AP Macro Unit 3

What is aggregate demand

The amount of a country’s output of goods and services demanded by households, firms, the government, and foreigners in a period of time

What does the AD describe the relationship between

The price level and the quantity of goods and services demanded in a country - at lower price levels more of a nation’s output is demanded while at higher outputs less is demanded

Why is the AD curve downward sloping

1. The Wealth Effect

2. The real interest rate effect

3. The net export effect

What is the Wealth effect

Higher price levels reduce the purchasing power or the real value of households wealth and savings ; therefore, consumers will spend less, leading to a decrease in the quantity of goods demanded.

What is the Real Interest rate effect

In response to a rise in price level banks raise the interest rates on loans to households and firms who wish to consume or invest ; this increase in interest rates leads to a decrease in consumer spending and business investment.

What is the net export effect

Looks at how a change in a country average price level affects the flow of exports and imports ; when domestic prices rise, exports become more expensive for foreign buyers, leading to a decrease in exports, while imports become cheaper, resulting in an increase in imports. This combination leads to a decrease in net exports.

What causes a shift in the AD curve

A change in any of the components of AD:

• Consumption

• Investment

• Government

• Net Exports

What are the determinants of Consumption spending

• Disposable income

• Wealth

• consumer confidence

• Expected inflation or deflation

• Interest rates

What are the determinants of investment spending

• Interest rates

• Business confidence

• expected inflation or deflation

• business taxes

• government regulations

What are the determinants of government spending

• Government fiscal policy

What are the determinants of net exports

• The exchange rate

• Income abroad

• Relative price levels

What is the spending multiplier

It quantifies the size of change in AD as a result of a change in any of the components of AD

What is the Tax Multiplier

The tax multiplier quantifies the size of the change in AD as a result of a change in taxes

What is the Marginal propensity to consume

It represents the change in consumer spending divided by the change in disopsable income experienced by a country households

Formula: MPC = Change in consumption Spending/ Change in income

What is the Marginal propensity to save

MPS = Change in savings/ Change in income

What is MPC + MPS =

1

What are the formulas for calculating the expenditure multiplier

1/1-MPC OR 1/MPS

What is the formula for the Tax multiplier

-MPC/MPS OR MPC/1-MPC

Why is the tax multiplier effect lower than the spending multiplier effect

because the tax multiplier effect is indirect and the spending multiplier effect is direct

What is Short Run Aggregate Supply

The quantity of goods and services that a country producers are willing and able to produce at a range of price levels in a period of time

What relationship does the Short Run aggregate supply curve represent

The price level and the quantity of goods and services supplied in an economy in the period which wages and other input prices are inflexible

• When prices rise, they want to produce more

• When prices lower, they want to produce less

What are sticky wages

It is the idea that in the short run, wages are fixed and cannot be changed, that means during a period of recession, people may be fired as it is more optimal than lowering wages

What causes a shift in the short run aggregate supply curve

Any factor that causes production costs to change

• Wage rates

• Resource costs

• Energy and transportation

• Government regulation

• Business taxes/subsidies

• Exchange rates

What does the Long Run aggregate supply curve represent

The long run aggregate supply curve represents the level of output achieved in an economy when wages and prices are fully flexible and adjust to the economy’s price level

How are the LRAS and the PPC related

They both represent maximum sustainable capacity or full employment output. An increase in a countrys maximum sustainable output shifts both the PPC and the LRAS

What determinants increase fully employment output

1. Labour

2. Land

3. Capital

4. Entrepreneurship

An outward shift in the LRAS or a inward shift in the LRAS has what effect on the PPC

Outward shift: PPC also moves outward

Inward shift: PPC also moves inward

Where does short run equilibrium occur

When the aggregate quantity of output demanded and the aggregate quantity of output supplied are equal

What is an output gap

When an economy short-run equilbirum output is above or below the full employment level, positive or negative gaps are created

What is a recessionary gap

When the short run equilibrium is below the full employment output

What is a inflationary gap

When the short run equilibrium is above the full employment output

What are output gaps the result of

Either supply or demand shocks

What does a positive demand shock lead to

It causes output, employment, and the price level to increase

What does a negative demand shock lead to

It causes output, employment, and the price level to decrease

What does a positive supply shock lead to

It caauses costs to businesses to be reduced

What does a negative supply shock lead to

It causes costs to businesses to increase

What is demand pull inflation

When a component of AD increases in an economy

What is cost push inflation

It is when a factor affecting SRAS to increase

What causes self adjustment with the SRAS curve

Scenario 1: Positive demand shock: If the AD curve has shifted to the right, then in the long run firms will attempt to compete with each other for hired labour which leads to an increase in wages, therefore decreasing the SRAS curve adjusting back to equilibirum

Scenario 2: Negative demand shock: if the AD curve has shifted to the left, then in the long run people will find it harder to find high paying jobs so they will accept lower wages, this leads to an increase in the SRAS therefore toward equilibirum

What causes a shift in the LRAS

• Increases in a nations potential output through advances in human capital or technology

Why do governments utilise fiscal policy

To achieve goals such as full employment, price level stability or economic growth

What are fiscal policies:

1. Change Government purchases and expenditures

2. Government transfer payments: Unemployment insurance - doesn’t count as a government purchase

3. Changes in Taxes

What is the reason for tax cuts being less impactful on the economy than government spending

because a decrease in taxes leads to households saving half of the tax cut

What is the relationship between the MPC and the MPS

The MPC will always be less than the MPS

What is expansionary fiscal policy

A fiscal policy aimed at stimulating economic growth through increased government spending or tax cuts to encourage consumption and investment.

What is contractionary fiscal policy

It's a policy aimed at reducing government spending or increasing taxes to curb inflation and slow down an overheating economy.

What is the formula for determing the size of an increase in spending or a decrease in taxes

Needed change in spending: Needed change in GDP/ spending multiplier

Needed change in taxes: Needed change in GDP/ tax multiplier

What is a time lag

Expected time lags to discretionary fiscal policy caused by factors such as the time it takes to decide on and implement policy action

What are automatic stabilizers

The built in changes in transfers and taxation that happen when an economy’s output and employment increase or decrease

What is discretionary fiscal policy

Government policymakers who change fiscal policy to either contract or expand AD

Triggering Automatic fiscal stabalizers

When changes in output or employment trigger automatic increases or decreases in spending and taxation