AP Macro Unit 3

Consumption function

shows how a household's consumer spending varies with the household's current disposable income

Marginal Propensity to Consume (MPC)

the increase in consumer spending when disposable income rises by $1

Marginal Propensity to Save (MPS)

the increase in household savings when disposable income rises by $1

Planned investment spending

the investment spending that businesses intend to undertake during a given period

inventory investment

the value of the change in total inventories held in the economy during a given period

Unplanned inventory investment

unplanned changes in inventories, which occur when actual sales are more or less than businesses expected.

actual inventory investment

the sum of planned investment spending and unplanned inventory investment

Autonomous change in aggregate spending (AAS)

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

spending multiplier

1/MPS or 1/1-MPC

aggregate demand curve

shows the relationship between the aggregate price level and the quantity of aggregate output demanded by households, businesses, the government, and the rest of the world

real wealth effect

a change in the aggregate price level is the change in consumer spending caused by the altered purchasing power of consumers' assets

interest rate effect

occurs when a change in the price level leads to a change in interest rates and, therefore, in the quantity of aggregate demand

exchange rate effect

When a lower price level reduces the interest rate, investors move some of their funds overseas in search of higher returns. This movement of funds causes the real value of the domestic currency to fall in the market for foreign-currency exchange. Domestic goods become less expensive relative to foreign goods. This change in the real exchange rate stimulates spending on net exports and thus increases the quantity of goods and services demanded.

When does aggregate demand increase?

When consumers/firms become more optimistic, when the real value of household assets rises, when the existing stock of physical capital is relatively small, when the government increases spending/cuts taxes, when the central bank increases the quantity of money

When does aggregate demand decrease?

When consumers and firms become more pessimistic, when the real value of household assets falls, when the existing stock of physical capital is relatively large, when the government reduces spending/raises taxes, when the central bank reduces the quantity of money

fiscal policy

the use of government purchases of goods and services, government transfers, or tax policy to stabilize the economy

Monetary policy

the central bank's use of changes in the quantity of money or the interest rate to stabilize the economy

aggregate supply curve

shows the relationship between the aggregate price level and the quantity of aggregate output supplied in the economy

nominal wage

the dollar amount of the wage paid

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

short-run aggregate supply curve

shows the positive relationship between the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed

When does the SRAS increase?

When commodity prices fall, when nominal wages fall, when workers become more productive, if inflation is expected to be lower

When does SRAS decrease?

When commodity prices rise, when nominal wages rise, when workers become less productive, if inflation is expected to be higher

Long-run aggregate supply curve

shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible

Potential Output

the level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible

full-employment level of output

the level of real GDP the economy can produce if all resources are fully employed

Short-run equilibrium aggregate price level

the aggregate price level in the short-run macroeconomic equilibrium

AD-AS Model

the aggregate supply curve and the aggregate demand curve are used together to analyze economic fluctuations

Short-run equilibrium aggregate output

is the quantity of aggregate output produced in the short-run macroeconomic equilibrium

demand shock

an event that shifts the aggregate demand curve

supply shock

an event that shifts the short-run aggregate supply curve

stagflation

A combination of inflation and recession, usually resulting from a supply shock.

recessionary gap

when aggregate output is below potential output

inflationary gap

when aggregate output is above potential output

output gap

the difference between actual output and potential output

stabilization policy

the use of government policy to reduce the severity of recessions and rein in excessively strong expansions

Social insurance

government programs intended to protect families against economic hardship

expansionary fiscal policy

increases aggregate demand

contradictory fiscal policy

reduces aggregate demand

tax multiplier

-MPC/(1-MPC) or -MPC/MPS, the factor by which a change in tax collections changes real GDP.

balanced budget multiplier

the factor by which a change in both spending and taxes changes real GDP

Lump-sum taxes

taxes that don't depend on the taxpayer's income

automatic stabilizers

government spending and taxes that automatically increase or decrease along with the business cycle

discretionary fiscal policy

fiscal policy that is the result of deliberate actions by policy makers rather than rules