AP MACROECONOMICS: UNIT 3 NATIONAL INCOME AND PRICE DETERMINATION

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Aggregate Demand

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59 Terms

1

Aggregate Demand

A model that shows the different quantities of real output demanded in a whole economy at different composite price levels.

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2

Price Level

The aggregation (not average) of all prices in an economy using a price index.

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3

Real Wealth Effect

Changes in the price level affect the real value of consumer assets (like houses, savings, investments) in the opposite direction.

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4

Interest Rate Effect

The price level directly impacts the interest rate that banks charge to borrowers, which in turn effects changes in business investment and consumption loans.

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5

Foreign Trade Effect

As the domestic price level falls, ceteris paribus, more will be exported and less will be imported, causing net exports to rise.

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6

INFO CHART

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7

Autonomous Expenditure

The spending consumers must do even if they have zero disposable income; spending that is independent of an increase in income, in contrast to induced spending.

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8

Induced Expenditure

Spending that is the direct result of an increase in income.

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9

Marginal Propensity to Consume

The fraction of each additional dollar of income that households will spend, expressed as a number between 0 and 1.

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10

Marginal Propensity to Save

The fraction of each additional dollar of income that households will save, expressed as a number between 0 and 1.

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11

Spending Multiplier

The principle that any autonomous expenditure will result in a change in aggregate demand by a maximum value of the expenditure multiplied by 1/MPS, or the inverse of the marginal propensity to consume.

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12

Tax Multiplier

The principle that any change in taxes will result in a change in aggregate demand up to the dollar value of the tax change multiplied by MPC/MPS, or the marginal propensity to consume divided by the marginal propensity to save; the impact is negative.

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13

Short-Run Aggregate Supply (SRAS)

The relationship between price level and the total value of goods and services supplied in an economy in a period in which some input costs are fixed.

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14

Sticky Wages

Inflexible prices for labor; the idea that a variety of factors prevent wages from responding directly to changes in market conditions.

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15

Menu Costs

All the supplier costs associated with changing prices, the classic example being the cost of printing new restaurant menus due to entrée price changes.

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16

Productivity Changes

Any of the factors of production (think robotics, increased literacy, etc… improvements in productivity will shift SRAS to the right while loss of productivity will shift SRAS left).

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17

Input Price Changes

(Anything that makes land, labor, and/or capital more or less expensive … higher input prices, like the wage rate, will shift SRAS to the left while lower machinery prices will shift SRAS to the right).

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18

Expected Changes in Inflation

(If suppliers think the price level is headed up, they'll produce less or wait, shifting SRAS left; they will have greater profitability after the price level increases. If they think inflation is slowing down or that there could be deflation, they'll produce more, shifting SRAS right; they will have greater profitability producing now rather than after the price level falls.)

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19

Immediate Short-Run Aggregate Supply (ISRAS)

It reflects that shortest timescale (think lunch rush) when both input and output prices are fixed, and the only determinant of real GDP is aggregate demand.

<p>It reflects that shortest timescale (think lunch rush) when both input and output prices are fixed, and the only determinant of real GDP is aggregate demand. </p>
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20

Maximum Sustainable Capacity

The aggregate output of the economy when at full employment of resources; real GDP at LRAS.

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21

Long-Run Aggregate Supply (LRAS)

The maximum sustainable aggregate output in an economy when all prices, costs, and wages are flexible, represented by a vertical on the AD–AS model.

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22

Three Output Ranges

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23

ISRAS

resource costs AND prices charged to consumers are fixed Shape: —

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24

SRAS

resource costs are fixed or very sticky, and prices charged to consumers are flexible Shape: /

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25

LRAS

resource costs AND prices charged to consumers are flexible Shape: |

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26

LRAS shifts to the right (increases) when there is …

  • more labor force participation

  • more capital available

  • more natural resources available

  • better human capital (education/training)

  • technological progress/growth in productivity

  • reduced business regulation

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27

CONNECTIONS

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28

AD-AS Model

Model that shows the downward-sloped aggregate demand curve, upward-sloping short-run aggregate supply, and the vertical long-run aggregate supply, illustrating a negative output gap, full employment, or an inflationary gap.

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29

Short-Run Equilibrium

The intersection point of aggregate demand and the short-run aggregate supply curve, which sets the equilibrium price level and aggregate output in the economy.

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30

Long-Run Equilibrium

The equilibrium price level and aggregate output with full employment, indicated by the intersection of aggregate demand, short-run aggregate supply, and long-run aggregate supply at the same point.

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31

Positive Demand Shock

A shift of the aggregate demand curve to the right.

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32

Negative Demand Shock

A shift of the aggregate demand curve to the left.

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33

Positive Supply Shock

A shift of the short-run aggregate supply curve to the right.

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34

Negative Supply Shock

A shift of the short-run aggregate supply curve to the left.

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35

Demand-Pull Inflation

A situation in which a rightward shift of aggregate demand pulls the price level in an economy up.

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36

Cost-Push Inflation

When a leftward shift of the short-run aggregate supply curve pushes the price level in an economy up.

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37

Stagflation

A situation in which an economy experiences high unemployment and high inflation, so economic stagnation and inflation, most often caused by a negative supply shock.

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38

Disinflation

Slowing of the rate of inflation, NOT a decrease in price level (that’s depression!)

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39

Fiscal Policy

Use of government taxing or spending legislation to impact the price level, aggregate demand, and real output of an economy.

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40

Government spending multiplier is STRONGER than the tax multiplier.

Tax changes are less powerful than spending changes to address a recessionary gap.

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41

Expansionary Fiscal Policy

Any government policy with the goal of reducing unemployment and increasing economic growth.

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42

Contractionary Fiscal Policy

Any government policy with the goal of lowering the inflation rate.

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43

Recognition Lag

The time it takes for policymakers to recognize a problem.

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44

Administrative Lag

The time it takes to achieve consensus on the policy that will help to fix it.

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45

Operational Lag

This time for execution, or carrying out of the policy action.

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46

Discretionary Spending

Government spending enacted through a legislative bill setting a specific dollar amount for a certain purpose.

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47

Mandatory Spending

Government spending that is determined by existing legislation and the number of eligible recipients.

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48

Automatic Stabilizers

Mechanism of existing government policy where tax revenues and safety net spending adjust reflexively in response to fluctuations in the business cycle.

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49

Social Service Programs

Government, institutional, or agency policies that provide assistance to people in need, often called "safety net programs"; transfer payments in these programs act as automatic stabilizers in the economy.

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50

Transfer Payment

Money granted by the government to households to influence their behavior in some way; income redistributed by the government.

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51

Regressive Tax Structure

System in which a person pays a lower percentage of their income as their income increases.

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52

Proportional Tax Structure

A system in which a person's tax burden increases at the same rate as their income.

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53

Progressive Tax Structure

A system in which a person pays a higher percentage of their income in taxes as their income increases.

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54

Tax Bracket

In a progressive system, a defined range of incomes that are taxed at a certain rate.

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55

Tax Revenues

The dollar value government collects in various forms of taxes, not to be confused with the tax rates which determine how much is collected; tax revenues automatically adjust in response to economic fluctuations.

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56

During a recession…

Tax revenues automatically decrease as the GDP decreases, which has the tax multiplier effect of helping consumption and lessening the severity of recession.

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57

During an inflationary period…

Tax revenues automatically increase as the GDP increases, slowing consumption down and keeping the economy from overheating.

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58

Two main types of automatic stabilizers

Social service ("safety net") programs and taxes (especially the progressive income tax).

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59

THE DIFFERENCE!

TAX RATE IS %, WHILE TAX REVENUE IS THE AMOUNT PAID TO THE GOVT!

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