macro unit 3

aggregate demand

total demand for ALL goods an services in an economy

• downward sloping curve

• inverse relationship b/n PRICE LEVEL and REAL domestic output (GDPr)

why is aggregate downward sloping?

wealth effect, interest rate effect, foreign trade effect

wealth effect

• HIGHER price levels REDUCE purchasing power of money. this decreases the amount of spending

• LOWER price levels INCREASE purchasing power and increases expedtitures

interest rate effect

• when 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

foreign trade effect

• when U.S. price level rises, foreign buyers purchase fewer American 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

4 components:

• consumer spending

• business investment

• government spending

• net exports

multiplier effect

• an initial change in spending (like government or investment) causes a large total change in GDP

• ex: if government spends $100 and that leads to $300 in total GDP growth, the multiplier is 3

• ONE PERSONS SPENDING BECOMES ANOTHERS 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

• formula: MPS= Change in savings//Change in disposable income

marginal propensity to consume (MPC)

• how much people CONSUME rather than spend when there is a change in disposable income

• always expressed as a fraction

• MPC= Change in consumption//Change in dispoable income

spending multiplier formula

(1/mps) or (1/1-mpc)

tax multiplier

MPC/MPS or 1 less than spending multiplierga

aggregate supply

TOTAL amount of goods and services that producers in an economy are willing and able to sell at different price levels.

short run aggregate supply

shows how much producers will supply in the short term when some costs (like wages) are sticky — not changing easily

• positive relationship b/n price level and real domestic output

long run aggregate supply

the number of goods and services that an economy is capable of producing w/ the full employment of resources.

shifters of SRAS: (R.A.P)

1. changes in price of resources

2. changes in taxes, subsidies, and/or regulations

3. change in productivity

4. expectations of inflation

why is LRAS vertical?

in the long run the economy output is determined by resources and productivity, NOT by the price level

• in long run, wages and prices are fully flexible, so even if prices rise or fall, total output (real gdp) stays the same b/c:

  • # of workers

  • tech

  • capital

  • natural resources

recessionary gap

• negative output gap

• economy is producing less than its full employment level of output.

• below potential——high unemployment and low gdp

inflationary gap

• positive output gap

• economy is producing more than its full employment of level of output

• economy is overheating, there is high demand which causes inflation

• signals low unemployment and rising prices.

supply shock

• a sudden or unexpected event that changes the cost or availability of resources, which affects how much producers supply.

positive supply shock

• increases supply

• lowers production costs

• shifts SRAS curve to right

• leads to lower prices and higher output

  • ex: new technology makes production more efficient

negative supply shock

• reduces supply

• increases production costs

• shifts the SRAS to the left

• leads to higher prices (inflation) and lower output

  • ex: a war disrupts oil supply, making energy expensive

stagflation

• economy experiences stagnation (slow or no growth) and inflation at the same time.

• stagflation = high inflation + high unemployment + low/negative GDP growth

• unemployment + inflation rise together which makes stagflation hard to fix

demand pull inflation

• overall demand in the economy increases, pushing prices up.

• too much demand, not enough supply → prices rise

• causes: increased consumer spending, business investment, gov’t stimulus, low int. rates

• AD curve shifts right

• called demand pull because rising demand is pulling prices up

fiscal policy

governments use of spending and taxes to influence economy

expansionary fiscal policy

• (used during a recession)

• increases spending and cuts taxes

• GOAL: boost demand, increase GDP, reduce unemployment

  • ex: stimulus checks, infastructure spending

contractionary fiscal policy

• used when economy is overheating

• decreases spending and raises taxes

• GOAL: slow down inflation

  • ex: cutting gov’t programs, raising income taxes.

discretionary fiscal policy

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

• one problem is lag times due to bureucracy

• it takes time for congress to act

• ex: in a recession, congress increases spending

non-discretionary fiscal policy

• AKA automatic stabilizers

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

• when GDP goes down, gov’t spending automatically increases and taxes automatically fall

• ex: welfare, unemployment, income tax