AP Macroeconomics - Unit 3 Review

Aggregate Demand

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

If price level increase then...

real GDP demanded decreases

If price level decreases, then...

real GDP demanded increases

Equation for Aggregate Demand

AD = C + I + G + (X-M)

What does not shift the aggregate demand curve?

changes in price level (these cause a movement along the curve)

Why is the aggregate demand curve downward sloping?

1. The wealth effect

2. Inters rate effects

3. Foreign trade effect

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 expenditure.

REAL BALANCE EFFECT

Intrest rate effect

when price level increases, lenders need to charge higher interest rates to get real return on their loans.

higher interest rates discourage consumer spending and business investment.

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)

Shifters of Aggregate Demand

1. Change in consumer spending

2. change in investment spending

3. Change in government spending

4. Change in Net Exports

Aggregate supply

the amount of good and services (real GDP) that firms will produce in an economy at different price levels. (the supply for everything by all firms)

Short Run Aggregate Supply (SRAS)

wages and resource prices are STICKY and will not change as price levels change

Long Run Aggregate Supply (LRAS)

Wages and resource prices are flexible and will change as price levels change

Shifters of aggregate supply on a graph

Anything that causes firms' costs of production to rise in the short run will shift SRAS curve to the left.

Anything that causes the cost of production faced by a nation's firms to decrease will cause the SRAS curve to increase and shift right.

Shifters of SRAS

R.A.P.

1. Change in resource prices (R)

2. Change in Actions of the government (NOT GOV SPENDING) (A)

3. Change in productivity

Change in Resource Prices

-Price of domestic and imported resources

-Supply shocks

-Inflationary expectations

Change in Actions of the government

-taxes on productions

-subsides got domestic producers

-government regulations

Change in Productivity

Technology

What happens in the long run?

In the long run, wages and resource prices will increase as price levels increase.

PRICE LEVEL INCREASES AND GDP DOES NOT

What do we assume occurs in the long run?

the economy will be producing at full employment

Shifters of LRAS

-a permanent change int eh production possibilities of the economy can shift LRAS

1. change in resource quantity or quality

2. Change in technology

Full employment

Long run equilibrium: the economy is at potential output

Inflationary gap

above or beyond full employment, positive output gap

-output is high and unemployment is less than NRU

-actual GDP is above potential GDP

Recessionary gap

Below or less than full employment, negative output gap

-output low and unemployment is greater then the NRU

-actual GDP below potential GDP

Stagflation

stagnate economy + inflation

Recessionary gap caused by decrease in aggregate supply

Causes of Inflation

Demand - pull inflation -demand pulls up prices (AD Increase).

Cost- push inflation - higher production costs increase prices - negative supply shock increase the costs of production and forces producers to increase prices (SRAS Decrease)

What happens in the long run when the economy is in an inflationary gap or recession and not policy action is taken.

the economy will self-correct in the long run when no policy action is taken.

Fiscal policy

now the government uses its powers to get rid of output gaps

Autonomous consumption

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

What is consumer spending made up of?

Autonomous consumption and disposable income

Discretionary Fiscal Policy

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

Non-Discretionary Fiscal Policy (automatic stabilizers)

permanent spending or taxation laws enacted to work counter cyclical to stabilize the economy

What are the two types of Non-Discretionary Fiscal Policy?

1. Contractionary Fiscal Policy (BREAK)

2. Expansionary Fiscal Policy (GAS)

Contractionary Fiscal Policy

laws that reduce inflation, decrease GDP (close an inflationary gap)

-decrease gov spending

-increase taxes

Expansionary Fiscal Policy

Laws that reduce unemployment and increase GDP (close recessionary gap)

-increase gov spending

-decrease taxes

Problem of Fiscal Policy

takes time to go into effect (time lags)

1. Recognition Lag

2. Administrative Lag

3. Operational Lag

Multiplier Effect

initial change in spending will set odd a spending chain that is magnified in the economy, it shows how spending is magnified in the economy (ALL SPENDING CAN BE MAGNIFIED)

Marginal Propensity to Consumer (MPC)

how much people consume rather than save when there is a change in disposable income

(ALWAYS EXPRESSED AS A FRACTION OR A DECIMAL)

MPC Equation

MPC= Change in consumption/change in disposable income

Marginal propensity to save (MPS)

how much people save rather than consume when there is a change in disposable income

(ALWAYS EXPRESSED AS A FRACTION OR DECIMAL)

What do MPS and MPC add up to and why?

MPS+MPC=1 because people can wither save or consume, nothing else

MPS Equation

MPS = change in savings/ change in disposable income

Finding total change in GDP

Total change in GDP = multiplier x initial change in spending

Spending Multiplier

1/MPS, 1/1-MPC

Tax cuts and the multiplier effect

changing taxes has led of an impact than gov spending because people will save part of this money. (TAX MULTIPLIER IS 1 LESS THEN SPENDING MULTIPLIER)

Simple Tax Multiplier Equation

MPC x 1/MPS or MPC/MPS

Government transfers

in a recession, gov may decide to increase unemployment benefits to stimulate the economy (ALWAYS 1 LESS THAN THE SPENDING MULTIPLIER)

How do unemployment benefits and social service programs act counter cyclical to stabilize the economy?

1. When GDP is down, unemployment is higher and more benefits will be paid out, This helps increase AD.

2. When GDP is up, unemployment is low and fewer benefits will be paid out, automatically decreasing AD.