AD-AS Model and Policy Vocabulary Flashcards

Vocabulary flashcards covering key AD-AS concepts, macroeconomic gaps, fiscal and monetary tools, and the money system.

Aggregate Demand (AD)

The total quantity of all final goods and services households, businesses, government, and foreigners are willing and able to buy at different overall price levels.

Wealth Effect

As the price level falls, the real value of money and fixed-value assets rises, increasing purchasing power and consumer spending.

Interest Rate Effect

A higher price level raises money demand, increases interest rates, and crowds out investment and consumption, lowering AD.

Movement along the AD Curve

A change in the overall price level that causes a movement along the AD curve, not a shift of the curve.

AD Curve Shift

A change in AD at every price level caused by changes in C, I, G, or Xn.

Consumption (C)

Household spending on goods and services; a major component of AD.

Investment (I)

Business spending on capital goods; a major component of AD and a driver of economic growth.

Government Purchases (G)

Government spending on goods and services; a direct component of AD.

Net Exports (Xn)

Exports minus imports; a component of AD.

Changes in Expectations

Shifts AD when optimism or pessimism about the future changes current spending and investment.

Changes in Wealth

Shifts AD due to wealth changes from assets like stocks or housing, independent of price level.

Changes in the Stock of Physical Capital

Shifts AD when the existing capital stock affects investment needs.

Government Policies (Fiscal/Monetary)

Fiscal policy (spending/taxes/transfers) and monetary policy (money supply/interest rates) can shift AD.

Labor Productivity (in relation to AD)

Not a driver of AD; affects aggregate supply (AS) rather than demand.

Aggregate Supply (AS)

Total quantity of goods and services firms are willing and able to produce at different price levels.

Short-Run Aggregate Supply (SRAS)

Upward-sloping in the short run because some input prices (like wages) are sticky.

Sticky Wages

Nominal wages that do not adjust immediately to changing economic conditions, affecting SRAS.

Commodity Prices

Prices of key inputs (e.g., oil) that can shift SRAS by changing production costs.

Nominal Wages

Wages fixed in the short run which can affect SRAS when they adjust.

Productivity (in relation to SRAS)

Higher productivity lowers costs and shifts SRAS to the right.

Long-Run Aggregate Supply (LRAS)

Vertical in the long run; shows the economy’s potential output when all prices and wages are flexible.

Potential Output

The economy’s sustainable full-employment level of real GDP, determined by resources and technology.

Recessionary Gap

When actual output is below potential output, with higher unemployment.

Inflationary Gap

When actual output is above potential output, with rising price pressures.

Self-Correcting Mechanism

The economy’s tendency to return to LRAS through adjustments in SRAS via wage/price changes.

Fiscal Policy

Government use of spending, taxes, and transfers to manage aggregate demand.

Government Transfers

Payments by the government to households (e.g., unemployment benefits) that affect AD indirectly.

Taxes (T)

Levies that affect disposable income and investment, influencing AD indirectly.

Expansionary Fiscal Policy

Increase G, decrease T, or increase transfers to shift AD right and reduce a recessionary gap.

Contractionary Fiscal Policy

Decrease G, increase T, or decrease transfers to shift AD left and curb inflation.

Multiplier

The ratio showing how much GDP changes in response to a change in autonomous spending: 1/(1−MPC).

MPC (Marginal Propensity to Consume)

The fraction of an additional dollar of disposable income that is spent.

Spending Multiplier

The GDP impact of a change in autonomous spending; equal to 1/(1−MPC) in simple spending cases.

Tax Multiplier

The GDP impact of a change in taxes; equal to −MPC/(1−MPC).

Automatic Stabilizers

Policy rules (like transfers and progressive taxes) that automatically counteract economic fluctuations.

Money

A medium of exchange, a unit of account, and a store of value in fiat form.

Fiat Money

Money whose value comes from government decree and acceptance, not intrinsic value.

M1

Narrow money: currency in circulation, checking deposits, and traveler's checks.

M2

Broader money: M1 plus near-moneys like savings deposits, time deposits, and money market funds.

Fractional-Reserve Banking

Banks keep only a fraction of deposits as reserves and loan out the rest, creating new money.

Reserve Ratio

The fraction of deposits banks must hold as reserves.

Money Multiplier

The factor by which an initial deposit can multiply the money supply: 1/reserve ratio.

Deposit Insurance

Government guarantees (e.g., FDIC) that protect bank deposits up to a limit to prevent runs.

Federal Funds Market

Overnight lending market between banks; the federal funds rate is the key rate.

Federal Funds Rate

The interest rate at which banks lend reserves to each other; the Fed targets this rate.

Open-Market Operations

Fed actions to buy or sell government securities to influence the money supply.

Open-Market Purchase

Fed buys government bonds, increases bank reserves, and expands the money supply.

Open-Market Sale

Fed sells government bonds, drains reserves, and contracts the money supply.

Transmission Mechanism of Monetary Policy

Process by which changes in the money supply affect interest rates, AD, and real output.

Money Demand Curve

Downward-sloping curve: higher interest rates raise the opportunity cost of holding money, reducing demand.

Money Supply Curve

Vertical in the short run; controlled by the central bank (the Fed).