AP Macro Unit 3

aggregate demand

aggregate demand

• CED: the demand for all goods and services purchased in product markets

• the amount of a nation’s output (real GDP) that buyers collectively desire to purchase at each possible price level.

• total demand for goods produced domestically

components of aggregate demand

• C (Consumption): demand by consumers for consumer goods 

• I (Investments): demand by firms for investment goods (capital stock or productive capacity)

• G (Govt. Spending): demand for goods and services by the government 

• Xn (Net Exports): demand for US goods and services by foreigners (EXPORTS)

aggregate demand formula

AD = C + I + G + Xn

price level & amount of real GDP demanded

the relationship between price level and amount of real GDP demanded is inverse or negative

price level & quantity of aggregate output demanded

• When the price level increases, the quantity of real GDP demanded decreases. This is because people don’t want to buy more goods/services at higher prices.

• When the price level decreases, the quantity of real GDP demanded increases. This is because people want to take advantage of the lower prices.

what relationship does the aggregate demand curve represent?

describes the relationship between the price level and the quantity of goods and services demanded by households (C), firms (I), government (G), and the rest of the word (Xn)

explain (w/ a graph) the slope of the AD curve and its determinants

• the negative slope of the AD curve is explained by the real wealth effect, the interest rate effect, and the exchange rate effect

• any changes in the components of AD that is NOT due to changes in the price level leads to a SHIFT in the AD curve.

income effect

when the price of an individual item falls, a consumer’s nominal (constant) income allows for a larger purchase of that item (Ex: the price of rice bags at Costco suddenly decreases. All the Asians are gonna buy as many as possible since the price got lowered)

substitution effect

as the price falls, consumers want to buy more of the good that’s price is lowered compared to the other goods, which may have higher/worse prices. The good that’s price is lowered is now relatively less expensive compared to the other goods, or “substitutes”. (Ex: Think of granola bars. If one brand suddenly becomes cheaper than all the other granola bar brands, then consumers will probably want to buy the less expensive brand compared to the substitutes since the price is lowered. After all, it's all the same, right?)

real-balances effect

a higher price level REDUCES the purchasing power of the public’s accumulated savings/The real value of assets with FIXED PRICES (Examples: saving accounts, bonds. So like during inflation the purchasing power would decrease)

interest-rate effect

A higher price level increases the demand for money. Consumers need more money to meet their payrolls. An increase in the price level will lead to an increase in interest rates. 

foreign-purchases effect

• When the US price level rises relative to foreign price levels, foreigners buy less US goods and Americans buy more foreign goods. Basically, foreign goods are now cheaper and US goods are more expensive. 

• when a change in the price level of one country leads to other countries purchasing more goods from that country. (Ex: there is a change in the price level in France. Basically, when goods from a certain country are cheaper due to a decrease in price level, more foreigners are gonna wanna buy stuff from that country. So in this example, more foreigners are willing to buy French goods.)

real wealth effect

when consumer income increases, consumers save less and spend more than they had been planning to since their income is now larger. This increase in consumer spending is the wealth effect.

exchange rate effect

When a country’s exchange rate increases, net exports will decrease and aggregate expenditure will go down at all prices.

SRAS

• Short Run Aggregate Supply

• lets us capture how all of the firms in an economy respond to price stickiness. When prices are sticky, the SRAS curve will slope upward

components of SRAS

aggregate output, real GDP and unemployment/employment, aggregate spending, aggregate income, aggregate price level

aggregate output

An increase in Real GDP is accompanied by a change in employment (so more output)

real GDP & unemployment/employment (in terms of SRAS)

• If Real GDP increases, employment increases and unemployment rate falls 

• If Real GDP decreases, unemployment rates rise

aggregate spending

Consumption, Govt. Spending, Net Exports (Exports-Imports), Gross Private Investment

aggregate income

Wages, Rent, Interest, Profit

aggregate price level

is the GDP deflator & a measure of inflation 

product markets

the marketplace where all final goods and services are sold to the household and foreign sector 

SHIFTS in the AD Curve

• An increase in the price level causes a movement up and to the left of a given aggregate demand curve. Increased prices 

• A decrease in the price level causes a movement down and to the right of a given aggregate demand curve. Decreased prices

dissavings

• spending more than your income

• usually happens w/ lower incomes

how dissavings occur

• going into debt (using your credit card having extra to pay on it)

• dipping into past savings

DI

disposable income

average propensity to consume

consumption/DI

average propensity to save

savings/DI

break-even level of income

• where consumption = disposable income

• you aren’t gaining or losing money

marginal income

extra income

marginal propensity to consume

• ΔC/ΔDI

• change in consumption/change in disposable income

marginal propensity to save

• ΔS/ΔDI

• change in savings/change in disposable income

average propensity to consume + average propensity to save

ALWAYS ADDS UP TO $1

marginal propensity to consume + marginal propensity to save

ALWAYS ADDS UP TO $1

MPC & MPS off of a Table!

Table: 

• Negative # of savings: add to get C (consumption)

• Positive # of savings: subtract to get C

• 0 savings: leave the same (consumption = savings)

the multiplier effect

• How strong the multiplier effect will be is determined by our decisions to save and spend

• As our income changes, we will spend a portion and save a portion of this change

multiplier formulas

1/1-MPC OR 1/MPS

why do taxes not impact the multiplier that much compared to spending?

taxes don’t impact the multiplier as much as spending does because when people get extra money, they tend to save it instead of spending it.

income

value of production

how to get Equilibrium GDP (MCQ)

find your multiplier, then add your other values, and then multiply everything

how to get equilibrium level of income (GDP)

find your multiplier, then add your other values, and then multiply everything

why are equilibrium level of income and GDP found the same way?

both have to do with income, which equates to the value of production.

spending multiplier

1/MPS

tax multiplier

• MPC/MPS OR Spending Multiplier - 1

• CED: quantifies the size of the change in AD as a result of a change in taxes

expenditure multiplier

CED: quantifies the size of the change in AD as a result of a change in any of the components of AD

tax changes on govt. spending

the impact of a tax change is ALWAYS LESS than govt. spending

relationship between tax & spending multiplier

tax multiplier is always 1 LESS than spending multiplier

which 2 multipliers depend on the MPC?

expenditure & tax

autonomous expenditures

C, I, G, Xn

total expenditures

AD

autonomous expenditures & total expenditures & total output

CED: a $1 change to autonomous (independent) expenditures leads to further changes in total expenditures and total outputs

maximum change in money supply

• not spent as usual

• MPS increases

• decrease in employment

fiscal policy

• govt. level

• = to aggregate demand

fiscal policy & recession

• taxes - decrease

• spending - increase

fiscal policy & inflation

• taxes - increase

• spending - decrease