Unit 3 Review

Real GDP

all the goods and services that buyers are willing and able to purchase at different price levels

What kind of relationship is between price level and RGDP?

inverse

How does a change in price affect the curve?

it causes a move along the curve

aggregate demand

the demand by consumers, businesses, government, and foreign countries

Wealth effect

•changes in price levels change the purchasing power of money and therefore consumption

•if price level increases, GDP demanded decreases

Interest rate effect

•When the price level increases, lenders need to charge higher interest rates to get a REAL return on their loans.

•Higher interest rates discourage both consumption and income

•If the price level increases, GDP demanded decreases

Exchange rate effect

•When U.S. price level increases, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods

•If the price level increases, GDP demanded decreases

Shifters of aggregate demand

•Change in consumer spending (C)

•Change i investment spending (I)

•Change in government spending (G)

•Change in net exports (XN)

Change in consumer spending

1. Increase in _________________ income

2. Consumer _________________________

3. Household ________________________

4. ___________

1. disposable

2. expectations

3. indebtedness

4. taxes

Changes in investment spending

1. ____________________ (price of borrowing)

2. Business ___________________

3. ___________________ (technology)

4. ________________

1. real interest rates

2. expectations

3. productivity

4. taxes

Change in government spending

buying goods and services (NOT transfer payment)

Change in net exports

1. ____________ rates

2. ____________ income compared to more ______________ income

1. exchange

2. national; foreign

If it changes ________ it shifts the AD curve

GDP

Business owners are less optimistic about the health of the economy

change in income and shift to the left

The government decreases welfare and veteran's benefits

change in consumption (disposable income) and shift to the left

The stock of physical capital has been falling for nearly a year

change in income (productivity) and shift to the right

Consumers expect the job market to be much stronger in the next few months

change in consumption (consumer expectations) and shift to the right

Only 2 options for using your income. . .

consume or save

Calculate MPC

1. If you received $100 and spent $50

2. If you received $100 and spent $80

3. If you received $100 and spent $100

1. 0.5

2. 0.8

3. 1

Calculate MPS

1. If you received $100 and saved $50

2. If you received $100 and your MPC is 0.7, what is your MPS?

1. 0.5

2. 0.3

If the multiplier is 4, how much will an initial increase of $5 in consumer spending increase the GDP?

20

How much will a decrease of $3 in spending decrease GDP?

-12

If MPC is .5, and consumption increased by $2M. How much will GDP increase?

$4 million

If MPC is 0 and investment increases $2M. How much will GDP increase?

$2 million

What kind of a relationship is there between MPC and the spending multiplier effect

positive

Dora earns $50,000 a year at her jobs. When she was given a raise of $5,000, her spending increased from $50,000 to $54,000. Calculate Dora's MPC and MPS.

MPS=0.8

MPC= 0.2

If MPC is 0.5 and the government increases spending by $3 billion, what is the change in real GDP?

$6 billion

Calculate MPC when a change in investment spending of $40 million leads to an increase in real GDP by $160 million.

0.25

Calculating the spending multiplier for each of the following. . .

1. MPC=0.5

2. MPS=0.6

3. MPC=0.8

4. MPS=0.1

1. 2

2. 1.67

3. 5

4. 10

In the short run, wages and resource prices are ________ which means that they will not increase as ___________________ increase. If prices increase without an increase in costs, it leads to higher ______________________, so firms have the incentive to ________________________ in the short run. There is also a trade-off between ____________ and ____________.

sticky; price levels; nominal profits; increase production; inflation; unemployment

Shifters of aggregate supply

•change in resource prices

•change in actions of the government (NOT government spending)

•change in productivity

Change in resource prices

1. Prices of domestic and imported _______________

2. Supply ____________

3. ________________ expectations

1. resources

2. shocks (negative)

3. inflationary

Changes in actions of government (NOT government spending)

1. __________ on producers

2. ______________ for domestic producers

3. ____________ regulations

1. taxes

2. subsidies

3. government

Change in productivity

1. _______________

1. technology

Increased production=

increased supply

Minimum wage increases

shift left

New production technology is developed

shift right

The economy experiences a period of deflation

shifts down the curve

What happens to wages and resource prices in the long run as price level increases?

wages and resource prices are flexible and will increase as the price level rises

Why do firms have no incentive to increase output in the long run?

Because real profit does not change when wages and resource prices adjust, so firms do not increase production.

What happens to GDP in the long run when the price level rises?

GDP remains constant because the economy always returns to full employment output

Is there a trade-off between inflation and unemployment in the long run?

No, in the long run, there is no trade-off because the economy self-adjusts to full employment

What causes the Long-Run Aggregate Supply (LRAS) curve to shift?

LRAS shifts when full-employment output changes due to factors like productivity, technology, or labor force growth

There is an overall increase in the technological innovation

1. LRAS?

2. Shift R or L

3. Change productive capacity?

1. Yes

2. Right

3. Increase

A hurricane destroys 75% of the oil refineries on the U.S. gulf coast

1. LRAS?

2. Shift R or L

3. Change productive capacity?

1. Yes

2. Left

3. Decrease

actual GDP=

potential GDP

Unemployment rate=

NRU

Inflationary Gap

1. AD _____ SRAS but _____ LRAS

2. Actual GDP (Y1) _____ Potential GDP (YP)

3. Unemployment rate ______ NRU

4. _____________ pressure on PL

1. equals; greater than

2. greater than

3. less than

4. inflationary

Recessionary Gap

1. AD _____ SRAS but _____ LRAS

2. Actual GDP (Y1) _____ Potential GDP (YP)

3. Unemployment rate ______ NRU

4. _____________ pressure on PL

1. equals; less than

2. less than

3. greater than

4. deflationary or disinflationary

Positive AD shock

shift to the right

Negative AD shock

shift to the left

Positive AS shock

shift to the right

Negative AS shock

shift to the left

Consumer wealth increases

1. ▲AD or AS

2. Shifter?

3. R or L shift

4. ▲PL

5. RGDP?

1. AD

2. consumer spending

3. right

4. increase

5. positive

The cost of natural resources (oil) increases

1. ▲AD or AS

2. Shifter?

3. R or L shift

4. ▲PL

5. RGDP?

1. AS

2. resource costs

3. left

4. increase

5. negative

Increase in US business inventories

1. ▲AD or AS

2. Shifter?

3. R or L shift

4. ▲PL

5. RGDP?

1. AD

2. investment spending

3. left

4. decrease

5. negative

Productivity increases due to improved internet access and speed

1. ▲AD or AS

2. Shifter?

3. R or L shift

4. ▲PL

5. RGDP?

1. AS

2. productivity

3. right

4. decrease

5. positive

The price of copper, streets, and other commodities has risen in global markets

shift to the left

Congress lowers taxes and increases spending

shift to the right

Without government action, ___________ wages and prices will adjust to restore ____________________ and the unemployment rate to the full employment.

flexible; unemployment rate; full employment

Consumer spending increases. . .

In the short run ______ increases so price level and output _____________

AD; increase

Consumer spending increases. . .

In the long run, _________ decreases as ___________ and other productions costs rise so price level ________, output returns to ______________.

SRAS; wages; increases; full employment

Consumer expectations fall causing consumer spending to plummet. . .

In the short run, ______ decreases so price level and output __________

AD; decrease

In the long run, ________ increases as __________ and other production costs decrease so price level __________, output returns to ________________

SRAS; wages; decreases; full employment

An increase in I means that businesses are buying _______________ which increases their output.

If I increases then, AD AS, and LRAS all _________ and shift to the _______

The resulting increase in _______ and _______ illustrates economic growth

capital stock

equal; left

AD; AS

What leads to economic growth?

potential output

What is consumer spending made of. . .

autonomous spending and disposable income

Classical theory (Adam Smith)

1. A decrease in AD will not change output even in the short run because prices of resources (wages) are very flexible

2. AS is vertical so AD can't increase without causing inflation

3. Price level will fall, and the economy will fix itself without government involvement

Keynesian theory (John Maynard Keynes)

1. A decrease in AD will lead to a persistent recession because prices of resources (wages) are NOT flexible in the short run

2. Increase in AD during a recession doesn't cause inflation until you get close to full employment

3. The government should deficit spend to close the recessionary gap (aka-use discretionary fiscal policy)

Tools of discretionary fiscal policy

1. directly changing _________________________

2. indirectly changing _______________ to effect household ______________ and therefore _______________

government spending; tax rate; disposable income; consumption

When should expansionary fiscal policy be used?

During a _______________ output gap

recessionary

What is the purpose of the expansionary fiscal policy?

To reduce cyclical ____________ by ___________ GDP

unemployment; increasing

How is expansionary fiscal policy implemented?

1. _________ GDP

2. ____________ tax rates to ___________ disposable income resulting in increased C

1. increasing

2. decreasing; increase

When should contractionary fiscal policy be used?

During an _____________ output gap

inflationary

What is the purpose of contractionary fiscal policy?

To reduce ___________ by ____________ GDP

inflation; slowing down

How is contractionary fiscal policy implemented?

1. __________ GDP

2. __________________ tax rates to ______________ disposable income resulting in increased C

1. decreasing

2. increasing; decrease

Problems with discretionary fiscal policy include. . .

time lags, politics, and deficit spending

Legislation that acts counter cyclically without explicit action by policy makers to. . .

1. Support the economy during ___________

2. Keep the economy from ______________ during expansions

1. recession

2. over-heating

Tac revenues. . .

1. decrease automatically as GDP _______ preventing _________ and ______ from falling further

2. increase automatically as GDP _______ slowing __________ and preventing the economy from over heating

1. falls; consumption, GDP

2. rises; consumption

_______________, such as unemployment and welfare, can also act counter-cyclically

transfer payments