAS: increase in full employment level, decrease in CPI