Aggregate Demand and Fiscal Policy

These flashcards cover key concepts related to Aggregate Demand, Fiscal Policy, and related economic principles, providing definitions and explanations.

Aggregate Demand (AD)

Shows the inverse relationship between the overall price level and real GDP demanded.

Wealth Effect

Higher prices decrease purchasing power.

Interest Rate Effect

Higher prices increase interest rates, reducing investment and consumption.

Exchange Rate Effect

Higher domestic prices decrease exports, leading to a decrease in AD.

MPC (Marginal Propensity to Consume)

The portion of income spent, calculated as ΔConsumption / ΔIncome.

MPS (Marginal Propensity to Save)

The portion of income saved, calculated as ΔSavings / ΔIncome.

Spending Multiplier

The total GDP change from $1 of new spending, calculated as 1 / MPS.

Tax Multiplier

One less than the spending multiplier; negative because taxes reduce spending.

Short-Run Aggregate Supply (SRAS)

Shows the relationship between price level and real GDP supplied in the short run.

Long-Run Aggregate Supply (LRAS)

Shows the economy’s potential output at full employment; represented as a vertical line.

Recessionary Gap

Condition where GDP is less than potential output, leading to increased unemployment.

Inflationary Gap

Condition where GDP is more than potential output, leading to decreased unemployment.

Fiscal Policy

Government’s use of spending and taxation to stabilize the economy.

Expansionary Fiscal Policy

Increases in government spending or decreases in taxes to shift AD right.

Contractionary Fiscal Policy

Decreases in government spending or increases in taxes to shift AD left.

Automatic Stabilizers

Built-in fiscal mechanisms that automatically reduce business cycle fluctuations.

Phillips Curve

Shows the inverse relationship between inflation and unemployment.

Natural Rate of Unemployment (NRU)

The level of unemployment at which inflation does not accelerate, represented by the Long-Run Phillips Curve.

Inflationary Gap Adjustment

Wages increase, causing SRAS to shift left, restoring potential output.

Recessionary Gap Adjustment

Wages decrease, causing SRAS to shift right, restoring potential output.