AD & AS PROF. MAHIMA MISHRA. Mahima

Transcription

1 AD & AS PROF. MAHIMA MISHRA Mahima 1

2 Adding Net Taxes (T) and Government Purchases (G) to the Circular Flow of Income Mahima 2

3 AGGREGATE DEMAND It s the total amount that all consumers, business firms, government agencies and foreigners spend on final goods and services. AD = C + I + G + NX Mahima 3

4 The aggregate demand (AD) curve is a curve that shows the negative relationship between aggregate output (income) and the price level. Its sum of all expenditure in the economy over a period of time Formula: AD = C+I+G+(X-M) Mahima 4

5 Consumption Function/ MPC It shows a relationship between changes in consumption due to changes in income. MPC = Changes in C/ Changes in DI Factors that Shifts Consumption Function 1. Price level 2. Wealth 3. Real interest rates 4. Future Income Expectations 5 Mahima

6 Multiplier Effect Multiplier = 1/MPS or 1/1- MPC 6 Mahima

7 Investment This is one of the most volatile component of AD. It greatly depends on state of Business Confidence which in turn depends on expectations about the future. It also depends on interest rates and tax provisions. 7 Mahima

8 Which of the following act constitute investment according to the economist s definition of that term? 8 A. Infosys builds a new building in Indore. B. You buy 100 shares of Infosys. C. Your family buys a old home in resale. D. You buy a new Toyota imported from Japan. Mahima

9 Net Exports Our import rises when our GDP rises and falls when our GDP declines. Our exports relatively insensitive to our own GDP but are quiet sensitive to GDPs of other nations. It also depends on relative price level and exchange rates. 9 Mahima

10 Mahima 10 An increase in the quantity of money supplied at a given price level shifts the aggregate demand curve to the right.

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12 Aggregate supply is the total supply of all goods and services in the economy. The aggregate supply (AS) curve is a graph that shows the relationship between the aggregate quantity of output supplied by all firms in an economy and the overall price level. Mahima 12

13 Mahima 13 In the short run, the aggregate supply curve (the price/output response curve) has a positive slope.

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15 Factors That Shift the Aggregate Supply Curve Shifts to the Right Increases in Aggregate Supply Shifts to the Left Decreases in Aggregate Supply Lower costs lower input prices lower wage rates Economic growth more capital more labor technological change Public policy supply-side policies tax cuts deregulation Higher costs higher input prices higher wage rates Stagnation capital deterioration Public policy waste and inefficiency over-regulation Good weather Mahima 15 Bad weather, natural disasters, destruction from wars

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18 Expansionary Fiscal Policy Keynesians believe that allowing for the market to self-adjust may be a lengthy and painful process. Price Level LRAS SRAS 1 SRAS 2 P 2 P 1 P 3 e 1 E 2 E 3 Expansionary fiscal policy stimulates demand and directs the economy to full-employment Y 1 Y F AD 1 At e 1 (Y 1 ), the economy is below its potential capacity Y F. There are 2 routes to long-run full-employment equilibrium: Wait for lower wages and resource prices to reduce costs, increase supply to SRAS 2 and restore equilibrium to E 3, at Y F. Alternatively, expansionary fiscal policy could stimulate AD (shift to AD 2 ) and guide the economy back to E 2, at Y F. Jump to first page AD 2 Goods & Services (real GDP) Copyright 2006 Thomson Business and Economics. All rights reserved.

19 Jump to first page Copyright 2006 Thomson Business and Economics. All rights reserved.

20 The Crowding-out Effect The Crowding-out effect indicates that the increased borrowing to finance a budget deficit will push real interest rates up and thereby retard private spending, reducing the stimulus effect of expansionary fiscal policy. The implications of the crowding-out analysis are symmetrical. Restrictive fiscal policy will reduce real interest rates and "crowd in" private spending. Crowding-out effect in an open economy: Larger budget deficits and higher real interest rates lead to an inflow of capital, appreciation in the dollar, and a decline in net exports. Jump to first page Copyright 2006 Thomson Business and Economics. All rights reserved.

21 Crowding-Out in an Open Economy Increase in budget deficit Higher real interest rates Decline in private investment Inflow of financial capital from abroad Appreciation of the dollar Decline in net exports An increase in government borrowing to finance an enlarged budget deficit places upward pressure on real interest rates. This retards private investment and Aggregate Demand. In an open economy, high interest rates attract foreign capital. As foreigners buy more dollars to buy U.S. bonds and other financial assets, the dollar appreciates. The appreciation of the dollar causes net exports to fall. Thus, the larger deficits and higher interest rates trigger reductions in both private investment and net exports, which limit the expansionary impact of a budget deficit. Jump to first page Copyright 2006 Thomson Business and Economics. All rights reserved.

22 Annual Financial Statement Article 112 Revenue a/c Capital a/c Expenditure Receipts Expenditure Receipts Mahima 22

23 Revenue a/c Receipts Tax Revenue Non Tax Revenue Direct Tax Indirect Tax Investment Income Service Income Grants Mahima 23

24 REVENUE a/c EXPENDITURE Mahima 24

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26 SUBSIDIES SUBSIDIES FOOD 1,39,419 crore 1,34, crore FERTILIZER 72, crore 70,000 crore FUEL 63, crore 26,947 crore TOTAL 2,41, crore 2,31, crore Mahima 26

27 CAPITAL RECEIPTS Debt Receipts Non Debt Receipts Loans Provident Fund Small Receipts Loans Recovery Disinvestment Mahima 27

28 Capital Expenditure Plan Expenditure Non Plan Expenditure Central Plan State Plan UT Plan 1. Defense K Exp. 2. Loans to PSUs 3. Loans to Foreigners 4. Loans to State/UT Mahima 28

29 TYPES OF BUDEGT DEFICIT 1. Budget Deficit 2. Fiscal Deficit 3. Primary Deficit Mahima 29

30 1. Budget Deficit Total Receipts (Revenue R.+ Capital R.) Total Expenditure (Rev E. + Capital E.) Mahima 30

31 Receipts and Expenditure of the Central Government 1. Revenue receipts (a+b) (a)tax revenue (net of States share) (b) Non-tax revenue 2. Revenue expenditure (a)interest payments (b)major subsidies (c)defence expenditure 3. Revenue deficit (2-1) Mahima 31

32 4. Capital receipts (a) Recovery of loans (b) Other receipt (mainly PSU disinvestment) (c) Borrowings and other liabilities 5. Capital expenditure 1.Expenditure on aquistion of assets like land, building, machinery,etc.. 2. Loans and advances granted to State govt and Union Territs. 3. Disbursements from The Public Account 6. Total expenditure [2+5=6(a)+6(b)] (a)plan expenditure (b) Non-plan expenditure Mahima 32

33 2. FISCAL DEFICIT (Sukhmoy Chakrabarti) Its that portion of government expenditure which is financed by borrowing ( Treasury Bills etc.) its inclusive of all the borrowings of government F.D = Budget Deficit + Govt. Market Borrowings & Liability Government can meet this deficit by 2 ways- 1. Internal & External Borrowing 2. Borrowing from RBI against government securities. Mahima 33

34 PRIMARY DEFICIT FISCAL DEFICIT -INTEREST PAYMENTS BUDGET DEFICIT + MARKET BORROWINGS Mahima 34

35 PRIMARY DEFICIT P. D = Fiscal Deficit Interest Payments Mahima 35

36 Measures To Decrease Fiscal Deficit 1. Increasing Revenue From Taxes a) Inclusion of black money in economy. b) Broadening the Direct Tax Bracket. c) Simplifying Tax procedures. d) More services to be covered under Service Tax. e) More emphasis on increasing productivity of PSUs. Mahima 36

37 2. Decreasing Public Expenditure a) Decreasing expenditure on Subsidies b) to cut expenditure on LTC, Bonus etc. of government employees c) funds raise through various means should be used to pay past debt & not on meeting current expenditures. Mahima 37

38 T A R G E T FRBM ACT (2003) REVENUE DEFICIT 0% of GDP By 31/03/2008 (2015) FISCAL DEFICIT 3% of GDP By 31/03/2009 (2017) Mahima 38