Understanding Macroeconomics: Key Concepts and Applications
Deflationary Gap: A deflationary gap, also known as a recessionary gap, occurs when aggregate demand falls below the full-employment level of national output. This gap, represented by the vertical distance between the 45-degree line and the aggregate demand curve at the full-employment output, indicates the amount by which aggregate demand must increase to reach full employment. Fiscal policy, specifically increasing public spending, can be used to close this gap.
When the government increases public expenditure, the multiplier effect leads to a larger increase in national product than the initial spending increase, helping to eliminate the gap and achieve full employment. Financing this increased spending through borrowing, such as issuing government bonds, is preferable to raising taxes, as tax increases can reduce consumption and investment demand.
Inflationary Gap: An inflationary gap arises when aggregate demand exceeds the full-employment level of national output. This excess demand, where demand surpasses the country’s productive capacity, leads to rising prices, or inflation. In this situation, a suitable fiscal policy involves reducing public spending to lower demand and bring it back in line with full-employment output.
Importance of Elasticity: Elasticity of supply and demand determines how the burden of a tax is distributed between buyers and sellers. If demand is elastic and supply is inelastic, producers bear the full tax burden. Conversely, if demand is inelastic and supply is elastic, consumers bear the tax burden. When both demand and supply are elastic, the tax burden is shared, with the distribution depending on the relative elasticities.
Keynesian Propositions:
- Economic equilibrium can exist even with high unemployment.
- Unemployment results from insufficient demand for goods and services.
- To eliminate unemployment, demand must be increased to match the full-employment supply level.
Gross National Product (GNP):
- Gross private investment includes the value of new equipment, plants, and inventory accumulation.
- Net private investment is gross private investment minus depreciation.
- Gross national product is the sum of private consumption, government consumption, gross private investment, exports, and minus imports.
- Net national product is gross national product minus depreciation.
Marginal Utility: Marginal utility is the additional satisfaction gained from consuming one more unit of a good or service. The law of diminishing marginal utility states that as consumption increases, marginal utility decreases. This has implications for pricing, as sellers may need to lower prices as consumers approach saturation.
Scarcity and Choice: Limited resources and unlimited human needs create the economic problem of scarcity. The production possibilities curve illustrates the trade-offs involved in choosing which goods and services to produce given limited resources.
Supply and Demand Theory: Demand theory describes how consumers respond to price changes, with quantity demanded increasing as price decreases and vice versa. Supply theory describes how producers respond to price changes, with quantity supplied increasing as price increases and vice versa.
Short-Term Costs:
- Fixed costs are independent of output.
- Variable costs change with output.
- Total costs are the sum of fixed and variable costs.
- Marginal cost is the increase in total cost from producing one more unit.
- Average cost is total cost per unit of output.
- Average variable cost is variable cost per unit of output.
- Average fixed cost is fixed cost per unit of output.
Consequences of Free Markets:
Positive Consequences:
- Efficient allocation of resources.
- Incentives for skill development.
- Efficient use of scarce resources.
Negative Consequences:
- Inequality.
- Focus on purchasing power over needs.
- Economic instability.
- Potential for market imperfections.
- Negative externalities.
Types of Monopoly:
- Fiscal Monopoly: State-controlled for tax revenue.
- Social Monopoly: Municipality or government-controlled to provide essential services at low cost.
- Profit Monopoly: Aims to maximize profits (prohibited by EEC treaty).
- Larval Forms of Profit Monopoly: Attempts to circumvent monopoly laws.
- State-Operated Profit Monopoly: State-controlled monopolies for public interest services.