Unit 3: National Income and Price Determination

Aggregate Demand (AD)

the amount of goods and services in the economy that will be purchased at all possible price levels

Shifters of Aggregate Demand

C + I + G + Xn (consumer spending, investment spending, government spending, net exports)

Price Level

a measure of the average prices of goods and services in the economy

Wealth Effect

The tendency for people to increase their consumption spending when the value of their financial and real assets rises and to decrease their consumption spending when the value of those assets falls.

Foreign Trade Effect

when US price level rises, foreign buyers purchase fewer US goods and Americans buy more foreign goods; when US price level falls, foreign buyers purchase more American goods and Americans buy less foreign goods

Marginal Propensity to Consume (MPC)

the change in consumption when there is additional disposable income - (change in consumption/change in disposable income)

Marginal Propensity to Save (MPS)

The change in saving when there is additional disposable income - (change in saving/change in disposable income)

Spending Multiplier

1/MPS or 1/1-MPC

Tax Multiplier

-MPC/MPS

Transfer Payment Multiplier

MPC/MPS

Aggregate Supply

the total amount of goods and services in the economy available at all possible price levels

Short-run Aggregate Supply (SRAS)

a curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms

Long Run Aggregate Supply (LRAS)

The level of output to which an economy will always return in the long run. Regardless of price level, output should remain at a constant in the long-run

full employment output

the real GDP created when there is no cyclical unemployment - when the AD, SRAS, and LRAS all meet

Recessionary Gap

when aggregate output is below potential output - occurs when AD and SRAS intersect below, or to the left of, the LRAS

Inflationary Gap

when aggregate output is above potential output - when AD and SRAS intersect beyond, or to the right of, the LRAS

Stagflation

A period of falling output and rising prices (rising price level during a recession)

Cost-push inflation

When prices rise due to an increase in the cost of production

demand-pull inflation

inflation that is caused by an increase in aggregate demand

Disposable income

Income remaining for a person to spend or save after all taxes have been paid

Fiscal Policy

Government policy that attempts to manage the economy by controlling taxing and spending.

Discretionary Fiscal Policy

fiscal policy that is the result of deliberate actions by policy makers - new laws or measures are passed to manipulate the economy

Automatic Stabilizers

changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action - (ie. income taxes, unemployment benefits)

Contractionary Fiscal Policy

reduces aggregate demand, used to respond to inflationary gaps (increase taxes or decrease gov't spending)

Expansionary Fiscal Policy

increases aggregate demand, used to respond to recessionary gaps (decrease taxes or increase government spending)