Unit 3 Vocabulary - National Income and Price Determination

Aggregate

A whole that is composed of many parts; everything put together.

Aggregate Price Level

The overall price level faced by households (Consumer Price Index).

Aggregate Output

The total amount of final goods and services produced in a country in a given period of time (real GDP).

Aggregate Demand (AD)

A curve that shows the relationship between the aggregate price level (CPI) and the quantity for aggregate output demanded by households, firms, the government, and the rest of the world.

Wealth Effect (Real Balances Effect)

A change in the aggregate price level influences the purchasing power of consumers. Prices go up, purchasing power goes down, and vice versa.

Interest Rate

The cost of borrowing money, expressed as a percentage of the total sum borrowed (known as the principal).

Interest Rate Effect

A rise in the aggregate price level causes interest rates to increase, which has a negative effect on business investment.

Fiscal Policy

Changes in government spending or taxes that are designed to affect overall (aggregate) spending.

Aggregate Supply

Shows the relationship between the aggregate price level (CPI) and aggregate output (real GDP) that producers are willing and able to supply.

Nominal Wage

The dollar amount earned by workers without adjusting for inflation.

Sticky Wages

Due to contracts and informal agreements, nominal wages are slow to adjust when the aggregate price level changes.

Short-Run

A period of time when input prices are not flexible (sticky) and do not adjust to the aggregate price level. Usually less than or equal to 2 years.

Long-Run

A period of time when input prices are completely flexible and can adjust to the aggregate price level. Usually greater than 2 years.

Short-Run Aggregate Supply (SRAS)

Supply curve that slopes upward due to sticky resource prices.

Long-Run Aggregate Supply (LRAS)

Supply curve that is perfectly inelastic at the level of full output; shows that the aggregate price level does not affect aggregate output in the long-run.

Potential Output

The normal level of output for the economy given the available factors of production. Shows the level of real GDP that the economy would produce if all input prices were completely flexible.

Short-Run Macroeconomic Equilibrium

Aggregate demand and short-run aggregate supply intersect to the left or right of the LRAS. The aggregate price level is above or below the expected price level, and output is above or below potential output (known as an Output Gap).

Long-Run Macroeconomic Equilibrium

Aggregate demand, short-run aggregate supply, and long-run aggregate supply intersect at one point on the graph. The aggregate price level matches the expected price level, and the actual output matches potential output. The economy is at full employment, and prices are stable.

Inflationary Gap

Output gap created when aggregate demand increases; prices rise above the expected price level (unexpected inflation), and unemployment falls below the natural rate. Happens when AD shifts rightward.

Recessionary Gap

Output gap that is created when aggregate demand decreases; prices fall below the expected price level (unexpected deflation or disinflation), and unemployment rises above the natural rate. Happens when AD shifts leftward.

Stagflation

A simultaneous increase in the rates of unemployment and inflation. This happens when the SRAS shifts leftward.

Self-Correcting

"Markets move toward equilibrium." If an output gap exists in the short run, the economy will gradually move back toward long-run equilibrium. If the output gap is negative, nominal wages will fall, SRAS will increase, and the economy will move back toward long-run equilibrium. If the output gap is positive, nominal wages will rise, and SRAS will decrease until the economy reaches long-run equilibrium.