AP Macro-Unit 3

Aggregate Demand

All goods and services that consumers, firms, and governments are willing and able to purchase at various price levelsover a specific period of time. It represents the total demand in the economy and is influenced by factors such as consumer confidence, government policies, and changes in income.

Why is the AD curve downturning?

3 reasons: the real wealth effect (purchasing power of money is reduced by higher prices), the interest rate effect (as interest rates rise, firms take out fewer loans and VV), and the exchange rate effect (as prices rise domestically, exported goods and services become more expensive). Basically the more expensive, the less is demanded.

When prices increase, what happens to aggregate real GDP demand?

It decreases. REMEMBER: inverse relationship. downturning.

What are the shifters of AD?

Consumer spending, Investment spending, Government spending, and Net exports. C+I+G+X-N

South Korea consumer confidence soars. What happens to AD?

It increases.

The British Government votes to shrink the size of its military. What happens to AD?

It decreases. There is a decrease in gov. spending.

Multiplier Effect

The multiplier effect refers to the phenomenon where an initial change in spending leads to a larger overall increase in national income. This occurs because increased spending generates additional consumption and investment throughout the economy.

Marginal Propensity to Consume

The marginal propensity to consume (MPC) is the proportion of additional income that a household consumes rather than saves. It indicates how much consumption will change with a change in income.

Marginal Propensity to Save

The marginal propensity to save (MPS) is the proportion of additional income that a household saves rather than consumes. It reflects the change in savings resulting from a change in income.

MPC Formula

The change in consumption divided by the change in income.

MPS Formula

The change in savings divided by the change in income.

The Spending Multiplier

The spending multiplier is the number we use to identify the total change in spending we will see after the initial spending. 

Tax Multiplier

The tax multiplier measures the change in total spending resulting from a change in taxes, calculated as the negative of the marginal propensity to consume divided by the marginal propensity to save.

Sticky Wages

Wages that do not adjust quickly to changes in economic conditions, resulting in temporary unemployment during economic downturns.

Recessionary Gap

A recessionary gap occurs when actual output is less than potential output, leading to higher unemployment and unused resources in the economy.

Inflationary Gap

An inflationary gap occurs when actual output exceeds potential output, resulting in upward pressure on prices and potential inflation.

Fiscal Policy

Government adjustments in spending and tax policies to influence economic activity.

The big weakness of Fiscal Policy

Time lag: recognition of the issue

Short-run aggregate equilibrium

is the point where aggregate demand equals short-run aggregate supply, determining the level of output and prices in the economy.

Long-run equilibrium

is the point where aggregate demand equals long-run aggregate supply, indicating full employment and stable prices in the economy.

Recessionary gap

when lras is above the equilibrium, it is a negative output gap

What shifts in the short run to self adjust lras?

the sras curve

Automatic stabilizers

A non-discretionary “first defense” against unexpected surges. Think taxes, unemployment insurance, and Medicaid.

stabilization policy

the use of policy (such as fiscal policy or monetary policy) to reduce the severity of recessions and excessively strong expansions; the goal of stabilization policy is not to eliminate the business cycle, just to smooth it out.

fiscal policy

the use of taxes and government spending to bring stabilization back to an economy

discretionary fiscal policy

fiscal policy that requires an action by a government to occur; for example, if a government has to pass a law to change government spending or taxes. A future lesson in this course discusses automatic stabilizers, which are fiscal policies that require no action to be taken.

transfer payments

payments made to groups or individuals when no good or service is received in return; transfers are the opposite of a tax (you receive transfers from the government, but pay taxes to the government).

the main discrepancy within fiscal policy

time lag: recognition, decision, implementation