Ap macro unit 3 national income & price determination

What is the difference between a market demand curve and the aggregate demand curve?

A market demand shows the demand for one good/service at different prices. Aggregate demand shows the demand for all goods and services at different price levels.

What three concepts explain why aggregate demand is downward sloping?

-real wealth effect

-interest rate effect

-exchange rate effect

What are the shifters of aggregate demand?

Anything that changes consumer spending, business investment, government spending, and or net exports

What is 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 multiplier depends on the amount that consumers spend of new income.

Define marginal propensity to consume (MPC)

How much people consume rather than save when there is a change in income.

Define marginal propensity to save (MPS)

how much people save rather than consume when there is a change in income

Equation for the simple spending multiplier.

1/MPS

Equation for the tax multiplier

MPC/MPS or 1/(MPS-1)

Why is the short run aggregate supply curve upward sloping?

Wages and resource prices are not flexible in the short-run.

What are the shifters of short-run aggregate supply?

Anything that affects producers and production. Availability and price of resources, actions of the government (business taxes, subsidies, regulation) & expected inflation.

Why is the long-run aggregate supply curve vertical?

In the long run, wages & resources prices are flexible. When price level increases, wages will increase by the same amount.

What is a negative supply shock?

A negative supply shock is an unexpected decrease in the availability of a key resource that temporarily decreases productivity.

What is a positive supply shock?

A positive supply shock is an unexpected increase in the availability of a key resource that temporarily increases productivity.

Define stagflation

When there is high unemployment and high inflation. It is the result of a decrease in SRAS.

Define deflation

A decrease in the general price level. The opposite of inflation.

What is autonomous consumption?

The minimum amount of consumer spending when people have no income.

What is disposable income?

The amount of money households have to spend or save after taxes.

Explain how the economy self-adjusts in the long run when there is a negative output gap.

A decrease in wages & resource prices causes production costs to fall & SRAS to shift to the right.

Explain how the economy self-adjusts in the long run when there is a positive output gap.

An increase in expected inflation causes wages to increase & SRAS to shift to the left.

Assume instead that Economy #2 (positive output graph) experiences economic growth. What happens to LRAS and output?

LRAS shifts to the right and output increases

Does the natural rate of unemployment increase, decrease, or stay the same when the LRAS shifts right?

NRU stays the same

Define expansionary fiscal policy

Laws that increase output by increasing government spending/ decreasing taxes

Define contractionary fiscal policy.

Laws that deccrease inflation by decreasing government spending or increasing taxes.

Explain why an increase in government spending will lead to more total spending than a decrease in taxes by the same amount.

Households save a portion of a tax cut. The tax multiplier is less than the spending multiplier.

Is there a recessionary or inflationary gap? (negative output)

Recessionary. Actual output below potential.

What happens to price level and output in the long run if no policy action is taken?

Price level will decrease, output will increase.

Assume instead that the government decides to use fiscal policy. Identify two policies that could close the gap.

Increase in government spending or decrease taxes on consumers.

Would an increase in private saving increase or decrease the effectiveness of fiscal policy?

Increasing savings will decrease the effective of fiscal policy since the multiplier falls

Why are there lags when the government uses discretionary fiscal policy?

It takes more time to decide on & implement a policy action.

Define discretionary fiscal policy

Congress creates a new bill that is designed to change AD through government spending or taxation

Define Non-Discretionary Fiscal Policy-

Permanent spending or taxation laws enacted to work counter cyclically to stabilize the economy

Identify three different examples of automatic stabilizers

-Unemployment benefits

-Welfar

-Progressive income taxes

An increase in expected inflation will decrease the short-run aggregate supply.

True

An increase in interest rates will increase investment and aggregate demand.

False

The spending multiplier is weaker than the tax multiplier.

False

Fiscal policy includes government spending and taxation

True

If the MPS is .2 the tax multiplier is 4

True

When the MPC increases, the spending multiplier decreases.

False

Government uses expansionary fiscal policy.

-Change in AD

-Overall increase

No policy when there is a recession

-Chnage in SRAS

-Overall increase

Government increases taxes on consumers

-Changes in AD

-Overall decrease

There is a decrease in imports

-Change in AD

-Overall increase

Positive output gap. Government takes no policy.

-Change in SRAS

-Overall decrease

Why does SRAS eventually become vertical?

Only so much output can be produced; therefore, anything beyond full-employment will cause inflation.