ap economics: module 17 terms

aggregate demand curve

aggregate demand curve

shows the relationship between the APL and the quantity of a.o. demanded by the 4 groups (households, firms, govt., foreigners)

• x-axis —> real GDP (a.o.), y-axis —> APL

t or f: the ADC is downward-sloping due to the law of demand

f: the ADC includes ALL g/s; no cheaper substitutes for products with increasing prices, LOD can’t be applied (for individual g/s)

• changes in consumption and APL have no effect

3 reasons for downward-sloping ADC

1. real wealth effect

2. interest rate effect

3. exchange rate effect

real wealth effect

of a change in the APL, is the change in CS caused by the altered PP of consumer’s assets

• increasing APL —> decreasing PP —> decreasing CS

interest rate effect

of a change in the APL, is the change in IS and CS caused by altered interest rates resulting from changes in demand for money

• increasing APL —> decreasing PP of holdings —> decreasing funds for lending —> increasing IR —> decreasing IS and CS

exchange rate effect

of a change in the APL, is the change in NE (net exports) caused by a change in the value of the domestic currency, which leads to a change in the relative price of domestic and foreign g/s

2 ways ΔAPL has an effect on NE

1. direct: ΔAPL —> change in relative price of domestic g/s compared those g/s in other countries

   a. increasing APL —> decreasing NE and RGDP

2. indirect: ΔAPL —> Δdomestic IR —> financial flows impacted

   a. as APL and IR decrease —> more investments in other countries (higher ROI) —> greater flow of $ in other countries —> lower value of currency —> greater NE

5 shifters of the ADC

1. Δexpectations

2. Δwealth

3. size of the existing stock of physical capital

4. fiscal policy

5. monetary policy

changes in expectations

optimistic —> increased AS (and vice-versa)

• affects C and I

changes in wealth

greater value of assets —> increased PP —> more AS (and vice-versa)

size of the existing stock of physical capital

greater PC —> lower demand (and vice-versa)

• firms’ incentive for IS depends on current capacity

fiscal policy

use of government purchases of g/s, transfers, or tax policy to stabilize the economy

• if recession —> more spending, less taxes

• if inflation —> less spending, more taxes

relationship between govt. spending, transfers, and taxes on ADC

direct (impacts AD): spending

• more spending —> R shift (and vice-versa)

indirect (impacts DI): transfers and taxes

• more taxes —> L shift

• more transfers —> R shift

monetary policy

the central bank’s use of changes in the quantity of money or the IR to stabilize economy

• central bank/Federal Reserve: mainly determines the quantity of money in circulation, not part of govt. or private institution

• more $ circulating —> more $ to households + firms, lower IR + higher IS and CS —> R shift (and vice-versa)

3 tools of the FED

set reserve ratio: required amount of total deposits banks must hold

set discount rate: interest rate FED charges on loans to banks

open market operations: buying & selling US treasuries/bonds

• buy bonds —> flow of $ into economy —> AD increase (expansionary) and vice-versa