AP Macro Unit 3: National Income & Price Determination

Aggregate Demand

total amount of goods + services that buyers r willing + able to purchase at diff price lvls

* demand for everything by everyone in the US

* inverse relationship btwn price lvl + real GDP demanded 

• AD = GDP = C + I + G + Xn

Reasons of why AD is downward sloping

Wealth Effect

change in price lcl affects the value of financial assets + the purchasing power of $

Interest Rate Effect

change in the price lvl directly influences interest rates + overall spending

Real (Foreign) Trade Effect

change in the price lvl affects a country’s exports + imports, which influences overall spending

Change in Consumer Spending

• disposable income

• consumer expectations

• household indebtedness

• taxes

Changes in Investment

• real interest rates

• business expectations

• profitability

• business taxes

Govt Spending

• public projects

• defense spending

• deficit spending

Change in Net Exports

• exchange rates

• political stability

• relative income compared to other countries 

Multiplier Effect

shows how spending is magnified in the econ

* MPC + MPS = 1

Marginal Propensity to Consume

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

• always expressed as a fraction (decimal)

* MPC = change in consumption/change in income

Marginal Propensity to Save

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

• always expressed as a fraction (decimal)

• MPS = change in savings/change in income

Spending Multiplier

1/MPS or 1/ 1-MPC

* total change in GDP = multiplier x initial change in spending

Tax Multiplier

• the multiplier effect also applies when the govt cuts/increase taxes

• but, changing taxes has less of an impact then govt spending bc ppl save a portion of the tax cut

* this is always 1 less than the spending multiplier 

MPC x 1/MPS or MPC/MPS

total change in GDP = tax multiplier x initial change in taxes 

Aggregate Supply

the amount of goods + services (real GDP) that firms will produce in an econ at diff price lvls. The supply for everything by all firms

Short-run Aggregate Supply

wages + resource prices r sticky + WILL NOT change as price lvls change

Long-run Aggregate Supply

wages + resource prices r flexible + WILL change as price lvls change

Shifters of SRAS

Change in Resource Prices

price of domestic/imported resources

Negative Supply Shock

sudden event that reduces the econs ability to produce goods + services (exs: natural disaster, oil shortage, pandemic)

Positive Supply Shock

sudden event that improves the econs ability to produce goods + services (exs: tech advancement, decrease in energy costs)

Inflationary Expectations

if ppl expect higher inflation, workers will demand higher ages to keep up w/rising prices + firms will raise prices in anticipation of higher costs. This increases production costs, which shifts the SRAS curve to the elft

Changes in Actions by the Govt

• subsidies

• regulation

• business taxes

• business tax credits

Business Tax Credits

incentives that reduce the amount of taxes a business owes. Increasing business tax credits would lower production costs + increase SRAs

Change in Productivity

• tech advancements & human capital

Negative Output Gap

• actual GDP < potential GDP

• UR > NRU

• cyclical unemployment

• producing below full employment

• recessionary gap

Full Employment

• actual GDP = potential GDP

• UR = NRU

• no cyclical unemployment

• only frictional & structural unemployment

Positive Output Gap

• actual GDP > potential GDP

• UR < NRU

• producing above full employment

• inflationary gap

Stagflation

when high inflation occurs at the same time as slow econ growth + high unemployment

Consumer Spending Increases

in SR:

C increase

AD increase

Y Increase

PL increase

UR decrease

in LR:

Wages increase

SRAs decrease

PL increase

Y decrease

UR increase

Consumer Spending Decreases

in SR:

G decrease

AD decrease

PL decrease

Y decrease

UR increase

in LR:

Wages decrease

SRAs increase

PL decrease

Y increase

UR increase

Economic Growth

the result of permanent increases i nthe quantity/quality of resources, or improvements in tech (same things that shift the ppc)

Capital Stock

total amount of physical capital, like machinery, tools, equipment, buildings + factories, that an econ has available to produce goods + services 

Discretionary Fiscal Policy

new laws that change govt spending, taxes/transfer payments to stabilize the econ

Non-discretionary Fiscal Policy (Automatic Stabilizers)

permanent spending/taxation laws enacted to work counter cyclically to stabilize the econ

Expansionary Fiscal Policy

laws that reduce unemployment + increase GDP to close a negative output gap

• increase govt spending

• decrease taxes to increasedisposable income + consumer spedning

• increase transfer payments

Contractionary Fiscal Policy

laws that reduce inflation + decrease GDP to close a positive output gap

• decrease govt spending

• increase taxes to decrease disposable income + consumer spending

• decrease transfer payments

Recognition Lag

congress must react to econ indicators before its too late

Administrative Lag

congress takes times to pass legislation

Operational Lag

spending/planning takes time to organize _ execute. changing taxes is quicker