AP Macro Unit 3 Definitions

LRAS

• Long Run Aggregate Supply

• considers Aggregate Supply/productive capacity when @ FULL EMPLOYMENT no matter price level

• goes vertical; called Y_FE

• Caused by CIGNX

SRAS

• Short-Run Aggregate Supply

• considers productive capacity of aggregate supply based on temporary changes in price level

• caused by two factors

  • Sticky Prices

  • Sticky Wages

Sticky Wages

• When wages are not rising at the same rate as inflation

  • Will first have to wait for negotiation

  • In turn, companies can produce more product since wages are cut

• ONLY CHANGES IN LRAS

Sticky Prices

• When companies do not raise the price level in equilibrium to the rate of inflation

  • THEREFORE, there is an expectation that production is more rapid to meet demand, since ppl are more willing to buy with low prices

MPC

• Marginal Propensity to Consume

• This is how much people purchase from what they earn per dollar

  *Both MPC and MPS have to add up to 1

MPS

• Marginal Propensity to Save

• This is how much people save in what they earn per dollar

  *Both MPS and MPC have to add up to 1

Government Spending Multiplier

• More effective in raising GDP over a reduction in taxes

Tax Multiplier

• Fraction of dollar spent on TAXES

Lags in Fiscal Policy

They can lead to inflationary gaps withing the economy, hurting it even more

Aggregate Demand

The relationship between the Real GDP and price level of goods (indicator for a country’s economy)

IRE (in terms of Aggregate Demand)

• Interest Rate Effect

• Real Wealth Effect

• Exchange Rate Effect

• These are the outcomes when price levels increase/change, affecting GDP

Interest Rate Effect

When prices increase, money is worth less and people pull out cash, leading to banks raising interest rates to mitigate pull-outs

Real Wealth Effect

When prices increase, the money saved will be worth less, leading to less purchasing power

Exchange Rate Effect

When prices rise, a country’s goods become more expensive, so less foreigners purchase and therefore weakens the GDP

Automatic Stabilizers

Temporary action to mitigate inflation effects on the economy during a recession

• Usually comes in the form of transfer payments and less taxes due to ppl getting laid off

• Helps give govn’t time to implement better fiscal policies

Positive Demand Shock

A sudden demand shock in the demand for a product or service

• Causes AD to move right & create new short-run equilibrium

• Effects:

  • Higher prices

  • Inflationary Gap

  • Increased output

• Causes AD to move to AD₂ →SR Equilibrium

Inflationary Gap (Positive Output)

When there is a difference between how much we should be producing (Y_FE) and how much is actually being produced (Y₁)

Recessionary Gap (Negative Output)

When the Short-Run Equilibrium is to the LEFT of LRAS

• indicates a recssion

Shifters of Aggregate Demand

• Consumer Spending

• Investment

• Government Spending

• Net exports (export-import)

Shifters of Aggregate Supply (RAP)

• Resource Prices

  • Price of Domestic + Imported Resources

  • Supply shocks

  • Inflationary Expectations

• Actions of Government

  • Taxes

  • Subsidies

  • Regulations

• Productivity

  • Technology

  • Labor Force & Capital Stock

Negative Supply Shock

Shifts in LRAS

1. Change in resource quantity or quality

2. Change in technology

• SAME SHIFTERS AS PPC (RAP)