AP Macro Unit 3

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46 Terms

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Aggregate Demand

all the goods and services (real GDP) that buyers are willing and able to purchase at different price levels

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Aggregate Demand Curve

→ the demand by consumers, businesses, government, and foreign countries
→ downward slope
→ x-axis: real domestic output, y-axis: price level

<p>→ the demand by consumers, businesses, government, and foreign countries <br />
→ downward slope<br />
→ x-axis: real domestic output, y-axis: price level</p>
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Wealth Effect

→ higher price levels reduce the purchasing power of money; this decreases the quantity of expenditures
→ lower price levels increase the purchasing power and increase expenditures
→ Real Balance Effect

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Interest Rate Effect

→ when the price level increases, lenders need to charge higher interest rates to get a REAL return on their loans
→ higher interest rates discourage consumer spending and business investment

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Foreign Trade Effect

→ when U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods
→ exports fall and imports rise causing real GDP demanded to fall

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Shifters of Aggregate Demand

( 1 ) Change in Consumer Spending
( 2 ) Change in Investment Spending
( 3 ) Change in Government Spending
( 4 ) Change in Net Exports (X - M)

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Change in Consumer Spending

→ increase in disposable income
→ consumer expectations
→ household indebtedness
→ taxes

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Change in Investment Spending

→ real interest rates (price of borrowing money)
→ future business expectations
→ business taxes

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Change in Government Spending

→ government expenditures

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Change in Net Exports

→ exchange rates
→ national income compared to abroad

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Marginal Propensity to Consume (MPC)

how much people consume rather than save when there is a change in disposable income (always expressed as a decimal)

MPC = Change in Consumption / Change in Disposable Income

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Marginal Propensity to Save (MPS)

how much people save rather than consume when there is a change in disposable income (always expressed as a decimal)

MPS = Change in Save / Change in Disposable Income

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Calculating the MPS

1 / MPS or 1 / 1 -- MPC

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Total Change in GDP

Total Change in GDP = Multiplier * Initial Change in Spending

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Calculating the Tax Multiplier

MPC / MPS
The Tax Multiplier is always one less than the Spending Multiplier

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MPS = 1 -- MPC

people can either save or consume

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Total Change in GDP (w/Tax Multiplier)

Total Change in GDP = Tax Multiplier * Initial Change in Taxes

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Aggregate Supply

the amount of goods and services (Real GDP) that firms will produce in an economy at different price levels, the supply for everything by all firms

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Short-run Aggregate Supply (SRAS)

wages and resource prices are sticky and WILL NOT change as price levels change

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Long-run Aggregate Supply (LRAS)

wages and resource prices are flexible and WILL change as price levels change

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Shifters of Short-run Aggregate Supply

( 1 ) Change in Resource Prices
( 2 ) Change in Actions of the Government (NOT Government Spending)
( 3 ) Change in Productivity

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Shifter of SRAS: Change in Resource Prices

→ price of domestic and imported resources
→ supply shocks
→ inflationary expectations

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Supply Shock

an unexpected event that suddenly changes the supply of a commodity resulting in an unforeseen change in price
→ negative supply shock: low supply, high price
→ positive supply shock: increased supply, low price

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Shifter of SRAS: Change in Actions of the Government

→ taxes on producers
→ subsidies for domestic producers
→ government regulations

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Shifter of SRAS: Change in Productivity

→ technology

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Shifters of Long-run Aggregate Supply

( 1 ) Change in Resource Quantity or Quality
( 2 ) Change in Technology
( 3 ) Change in Population
(SAME SHIFTERS AS THE PPC!!!!)

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Difference Between SRAS and LRAS

SRAS → in the short run, wages and resource prices are sticky and WILL NOT change when price level changes

LRAS → in the long run, wages and resource prices are flexible and WILL change when price level changes

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AD/AS Equilibrium: Full Employment

Long Run Equilibrium
the economy is at potential output

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AD/AS Equilibrium: Inflationary Gap

ABOVE or BEYOND full employment, positive output gap

<p>ABOVE or  BEYOND full employment, positive output gap</p>
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AD/AS Equilibrium: Recessionary Gap

BELOW or LESS THAN full employment, negative output gap

<p>BELOW or LESS THAN full employment, negative output gap</p>
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Stagflation

stagnant economy + inflation
SRAS decreases, causing high unemployment and high inflation

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Disposable Income

the amount of money households have to save or spend after taxes

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(Supply) Cost-Push Inflation

(SRAS decrease)
→ tighter production costs increase prices
→ a negative supply shock increases the costs of production and forces producers to increase prices

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(Demand) Demand-Pull Inflation

(AD increase)
→ demand pulls up prices: consumers want goods and services so bad they pull up prices
→ "too many dollars chasing too few goods"

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Role of Consumers in the Economy

→ consumers will spend a certain amount no matter what, regardless of their income (this is usually called autonomous consumption)
→ consumer spending is made up of autonomous spending and disposable income
→ if incomes are less than autonomous spending, then there is dissaving (or negative savings)

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How Does the Government Stabilize the Economy?

( 1 ) Fiscal Policy → actions by Congress to stabilize the economy
( 2 ) Monetary Policy → actions by the Federal Reserve Bank to stabilize the economy

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Discretionary Fiscal Policy

Congress creates a new bill that is designed to change AD through government spending or taxation
→ one problem is lag times due to bureaucracy
→ it takes time for Congress to act
→ EX.) in a recession, Congress increases spending

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Non-Discretionary Fiscal Policy

(AKA: Automatic Stabilizers)
Permanent spending or taxation laws enacted to work counter-cyclically to stabilize the economy
→ when GDP goes down, government spending automatically increases, and taxes automatically fall
→ EX.) Welfare, Unemployment, Income Tax

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Contraction Fiscal Policy (The BRAKE)

Laws that reduce inflation, decrease GDP (close an Inflationary Gap)
→ decrease government spending
→ increase taxes (decrease disposable income)
→ combinations of the two

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Expansionary Fiscal Policy (The GAS)

Laws that reduce unemployment and increase GDP (close recessionary gap)
→ increase government spending
→ decrease taxes (increasing disposable income)
→ combinations of the two

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Timing and Fiscal Policy

Fiscal Policy has three time lags:
( 1 ) Recognition Lag → Congress must react to economic indicators before it's too late
( 2 ) Administrative Lag → Congress takes time to pass legislation
( 3 ) Operational Lag → spending/planning takes time to organize and execute (changing taxing is quicker)

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The Multiplier Effect

the idea that an initial change in spending will set off a spending chain that is magnified in the economy; the strength of the multiplier depends on the amount that consumers spend of new income

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Autonomous Consumption

the minimum amount of consumer spending when people have no income

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LRAS Self-Adjustment: Positive Output Gap

SRAS will shift left due to an increase in expected inflation, which causes wages to increase

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LRAS Self-Adjustment: Negative Output Gap

SRAS will shift to the right due to a decrease in wages and resource prices, which causes production costs to fall

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Automatic Stabilizers

policies that are already in place in an economy due to previously passed legislation