Elasticity: Economic Concepts, Fiscal Policies, and Inflation

Elasticity in Microeconomics and Macroeconomics

Elasticity Microeconomics: The unit of analysis is focused on the individual behaviors Macroeconomics: It is about the aggregate, how the whole economy behaves

Main Determinants of Demand

• Price of de good The higher price the lower demand depends on elasticity.
• Income Normal goods: More income, more demand. Inferior goods: More income, less demand.
• Ethic
• Quality
• Substitute

Understanding Elasticity

• How much the demand reacts to any type of changes
• How it will change depending on the price
• Level of responsiveness of price - demand There exist different types of elasticity Negative: Higher price, less demand (change because of the price)

Possible Results of Elasticity

1. Perfectly inelastic (elasticity = 0): It doesn't matter how much the price changes, the quantity of demand doesn't
   • Eg: Water in a emergency, people would buy the same amount of water. A monopoly
2. Inelastic (elasticity < 1): Consumers still buy practically the same quantity even the price changes a lot
   • Eg: People stills buy meds even the price rises
3. Elastic (elasticity > 1): A change in the price makes the same change in the quantity of demand. If the price rises a 10% the change in demand will decrease a 10%.
   • Eg: If the price of ice creams rises a bit a lot of people stops buying them, that means the demand is elastic
4. Perfectly elastic elasticity = infinite): A small rise of prices changes the demand completely

Factors Determining Elasticity

1. Close substitutes available (amount of goods): much options and alternatives easier to you to change
   • Perfect elasticity
2. Price of the product in relation to total income: you will be unwilling to consume it because it will take more of your income
   • Elastic demand
3. Cost of substituting between different products (changing of one good to another): The higher cost of substituting goods. If changing it is too expensive: Inelastic
   • Eg: Si estas en una telefonia movil y suben el precio querrás ir a otra, pero, al cambiarte te hacen pagar (net cost), por lo tanto decides no cambiar aunque pagues mas
4. Brand loyalty: The more loyal the more inelastic
   • Perfect inelastic
5. Degree of necessity / luxury
   1. The more necessity the more inelastic
   2. The more luxury depends on the group of consumers (status)
      • Less price on something luxury = it transforms in a vulgar good
      • More price on something luxury = it gives more status, people will buy it

Dynamic Surge Pricing

Dynamic surge pricing The price is very flexible and volatile.

• Depending on the time (moment of buying ... )
• Strategi followed to set different prices, depending on the consumers and the time

Budget Revenues

Budget revenues Budget (government)

1. Capital Receipts
2. Revenue Receipts
   1. Non-tax Revenue:
      1. Interest receipts
      2. Profits and dividend
      3. Fees and fines
      4. Externar grants
      5. Special assessment

Tax and Fee Distinction

Tax: will cover all the expenditures Fee: will cover a specific expenditure

Tax Revenue Types

1. Tax Revenue
   1. Direct Taxes (progressive: the more I have, the more taxes I pay): They are taken from the income, taxing the income
   2. Indirect Taxes (regressive: I'm paying the same tax even if I have more money): Taxing indirectly the income trough consumption

Direct Taxes Examples

Direct taxes

• Income taxes: the more you have, the more you pay
• Corporation tax:
• Expenditure tax:
• Wealth tax:
• Estate duty:

Indirect Taxes Examples

Indirect taxes

• Sales tax:
• Custom duty:
• Excise duty:
• Service tax:
• Value added tax:

Budget Spending Categories

Budget spending

1. Capital spending: you expect to receive something in exchange, but not exactly in a material way, more in a social way
   • People will be
2. Current spending: the government needs public services, civil servants (salaries), make the administration work, also buildings, cars. Every expenditure the government needs to work currently
3. Transfer payment: Subsidies, grants, pensioners

Budget Deficit Analysis

Budget deficit A budget surplus (deficit) occurs when revenue exceeds current spending. In situations in which the inflows equal the outflows, the budget is said to be balanced.

1. Revenue deficit: expenditure - revenue
2. Fiscal deficit: the same but you will not consider the borrowing
3. Primary deficit: fiscal deficit (no borrowing) - interest payments

Correcting Budget Deficits

How to correct the deficit:

1. Correct: increase taxes
2. Cover: borrowing (debt) or monetization (limited), print more money -> value of the money decrease You will have to save more money the next year to pay the debt The higher interest rate, the more appealing but it has a consequence -> the credits will become more expensive -> crowding out effect
   • Crowding-out: when the government spends or borrows a lot of money, leaving less available for people and businesses to use. This can make it harder for them to borrow money for their own projects.

Reading on Budget Deficit

Reading

• How the article address the issue of the budget deficit
• Relation between crowding
• European union countries, Eu fiscal rules sets for national budget deficits to ensure sound public finances

Fiscal and Budgetary Policy

Fiscal and budgetary policy Economy authority has goals:

1. Foreign balance
2. Price stability
3. Economic growth
4. Employment
5. Satisfy public needs (redistribute income)

Quasi Goals of Policy

Quasi goals

1. Debt
2. Budget deficit

Policy Instruments

Instruments

1. Conjunctural: situation in a given moment
   • Fiscal policy/Budgetary policy
   • Trade policy
   • Monetary policy
   • Exchange rate: value of one currency in terms of another currency Value of
2. Structural: to modify the economic structure
   • Sectorial policy
   • Regulatory policies
   • R + D+I

Fiscal Policy Definition

Fiscal policy Refers to the budgetary policy, the government, which involves the government manipulating its level of spending and tax rates within the economy. The government uses these two tools to monitor and influence the economy:

• Increase/decrease the Aggregate Demand
• Redistribute income and wealth

Fiscal Policy and Aggregate Demand

Fiscal policy expands or contracts the aggregate demand GDP: Calculated as consumption (all agents in economy) C (fam consumption)+ I (investment private companies) + G (government expenditure) + X - M (net export)

Questions on Fiscal Policy

Questions: Which are the adequate fiscal policies to foster employment?

• Reducing taxes to companies
• Increasing public spending
• Incentives to exports

How to confront inflation?

• Increasing fiscal pressure to families and companies
• Reducing public spending -> less investment in the economies, less consumption from the families and also less investment from the private companies
• Reducing transfers
• Increase taxes -> reduce the aggregate demand

Types of Fiscal Policies

Types of fiscal policies

1. Automatic stabilizers Measures that work automatically, once they are applied there is no need for intervention by the government.
   • Work by their own
   • Countercyclical: does the opposite of the cycle
   • Prevents the overheating or slams in economy:
   • When the economic aggregate demand goes up, automatic stabilizers maintains economy in a lower level so it doesn't appear inflation
   • When the economy collapses, stabilizers support it to avoid overshooting. E.g:
   • Tax system (progressive) in expansionary periods
   • Transfers to families in contradictory periods: unemployment benefits
2. Discretionary measures Measures that you use to discriminate against the people or the moment, it is done on purpose.
   • Deliberates changes in the budgetary policy:
   • Volum, structure, composition of public expenditures
   • Volum, structure and type of taxes
   • Level of transfers
   • Level of deficit

Reading on Fiscal Policy

Reading Which type of fiscal policy is seen in the article

• Contractionary. Because it contracts the aggregate demand by raising taxes

What is the purpose of this fiscal policy

• Cover the gap, the incomes are lower and the expenditure higher. They are covering by increasing taxes

Is the article mentioning an alternative for this purpose

• Additional borrowing, debt

How is the UK tax burden compared to other countries

• Raising but stills lower if we compare it to other countries as US

How this fiscal policy has been implemented

• Raising taxes to the wealthier ones

Inflation and Price Stability

Inflation It is a tool, with the one we achieve the price stability Inflation: is the rate of increase in prices over a given period of time. The opposite is called deflation

Measuring Inflation

How is it measured (indicators)

1. Consumer Price Index: Measures the average price change over time for a fixed basket of consumer goods and services, indicating inflation's impact on consumers' cost of living.
   • Harmonized Index of Consumer Prices: A standardized CPI for EU countries, enabling cross-country inflation comparisons within the European Union. It is made to compare prices between different European countries, using the same shopping list.
2. GDP Deflator: Reflects price changes for all goods and services in an economy, adjusting nominal GDP to real GDP for a clearer economic growth picture.
   • Use the same variables = Nominal GDP / Real GDP . 100
   • Nominal GDP: is the total value of all goods and services produced in an economy at current prices (including inflation).
   • Real GDP: is the value of all goods and services produced, adjusted to remove the effects of inflation (using base year prices).
3. Core inflation: Tracks long-term inflation by excluding volatile items like food and energy, focusing on persistent price trends. E.g: Flood that has destroyed the crops ...

Inflation Goal and Importance

The goal Price stability = 2-3% Inflation shows how the economy evolves. 0 would mean that is not going well, because people will not be spending Why? (inflation control and economic stability are crucial)

1. Distortions and Arbitrary Redistributions: High inflation makes prices confusing and unpredictable. This can hurt savers because their money loses value, but it helps borrowers who repay loans with money that's worth less. E.g: can arbitrarily shift wealth-like from savers (who lose value) to borrowers (who pay back loans with cheaper money).
2. Strengthen Expectations: Stable inflation helps people and businesses plan for the future. If they trust that prices will stay steady, they're more likely to invest and spend confidently, leading to healthier economic growth.
3. Re-allocation of Resources: When inflation is under control, resources like money, labor, and materials are used more efficiently. High inflation makes businesses focus on protecting their money instead of improving or growing their businesses.

Methods for Economic Stability

How? (these are methods used to achieve economic stability)

1. Predominance of Monetary Policy: Central banks control interest rates and the money supply to manage inflation. This is seen as the primary tool to stabilize the economy because it directly impacts spending, borrowing, and saving.
2. Independent Central Banks: Central banks in many countries are independent so they can focus on the economy, not politics. This helps keep inflation under control because they base decisions on data, not political goals.
3. Little Use of (Counter-Cyclical) Fiscal Policy (Monetarist School): According to Monetarist thinking, fiscal policy (government spending and taxes) should not be heavily relied on for economic stability. Instead, controlling the money supply through monetary policy is preferred, as it is seen as more effective and less prone

Types of Inflation

Types of inflation

1. Demand pull inflation: Inflation caused when demand exceeds supply, leading to higher prices.
   • It happens when people have more money or confidence, increasing spending. E.g: A booming economy causes higher demand for cars, pushing prices up as supply can't keep up.
2. Cost push inflation: Inflation that occurs when rising production costs lead to increased prices.
   • Higher costs for wages or raw materials make businesses raise prices. E.g: A spike in oil prices increases transportation costs, leading to higher prices for goods.
3. Structural inflation: Inflation due to persistent structural issues in the economy, like supply-demand mismatches
   • Certain sectors face chronic shortages or rigidities in the market E.g: A reliance on imported goods with supply chain disruptions consistently raises prices in that sector.