Unit 3: National Income and Price Determination

Aggregate Demand (AD)

the inverse relationship between all spending on domestic output and the aggregate price level of that output

What does aggregate demand measure?

the sum of consumption spending by households, investment spending by firms, government purchases of goods and services, and net exports (exports minus imports)

What are the 3 general groups of substitutes for national output?

Foreign sector substitution effect, interest rate effect, and wealth effect

Foreign Sector Substitution Effect

when goods and services produced in other nations are more appealing due to domestic inflation → brings real GDP down

Interest Rate Effect

wait-and-see mentality for goods and services in the future as prices rise and real GDP falls

Wealth Effect

as aggregate price level rises, the purchasing power of wealth decreases → reduce quantity of domestic output purchased

Wealth

the value of accumulated assets like stocks, bonds, savings, and cash on hand

What does a combination of foreign section substitution, interest rate and wealth effects predict?

a downward sloping AD curve → as aggregate prices rise, the consumption of domestic output (real GDP) falls (inverse relationship)

What happens when one of the components of aggregate demand increases while holding price level constant? What happens to GDP? What shift?

Aggregate demand increases → real GSP increases → right shift from aggregate demand

What happens when one of the components of aggregate demand decreases while holding price level constant? What happens to GDP? What shift?

Aggregate demand decreases → real GSP decreases → left shift from aggregate demand

How to stimulate real GDP/lower unemployment?

boost any or all components of AD

How to slow down aggregate demand?

rein the components of aggregate demand

What are the 4 components of aggregate demand?

consumer spending, investment spending, government spending, and net exports

Consumer Spending

when households with more money are more likely to consume and save it

Investment Spending

when firms increase investment if they believe the investment will be profitable

Government Spending

when government pushes money into the economy through various ways (direct increase in aggregate demand)

Net Exports

measure used to aggregate a country’s expenditures or GDP in an open economy

Multiplier Effect

the idea that an initial change in spending will set off a spending chain that is magnified in the economy

Marginal Propensity to Consume (MPC)

how much people consume rather than save when there is a change in income

Marginal Propensity to Save (MPS)

How much people save rather than consume when there is a change in income

how to calculate MPC

dividing the change in consumption by dividing the change in disposable income

how to calculate MPS

dividing the change in savings by dividing the change in disposable income

what should the sum of MPC and MPS equal?

MPC + MPS = 1

Spending Multiplier

an economic measure of the effect that a change in government spending and investment has on the Gross Domestic Product of a country

Tax Multiplier

used to determine the maximum change in spending when the government either increases or decreases taxes

Aggregate Supply (AS)

the relationship between the aggregated price level of all domestic output and the level of domestic output produced

Short Run Aggregate Supply (SRAS)

the positive relationship between the level of domestic output produced and the aggregate price level of that output

What happens during a macroeconomic short run period? How is the SRAS curve drawn?

the prices of goods and services are changing in their respective markets, but input prices have not been adjusted to those product market changes; SRAS curve is typically upward sloping

What happens in stage 1 of macroeconomic short-run period?

the economy is in a recession with low production meaning there are many unemployed resources

What happens in stage 2 of macroeconomic short-run period?

real GDP increases and approaches full employment, available resources are harder to find and input costs begin to rise

What happens in stage 3 of macroeconomic short-run period?

the economy is growing and approaching the nation’s productive capacity where firms cannot find unemployed units

What effects does input prices have on short run on aggregate supply curve?

If input prices fall economy-wide, the short-run AS curve increases without changing the level of full employment.

What effect does tax policy (supply side tax) haveon short run on aggregate supply curve?

if “supply-side taxes” are lowered, short-run AS shifts to the right

What effect does deregulation have on short run on aggregate supply curve?

when the regulation of industries restricts their ability to produce, the short-run AS likely increases

What effect does environmental phenomena have on short run on aggregate supply curve?

For a smaller nation or a large nation hit by an epic disaster, this could be a permanent decrease in the ability to produce

Long-Run Aggregate Supply (LRAS)

the number of goods and services that an economy is capable of producing with the full employment of resources

What happens during a macroeconomic long run period?

the input prices have enough time to fully adjust to market forces → all product and input markets are balanced = economy is at full employment (GDPf)

What effect does availability of resources have on long run on aggregate supply curve?

A larger labor force, a larger stock of capital, or more widely available natural resources can increase the level of full employment

What effect does technology and productivity have on long run on aggregate supply curve?

Better technology raises the productivity of both capital and labor; A more highly trained or educated populace increases the productivity of the labor force

What effect does policy incentives (ex. tax incentives) have on long run on aggregate supply curve?

If the policy provides large incentives to quickly find a job, full-employment real GDP rises; If the government gives tax incentives to invest in capital or technology, GDPf rises.

What does LRAS curve shift right indicate?

it indicates economic growth

Macroeconomics Equilibrium

occurs when the quantity of real output demanded is equal to the quantity of real output supplied → graphically the intersection of aggregate demand and short run aggregate supply

Recessionary Gap

the amount by which full-employment GDP exceeds equilibrium GDP

Inflationary Gap

the amount by which equilibrium GDP exceeds full employment GDP

Supply Shocks

economy-wide phenomenon that affects the costs of firms and the position of the SRAS curve, either positively or negatively; cause of SRAS shifts

what are positive supply shocks the result of?

higher or lower energy prices

When do negative supply shocks usually occur?

economy-wide input prices suddenly increase

Fiscal Policy

deliberate changes in government spending and net tax collection affect economic output, unemployment, and the price level

Expansionary Fiscal Policy

real GDP is low and unemployment is high when the economy suffers a recession

Contractionary Fiscal Policy

when the economy operates beyond full employment, inflation becomes a problem, so the government might need to contract the economy

Sticky Prices

when price levels do not change, especially downward, with changes in AD

Automatic Stabilizers

a type of fiscal policy that is already in place to offset the fluctuations or economic activity in our economy

what happens during a recessionary period?

less people are employed and less income is made for those unemployed families

what happens during a inflationary period?

income taxes with come into effect

Progressive Income Taxes

describe income taxes that tax more if that household earns more income