AP MACRO UNIT 3 REVIEW Short Answer Questions

aggregate

"added all together"

Aggregate Demand

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

what type of relationship do Price Level and Real GDP have?

inverse relationship

if the price level increases (inflation), then real GDP demanded _________

falls

if price level decreases (deflation), the real GDP demanded ____________

increases

What definitely doesn't shift the curve?

changes in price level (instead, they cause a move along the curve)

The Wealth Effect

-Higher price levels reduce the purchasing power of money.
-This decreases the quantity of expenditures
-Lower price levels increase purchasing power and increase expenditures

what would happen if the price level doubles?

people are going to buy less stuff because they have less purchasing power

what happens to the price level if GDP demanded goes down?

price level goes up

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 consumer spending and business investment.

what happens to the interest rate if the price increases?

An increase in prices leads to an increase in the interest rate from 5% to 25%

Foreign Trade Effect

-When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods
-Exports fall and imports rise causing real GDP demanded to fall. (XN Decreases)

what are the shifters of aggregate demand?

C + I + G + Xn

which direction does aggregate demand shift when spending increases?

right

which direction does aggregate demand shift when spending decreases?

left

how does consumer spending shift aggregate demand?

-Increase in Disposable Income (Higher incomes...)
-Consumer Expectations (People fear a recession...)
-Household Indebtedness (More consumer debt...)
-Taxes (Decrease in income taxes...)

how does investment spending shift aggregate demand?

-Real Interest Rates (Price of borrowing $)
(If interest rates increase...) (If interest rates decrease...)
-Future Business Expectations (High expectations...)
-Productivity and Technology (New robots...)
-Business Taxes (Higher corporate taxes means...)

how does government spending shift aggregate demand?

-Government Expenditures
(Decrease in defense spending...)
(Increase in public works programs...)

how does government spending shift aggregate demand?

-Exchange Rates
(If the us dollar depreciates relative to the euro...)
-National Income Compared to Abroad
(If a major importer has a recession...)
(If the US has a recession...)

aggregate demand formula

AD = GDP = C + I + G + Xn

Aggregate Supply

the amount of goods and services (real GDP) that firms will produce in an economy at different price levels

Short-run Aggregate Supply

Wages and Resource Prices will not increase as price levels increase.

Long-run Aggregate Supply

Wages and Resource Prices will increase as price levels increase.

In the Short Run, wages and resource prices will ____ ____________ as price levels increase.

NOT increase

In the Long Run, wages and resource prices ____ ____________ as price levels increase.

WILL increase

In long run, price level _________ but GDP ______________

increases & doesn't

what can shift aggregate supply?

An increase or decrease in national production can shift the curve right or left

3 shifters of aggregate supply

1. change in resource prices
2. change in actions of the government
3. change in productivity

Change in Resource Prices

-Prices of Domestic and Imported Resources
(Increase in price of Canadian lumber...)
(Decrease in price of Chinese steel...)
-Supply Shocks
(Negative Supply shock...)
(Positive Supply shock...)
-Inflationary Expectations
(If workers expect higher prices in the future...)

what happens if producers expect higher prices in the future?

If producers expect higher prices in the future, workers will demand higher wages and costs will increase. This will decrease AS

Change in Actions of the Government
(NOT Government Spending)

-Taxes on Producers
(Lower corporate taxes...)
-Subsidies for Domestic Producers
(Lower subsidies for domestic farmers...)
-Government Regulations
(EPA inspections required to operate a farm...)

Change in Productivity

Technology
(Computer virus that destroy half the computers...)
(The advent of a teleportation machine...)

formula for aggregate supply

AS = R + A + P
(R: resource prices)
(A:actions of the govt)
(P: productivity)

inflationary gap

Output is high and unemployment is less than NRU

recessionary gap

Output low and unemployment is more than NRU

which of the following will most likely occur as a result of increase in labor productivity in an economy?

an increase in output and a decrease in inflation

Classical Theory

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

Keynesian Theory

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

"Sticky Wages"

prevents wages from falling

Keynesian Range on a graph

Horizontal at low output

Intermediate Range on a graph

Upward sloping

Classical Range on a graph

Vertical at Physical Capacity

the Phillips Curve

Shows tradeoff between inflation and unemployment.

what type of relationship do unemployment and inflation have?

inverse relationship

autonomous consumption

consumers will spend a certain amount no matter what, regardless of their income

what is consumer spending made up of?

made up of autonomous spending and disposable income (income after taxes)

what happens if incomes are less than autonomous spending

there is dissaving (or negative savings)

Fiscal Policy

Actions by Congress to stabilize the economy

Monetary Policy

Actions by the Federal Reserve Bank to stabilize the economy

Discretionary Fiscal Policy

Congress creates a new bill that is designed to change AD through government spending or taxation

problem with Discretionary Fiscal Policy

-Problem is time lags due to bureaucracy.
-Takes time for Congress to act.

example of Fiscal Policy

Ex: In a recession, Congress increase spending.

Non-Discretionary Fiscal Policy

-AKA: Automatic Stabilizers
-Permanent spending or taxation laws enacted to work counter cyclically to stabilize the economy

example of Non-Discretionary Fiscal Policy

-Ex: Welfare, Unemployment, Min. Wage, etc.
-When there is high unemployment, unemployment benefits to citizens increase consumer spending.

Contractionary Fiscal Policy (The BRAKE)

Laws that reduce inflation, decrease GDP (Close a Inflationary Gap)

what does Contractionary Fiscal Policy decrease and increase?

-Decrease Government Spending
-Increase Taxes (Decreasing disposable income)
-Combinations of the Two

Expansionary Fiscal Policy (The GAS)

Laws that reduce unemployment and increase GDP (Close a Recessionary Gap)

what does Expansionary Fiscal Policy (The GAS) increase & decrease?

-Increase Government Spending
-Decrease Taxes (Increasing disposable income)
-Combinations of the Two

The Multiplier Effect

An initial change in spending will set off a spending chain that is magnified in the economy.

what does The Multiplier Effect show?

The Multiplier Effect shows how spending is magnified in the economy.

example of the Multiplier Effect?

-Bobby spends $100 on Jason's product
-Jason now has more income so he buys $100 of Nancy's product
-Nancy now has more income so she buys $100 of Tiffany's product.
-The result is an $300 increase in consumer spending

Marginal Propensity to Save (MPS)

-How much people save rather than consume when there is an change in income.
-It is also always expressed as a fraction (decimal)

Marginal Propensity to Consume (MPC)

-How much people consume rather than save when there is an change in income.
-It is always expressed as a fraction (decimal).

Total Change in GDP (the Gap) formula

multiplier x initial change in spending

calculating the spending multiplier

1/MPS or

simple tax multiplier

Non-Discretionary Fiscal Policy

Legislation that act counter cyclically without explicit action by policy makers.

5 problems with fiscal policy

1. deficit spending
2. problems of timing
3. politically motivated policies
4. crowding-out effect
5. net export effect

2 types of deficit spending

-budget deficit
-national debt

Budget Deficit

when the government's expenditures exceeds its revenue

National Debt

the accumulation of all the budget deficits over time

3 problems of timing

-recognition lag
-administrative lag
-operational lag

recognition lag

Congress must react to economic indicators before it's too late

Administrative Lag

Congress takes time to pass legislation

Operational Lag

Spending/planning takes time to organize and execute (changing taxing is quicker)

Politically Motivated Policies

Politicians may use economically inappropriate policies to get reelected.

Crowding-Out Effect

Government spending might cause unintended effects that weaken the impact of the policy.

example of the "crowding-out effect"

-We have a recessionary gap
-Government creates new public library. (AD increases)
-Consumers now spend less on books (AD decreases)

Net Export Effect

International trade reduces the effectiveness of fiscal policies.

capital stock

Machinery and tools purchased by businesses that increase their output