AP Macro Unit 3

Aggregate Demand

the amount of goods and services in the economy that will be purchased at all possible price levels

Aggregate demand curve shifters

1. Consumer spending

2. Business Investments

3. Government spending

4. Net Exports

Wealth effect

higher price levels reduce the purchasing power of money

interest rate effect

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

Foreign Trade Effect

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

Aggregate Supply

the total amount of goods and services in the economy available at all possible 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 are flexible and will change as price levels change.

Shifters of Aggregate Supply

1. Resource Prices

2. Actions of the Government (ex: taxes, regulations)

3. Productivity

inflationary gap

when aggregate output is above potential output

recessionary gap

when aggregate output is below potential output

Stagflation

a period of slow economic growth and high unemployment (stagnation) while prices rise (inflation)

What does not cause economic growth

Increase in consumption or government spending

What causes economic growth?

Investments

Classical theory of economics

Prices change to remove surpluses and shortages of goods, efficiently allocating resources. Markets are self regulating.

Keynesian Theory

an economic theory stating that the government can stabilize the economy- that is, can smooth business cycles- by controlling the level of aggregate demand, and that the level of aggregate demand can be controlled by means of fiscal and monetary policies

What shifts the Phillips Curve?

1. Expectations about future prices

2. Supply shocks

How does Government stabilize the economy

1. Fiscal Policy: Actions taken by congress to stabilize the economy

2. 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

contractionary fiscal policy

Laws that reduce inflation, decrease GDP

Non-Discretionary Fiscal Policy

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

expansionary fiscal policy

laws that reduce unemployment and increase GDP

Marginal Propensity to Consume (MPC)

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

Marginal Propensity to Save (MPS)

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

Marginal Propensity to Consume equation

change in consumption/change in disposable income

Marginal propensity to save equation

change in saving/change in income, 1 - MPC

Tax Multiplier Equation

MPC/MPS

Automatic stabilizers of Non-Discretionary Fiscal Policy

government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands

budget deficit

a shortfall of tax revenue from government spending

national debt

The sum of government deficits over time.

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

the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending

net export effect

The idea that the impact of a change in monetary policy or fiscal policy will be strengthened or weakened by the consequent change in net exports. The change in net exports occurs because of changes in real interest rates, which affect exchange rates

Which of the following would cause the short-run aggregate supply curve to shift to the right?

A decrease in the expected price level

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

An increase in output and a decrease in inflation

A simultaneous increase in inflation and unemployment could be explained by an increase in which of the following?

Inflationary expectations

An increase in consumer spending will most likely cause the price level and real GDP to change in which of the following ways in the short-run?

increase; increase

An increase in personal income taxes will most likely cause aggregate demand and aggregate supply to change in which of the following ways in the short run?

Aggregate Demand: Decrease, Aggregate Supply: Not Change

When firms restructure their operations to decrease production costs, the aggregate supply curve, the price level, and real output will change in which of the following ways?

Supply Curve: Shift to the right, Price Level: Decrease, Real Output: Increase

Which of the following would cause a leftward shift in aggregate demand?

1. Congress increases personal income taxes

2. An increase in government spending on public goods

3. A recession in another country that is a close trading partner

1 and 3 only

If the government increases expenditures on goods and services and increases taxation by the same amount, which of the following will occur?

Aggregate demand will increase

Which of the following would cause the short-run aggregate supply curve to shift to the right?

a decrease in the expected price level

An increase in consumer spending will most likely cause the price level and real GDP to change in which of the following ways in the short-run?

increase; increase

When firms restructure their operations to decrease production costs, the aggregate supply curve, the price level, and real output will change in which of the following ways?

Supply Curve: Shift to the right, Price Level: Decrease, Real Output: Increase

An increase in personal income taxes will most likely cause aggregate demand and aggregate supply to change in which of the following ways in the short run?

Aggregate Demand: Decrease, Aggregate Supply: Not Change

The intersection of the aggregate demand and aggregate supply curve occurs at the economy's equilibrium level of

Real domestic output and price level

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

An increase in output and a decrease in inflation

Assume that current real GDP falls short of full-employment output by $400 billion and the MPC is .8. What is the minimum increase in government spending that could bring about full employment?

$80 Billion

Assume that Jane's marginal propensity to consume equals 0.8 and that in 2004 Jane spent $36,000 from her disposable income of $40,000. If her disposable income in 2005 increased to $50,000, her consumption spending increased by

$8,000

The formula to calculate the expenditures or simple multiplier is

1/1-MPC

An increase in the marginal propensity to save clearly cause a decrease in which of the following?

Simple spending multiplier

Which of the following is true about the marginal propensity to consume?

It determines the size of the simple spending multiplier

According to classical economists, which of the following will occur to move this economy to long-run equilibrium

Wages will decrease causing aggregate supply to increase

If congress wants to close a recessionary gap, which policy is matched to the change in policy, output and price level?

Decrease Taxes / Increase / Increase

An increase in the wealth of consumers will likely cause price level and unemployment to change in which of the following ways?

Price level: increase, unemployment: decrease

Which of the following is an example of expansionary fiscal policy?

A decrease in personal income tax rates

Assume that Canada imports products from the United States. A large decrease in the Canadian incomes will cause the United States price level and real GDP to change in which of the following ways?

Price level: decrease, price level: decrease

If government expenditures and taxes are increased by the same amount, which of the following will occur?

Aggregate demand will increase

Which of the following is the best example of a non-discretionary fiscal policy to combat demand-pull inflation?

progressive income tax system