AP Macro Unit 3 Vocab

Marginal Propensity to Consume

The increase in consumer spending when disposable income increases by $1.

Marginal Propensity to Save

The increase in household savings when disposable income rises by $1.

Relationship between MPC and MPS

 MPC + MPS = 1

Multiplier

The ratio of total change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change.

Multiplier Formulas

1 / (1-MPC), or 1 / MPS

Autonomous Change in Aggregate Spending

An initial rise or fall in aggregate spending that is the cause, not the result, of a series of income and spending changes.

Aggregate Consumption Function

Relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending.

C = A + MPC × Yd

C: aggregate consumer spending

A: Aggregate autonomous consumer spending (the amount of consumer spending when consumer spending is 0)

Yd (also called DI): disposable income

Causes of Shifts in the Consumption Function

Changes in expected future income, and changes in aggregate wealth.

Changes in Expected Future Income

Consumption may increase if one expects to get an increase of money in the near future, and vice versa.

Changes in Aggregate Wealth

If two people make the same amount of money, but one has more wealth, that person will likely spend more and save less for retirement. When aggregate wealth increases, consumption function shifts up. Example of increase in wealth: booming stock market. Example of decrease in wealth: drop in house prices.

Aggregate Demand Curve

Shows the indirect relationship between the aggregate price level and the quantity of aggregate output demanded by households, businesses, and the rest of the world.

Wealth Effect

The change in consumer spending caused by the altered purchasing power of consumer's assets. More simply, a change in the price level changes the purchasing power in money, changing consumers' overall wealth. Contributes to downward slope of demand curve.

Interest Rate Effect

The change in investment and consumer spending caused by altered interest rates that result from changes in demand for money. An increase in price level causes people to hold more money and spend less on borrowing or assets, so have the same purchasing power as before. This decrease of funds available to lend drives interest rates up, and therefore reducing investment spending. Consumer spending also decreases because more money is being saved instead of spent.

What Will Cause the AD Curve to Shift

Change in expectations of the state of the economy. change in wealth, change in existing stock of capital, change in fiscal policy (government spending, taxes, and transfer payments), change in monetary policy (interest rates and money supply). See chart for more details.

Short Run Aggregate Supply Curve

Shows the direct relationship between the total quantity of goods and services supplied and the price level.

What Determines Slope of SRAS Curve

Nominal wages are sticky in the short run, so while a change in price level changes the amount of revenue taken in, wages to not adjust accordingly. A decrease in price level leads to less revenue, and once the wages are subtracted, less money is available to create output, and vice versa.

Sticky Wages

Nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages

What Will Cause the SRAS Curve to Shift

Change in commodity prices, change in nominal wages, change in productivity. See chart for more info.

Commodities

Standardized inputs bought and sold in bulk quantities, such as oil. Increases reduce production costs, and decreases raise production costs. May drastically change due to industry specific shocks in supply.

Short Run vs. Long Run

In the short run, wages and other prices are fixed, while in the long run, they're flexible.

Long Run Aggregate Supply Curve

A vertical line that intersects real GDP at potential output (Yp). Nominal wages are flexible, so they don't affect the curve, causing it to be vertical.

Demand Shock

An event that shifts the aggregate demand curve. A negative demand shock (shift left lowers output and price level - what causes most recessions. A positive demand shock (shift right) raises output and price level.

Supply Shock

 An event that shifts the short-run aggregate supply curve. A positive demand shock raises output and lowers price level and inflation. A negative supply shock lowers output and raises price level (known as stagflation).

Stagflation

Caused by a negative demand shock. Lowers real GDP and output, and raises price level. This creates a recession and inflation at the same time. Usually, government policy takes on the inflation issue first, worsening the recession, and then fixing the recession.

Output Gap

The percentage difference between actual aggregate output and potential output.

(Actual output - potential output) / Potential output x 100

Recessionary Gap

When aggregate output is below potential output. Closed by expansionary policy. Self corrects when, over time, nominal wages fall in the long run due to a decrease in revenue, shifting the supply curve right.

Inflationary Gap

When aggregate output is above potential output. Closed by contractionary policy. Self corrects when, over time, nominal wages rise to attract workers during the period of low unemployment, which shifts the supply curve left.

What Causes RAS to Shift

Changes in production capabilities.

Fiscal Policy

The use of taxes, government transfers, or government purchases of goods and services to stabilize the economy.

Transfer Payments

Payments by the government to households for which no good or service is provided in return. Ex: Social Security, Medicare, and Medicaid. They affect consumption less than government spending does

Multiplier for Transfer Payments

MPC / (1-MPC)

Expansionary Fiscal Policy

Fiscal policy that increases aggregate demand and boosts economy.

Contractionary Fiscal Policy

 Fiscal policy that decreases aggregate demand and slows economy to slow inflation.

Discretionary Fiscal Policy

Fiscal policy that is the result of deliberate actions by policy makers rather than rules. Experiences time lags of realization, learning, acting, compromising, and putting into effect. Due to these time lags, its effectiveness varies.

Automatic Stabilizers

Government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands. Examples: tax rates and government transfers

Change in GDP Due to Government Spending

1 / (1-MPC) x change in G

Change in GDP Due to Transfer Payments

1 / (1-MPC) x change in transfer payments

Effects of Interest Rates in Planned Investment Spending

If interest rates increase, investment spending decreases, and vice versa.

Self-Corrections of Output Gap

Over time, wages will adjust, shifting SRAS to LRAS.