AP Econ Unit 3

aggregate demand

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

aggregate demand curve

x axis: real GDP

y axis: price lvl

AD=C+I+G+Xn

why is Aggregate demand downward sloping

1. wealth effect

2. interest rate effect

3. foreign trade effect

wealth effect

• higher price levels reduce the purchasing power of money which decreases the quantity of expenditures

• lower price levels increases purchasing power & increases expenditures

• AKA real balance effect

Interest rate effect

• when price level increases lenders need to charge higher interest rates to get a REAL return on their loans

• higher interest rates discourage consumer spending & business investment

foreign trade effect

• when US price levels rise foreign buyers purchase fewer US goods & Americans buy more foreign goods

• exports decreases and imports increases causing real GDP demand to decrease (less net exports)

Shifters of aggregate demand

1. changes in consumer spending

2. changes in investment spending

3. changes in gov spending

4. changes in net exports

Marginal Propensity to Consume

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

• always expressed as a fraction/decimal

equation for MPC

MPC = change in consumption/change in disposable income

Marginal propensity to save

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

• always expressed as a fraction/decimal

equation for MPS

MPS= change in savings/change in disposable income

MPS=

1-MPC

calculating the spending multiplier

SM= 1/MPS OR - 1/1-MPC

how to calculate total change in GDP with the spending multiplier

multiplier x initial change in spending

tax multiplier formula

simple tax multiplier = -MPC x 1/MPS or -MPC/MPS

tax multiplier

• always 1 less than the MPS

• an increase in taxes decreases GDP so the tax multiplier is negative

to find total change in GDP w/ tax multiplier

tax multiplier x initial change in taxes = total change in GDP

• also true for transfer payments but w/out negative

Aggregate supply

the amount of goods & services (GDP_R ) that firms will produce in an economy at different price levels

• the  supply for everything by all firms

short run Ag supply

wages & resource prices are sticky & will not change as price levels change

long run ag supply

wages & resource prices are flexible & will change as price levels increase

in the long run price level increases but GDP does not

shifters of the short run ag supply

1. change in resource prices

2. changes in actions of the gov

3. change in productivity

shifts in LRAS

a permanant change in the production possibilities of the economy

same as PPCC shifters

1. change in resource quantity or quality      - includes trade/people

2. change in tech

3 places economy has the potential to be

1. negative output gap

2. full employment

3. positive output gap

inflationary gap

aka positive output gap

output is high & unemployment is < NRU

recessionary gap

aka negative output gap

output is low & unemployment is > NRU

causes of inflation

demand- pull inflation

• demand pulls up price, consumers want goods & services so they bid up prices

cost- push inflation

• higher production costs increases prices

• negative supplyshock increases the costs of production & forces producers to increase prices

long run self adjustment

• if consumer spending increase in long run wages & costs up so supply shifts left

• if consumer spending decreases wages & costs down supply shifts right

• if investment spending increases supply & LRAS shift right

roll of consumers in economy

• always spend certain amount no matter what regardless of income (autonomous consumption)

• consumer spending is made up of autonomous spending & disposable income

• if income < autonomous spending then there is disavings (- savings)

contraction fiscal policy

laws that decrease inflation & decrease GDP (close inflationary gap)

• decrease gov spending

• increase taxes

• combinations of the 2

expansionary fiscal policy

laws that decrease unemployment & increase GDP (close recessionary gap)

• increase gov spending

• decrease taxes

• combination of the 2

3 fiscal policy time lags

1. recognition lag- congress needs to realize a problem exists & react to economic indicators

2. administrative lag- takes time to pass legislation

3. operational lag- spending/planning takes time to organize & execute

discretionary fiscal policy

congress creates a new bill that is designed to change AD through gov spending or taxation

non discretionary fiscal policy

aka automatic stabilizers

• spending/tax laws that already exist & work to stabilize the economy

• us progressive income tax system

• unemployment benefits

• social service programs