Unit 3 AP Macroeconomics

Aggregate demand

Total demand for goods and sources in the economy at different price levels- think about the economy as a big store. It shows how much everyone wants to buy depending on different price levels. Can be used as “total spending”

Aggregate supply formula

C+I+G+X-M

Consumption in AS

What households buy (food, clothes, video games)

Investment in AS

What businesses buy to grow (machines, buildings)

Government spending in AS

Roads, schools, public services

Net Exports in AS

Exports minus imports

Why prices affect demand

Wealth affect, interest rate effect, and exchange rate effect

Wealth effect

Lower prices=feel richer=spend more

Interest rate effect

Lower prices=lower interest rates=borrow and invest more

Exchange rate effect

Lower domestic prices=exports rise=net exports increase

Shifts in AD

caused by changes in spending

Movements in AD

Caused by price changes

Aggregate supply

The total quantity of goods and services producers are willing and able to supply at different price levels

Helps determine the overall level of output and prices when combined with AD

Types of AS

Short run and long run

SRAS

Focuses on short term production when some prices (especially wages) are sticky

SRAS curve

Slopes upward

When prices rise, producers are willing to make more goods

Sticky wages and input costs

Subject to change, means that companies can make more money when prices go up (for a little while)

SRAS shifts

Based on production costs

SRAS shifts right

Lower input costs, higher productivity, lower taxes or more resources

SRAS shifts left

Higher wages or energy prices, natural disasters, higher business taxes

Sticky wages

Worker pay doesn’t change quickly even when prices do, explains why SRAS slopes upward. In the long run, wages catch up, so there is no more incentive to produce extra

LRAS curve

Vertical— shows potential output at full employment=, not affected by price level

LRAS depends on

Labor, capital, technology

LRAS in long run

Wages and prices are flexible, the economy returns to full employment

Macroeconomic equilibrium

AD=AS

Where they intersect

Economy output at ME

Real GDP

Price level at ME

Stable

Short run equillibrium

When AD=SRAS

SRE economy at full employment

Output at potential GDP

SRE economy below full employment

Recessionary gap

SRE economy above full employment

Inflationary gap

Recessionary gap

Happens when actual output< potential output, unemployment is high. Economy produces less that it could

Inflationary gap

Happens when actual output>potential output

Unemployment is low, but prices rise

The economy overheats means inflation increases

Long run equillibrium

Occurs where AD, SRAS, and LRAS all meet5

Economy is at full employment

No inflationary or recessionary gap

In the long run, wages and prices adjust, moving SRAS back to full employment

Economy below full employment

Wages and prices fall, SRAS shifts right

Economy is above full employment

Wages and prices rise, SRAS shifts left

Naturally brings economy back to equilllibrium over time

Fiscal policy

Government actions to influence the economy through spending and taxation

Fiscal policy purpose

Stabilize output, employment, and price levels

Expansionary fiscal policy

Stimulates economic growth

Contractionary fiscal policy

Slow down inflationary pressures

Expansionary fiscal policy goal

Close a recessionary gap

Expansionary fiscal policy

Increase government spending and decrease taxes

Expansionary fiscal policy effect

Aggregate demand shifts right, higher GDP and price level

Contractionary fiscal poly goal

Reduce an inflationary gap (control rising prices)

Contractionary fiscal policy methods

Decrease government spending, increase taxes

Contractionary fiscal policy Effect

AD shifts left, lower price level and output

MPC

How much people spend from extra income

Spending multiplier formula

1/1-MPC

Tax multiplier formula

MPC/1-MPC

MPC visual

Government spends, people spend, GDP grows

Crowding out effect

When the government spends a lot, it may borrow money, which can make interest rates go up. Higher interest rates make it harder for business and people to borrow. As a result, private spending goes down, so economy doesn’t grow as lunch as planned.

Limits of fiscal policy

Time lags, political constraints, crowding out, deficits and debt

Automatic stabilizers

Built in features of the economy that actually adjust to economic conditions

Automatic stabilizers effect

Reduce the severity of business cycle fluctuations without new legislation