AP Macroeconomics Unit 3 Flashcards

Wealth

The value of a households’s accumulated savings

Aggregate demand (GDP)

Total amount of goods and services that households, businesses, the government, and foreigners are willing and able to purchase at different price levels in a given period of time. It is the demand of everything by everyone in a country.

Shifters of AD

• Consumer Spending (C)

• Investment (I)

• Government Spending (G)

• Net Exports (X)

Change in Consumer Spending

• Disposable Income

• Consumer Expectations

• Household Indebtedness

• Taxes

Increase consumer spending = increase AD

Change in Investment

• Real Interest Rates

• Business Expectations

• Profitability

• Business Taxes

Increase investment = increase AD

Planned investment spending

The investment spending that businesses intend to undertake during a given period

Inventory investment

The value of the change in inventories held in the economy during a given period

Government Spending

• Public projects

• Defense spending

• Deficit spending

Increase G = increase AD

Change in Net Exports

• Exchange rates

• Political stability

• Relative income compared to other countries

Increase Xn = increase AD

Real wealth effect

Change in consumer spending caused by altered purchasing power of consumers’ assets

• Increase in PL depreciates the value of assets, meaning that consumers can spend less

Interest Rate Effect

Change in investment and consumer spending caused by altered interest rates that result from changes in the demand for money

• As PL increases, people need to borrow more, this increases the interest rate, which increases the cost of borrowing, which causes consumer spending to decrease as consumers save more

Exchange Rate Effect

Change in net exports caused by a change in the value of the domestic currency which leads to change in the relative price of domestic and foreign goods and services

• Decrease in PL causes domestic financial investors invest more in foreign markets, which decreases the value of the currency in foreign markets, which increases net exports because domestic goods and services become cheaper for foreign buyers.

Marginal Propensity to Consume (MPC)

The increase in consumer spending when disposable income rises by $1

Marginal Propensity to Spend (MPS)

The increase in household savings when disposable income rises by $1

Expenditure Multiplier

Equal to 1/(1-MPC) or 1/MPS

It is the ratio of the total change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change. It indicates the total rise in real GDP that results from each $1 of an initial rise in spending.

Tax Multiplier

Equal to -MPC/(1-MPC) = -MPC/MPS = -Expenditure multiplier + 1

It is the factor by which a change in tax collections changes real GDP. This also applies to transfer payments. 

Aggregate Supply

The total amount of all goods and services all firms are willing to produce at all prices.

Nominal wage

The dollar amount of the wage paid

Sticky wages

Nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages. These are found in the short run

Short Run Aggregate Supply Curve (SRAS)

Positive relationship between the aggregate price level and real GDP. Many costs are considered fixed during this time period. 

Shifters of SRAS

1. Resource prices

2. Government action

3. Productivity

Change in Resource Price

• Price of Domestic or Imported Resources

• Negative Supply Shock

• Positive Supply Shock

• Inflationary Expectations- If people expect higher inflation, workers will demand higher wages to keep up with rising prices, and firms will raise prices in anticipation of higher costs. This increases production costs, which shifts the short-run aggregate supply curve to the left.

Negative supply shock

A sudden event that reduces the economy’s ability to produce goods and services (Examples: Natural disaster, Oil Shortage, Pandemic)

Positive Supply Shock

A sudden event that improves the economy’s ability to produce goods and services (Example: Technological Advancement, Decrease in Energy Costs)

Change in Government Action

• Subsidies

• Regulation

• Business taxes

• Business tax credits

Business tax credits

Incentives that reduce the amount of taxes a business owes. Increasing business tax credits would lower production costs and increase short-run aggregate supply

(eg, Carbon tax: if firms reduce carbon emissions, they get tax credits)

Short run

Time period in which many production costs, including nominal wages, are not fully flexible (sticky)

Long run

Time period in which all prices, including nominal wages, are fully flexible

Long Run Aggregate Supply Curve (LRAS)

Shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible. It is a vertical line. LRAS = potential GDP = NRU = full employment output

Potential output

The level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible. It represents the economy’s maximum sustainable production capacity. 

Full employment output level

The level of real GDP the economy can produce if all resources are fully employed

Shifters of LRAS

• Change in quantity or quality of the factors of production

• Improvements in technology

AD-AS model

The AS curve and AD curve are used together to analyze fluctuations in the PL and GDPr

Short run macroeconomic equilibrium

Occurs where quantity of aggregate supply = quantity of aggregate demand (intersection of AD and SRAS) (E_SR)

Short run equilibrium PL

the PL in the short run macroeconomic equilibrium. It is on the vertical axis of the graph. (PLe)

Short run equilibrium GDPr

Quantity of aggregate output (GDPr) produced in the short run macroeconomic equilibrium. (Ye)

Long run macroeconomic equilibrium

When short run macroeconomic equilibrium is at the full employment level of output (on the lRAS curve) (E_LR)

Output gap

Difference between actual aggregate output and potential output (it is a GDPr measure)

Recessionary gap

When aggregate output is below potential output. (Ye < Yp)

Inflationary gap

When aggregate output exceeds potential output (Ye > Yp)

Demand shock

An event that shifts the AD curve

Supply shock

An event that shits the SRAS curve

Stagflation

The combination of inflation and stagnating or falling GDPr

Cost push inflation

An inflation that is caused by a significant increase in the price of an input with economy wide importance (eg, a dramatic increase in oil or energy prices) → SRAS shifts left

Demand pull inflation

Inflation that is caused by an increase in aggregate demand → AD shifts right