Unit 3 National Income and Price Determination Summary

Aggregate Demand

The total demand for all goods and services in an economy at a given price level.

Real GDP

The total value of all goods and services produced in a country, adjusted for inflation.

Real Wealth Effect

Higher price levels shrink the purchasing power of money, decreasing quantity of expenditures.

Interest Rate Effect

As the price level rises, lenders charge higher interest rates, discouraging spending and investment.

Foreign Trade Effect

When the US price level increases, US exports decrease and imports increase, reducing real GDP demand.

Shifters of Aggregate Demand

Components that affect aggregate demand: Consumer spending (C), Investment (I), Government spending (G), Net exports (Xn).

Multiplier Effect

The concept that an initial change in spending leads to a larger overall change in the economy.

Marginal Propensity to Save (MPS)

The fraction of additional disposable income that a household saves rather than consumes.

Marginal Propensity to Consume (MPC)

The fraction of additional disposable income that a household consumes rather than saves.

Spending Multiplier Equation

The formula for the spending multiplier: 1/MPS or 1/(1-MPC).

Expansionary Fiscal Policy

Government policy to reduce unemployment and increase GDP, through increased spending or decreased taxes.

Contractionary Fiscal Policy

Government policy to reduce inflation and decrease GDP, through decreased spending or increased taxes.

Discretionary Fiscal Policy

Policy measures that require legislative action, aimed at changing aggregate demand through government spending or taxation.

Non-Discretionary Fiscal Policy

Automatic stabilizers designed to work counter cyclically to stabilize the economy, such as welfare and unemployment benefits.

Negative Output Gap

A situation where actual output is less than potential output, indicating underutilization of resources.

Positive Output Gap

A situation where actual output exceeds potential output, indicating an economy operating above its capacity.

Supply Shocks

Unexpected events that change the supply of goods and services in the economy, causing shifts in supply curves.

Cost-Push Inflation

A type of inflation that occurs when the overall prices increase due to increases in the cost of wages and raw materials.

Demand-Pull Inflation

A type of inflation that occurs when demand for goods and services exceeds supply.