AP Macro Unit 3

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Aggregate Demand

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46 Terms

1

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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2

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 → downward slope → x-axis: real domestic output, y-axis: price level</p>
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3

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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4

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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5

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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6

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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7

Change in Consumer Spending

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

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8

Change in Investment Spending

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

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9

Change in Government Spending

→ government expenditures

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10

Change in Net Exports

→ exchange rates → national income compared to abroad

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11

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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12

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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13

Calculating the MPS

1 / MPS or 1 / 1 -- MPC

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14

Total Change in GDP

Total Change in GDP = Multiplier * Initial Change in Spending

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15

Calculating the Tax Multiplier

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

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16

MPS = 1 -- MPC

people can either save or consume

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17

Total Change in GDP (w/Tax Multiplier)

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

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18

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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19

Short-run Aggregate Supply (SRAS)

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

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20

Long-run Aggregate Supply (LRAS)

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

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21

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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22

Shifter of SRAS: Change in Resource Prices

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

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23

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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24

Shifter of SRAS: Change in Actions of the Government

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

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25

Shifter of SRAS: Change in Productivity

→ technology

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26

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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27

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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28

AD/AS Equilibrium: Full Employment

Long Run Equilibrium the economy is at potential output

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29

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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30

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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31

Stagflation

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

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32

Disposable Income

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

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33

(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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34

(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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35

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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36

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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37

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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38

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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39

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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40

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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41

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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42

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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43

Autonomous Consumption

the minimum amount of consumer spending when people have no income

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44

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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45

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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46

Automatic Stabilizers

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

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