ECON U3 NATIONAL INCOME AND PRICE DETERMINATION

Aggregate Demand

The aggregate demand (AD) curve describes the relationship between aggregate price level and the quantity aggregate output demanded by households (consumption), firms (investment), government (government spending), and the rest of the world (net exports)

Aggregate demand curve slope

Downward sloping because of the real wealth effect, interest rate effect, and net export effect

Real wealth effect

refers to the change in consumer spending that occurs due to a change in the value of money or assets. When prices fall, the real value of money increases, leading to higher consumption.

Interest rate effect

refers to the change in investment and consumer spending caused by altered interest rates that result from changes in the demand of money

Exchange rate effect

refers to change in net exports caused by a change in the value of the domestic currency, which leads to a change in the relative price of domestic and foreign goods and services

Aggregate Demand Curve shifts

Any change to the components of aggregate demand (consumer spending, government spending, investment, or net exports) that is not due to a change in price level leads to _

Changes in expectations (ADC shifter)

Increased optimism (consumers/firms) ↑ AD; pessimism ↓ AD

Changes in wealth (ADC shifter)

Rise in real value of assets ↑ AD; fall in value ↓ AD (ex. a stock market crash).

Existing stock of physical capital (ADC shifter)

Small existing stock (or high utilization) ↑ AD; large existing stock (excess capacity) ↓ AD.

Fiscal policy (ADC shifter)

↑ Government Spending (G) or ↓ Taxes ↑ AD; ↓ Government Spending or ↑ Taxes ↓ AD.

Monetary policy (ADC shifter)

Central bank ↓ Interest Rates ↑ AD; Central bank ↑ Interest Rates ↓ AD.

expenditure multiplier

quantifies the size of the change in aggregate demand as a result of a change in any of the components of aggregate demand

tax multiplier

quantifies the size of the change in aggregate demand as a result of a change in taxes 

autonomous change

$1 increase in _ causes changes in total GDP and total aggregate output

Marginal propensity to consume (MPC)

the expenditure multiplier  and tax multiplier depend on _, change in consumer spending divided by the change in disposable income

Marginal propensity to save (MPS)

the fraction of additional income that is saved rather than spent on consumption.

1

MPC+MPS

Short-run aggregate supply curve (SRAS)

relationship between aggregate price level and the quantity of aggregate output supplied in the short-run, positive relationship because of sticky wages and prices

Cause of shift of SRAS curve

changes in production costs

Short-run trade off

unemployment and inflation, unemployment decreases as inflation increases

Long-run aggregate supply curve

all prices and wages are fully flexible, vertical line because changes in aggregate price level have no effect on aggregate output in the long run

Potential output

corresponds to LRAS curve, both represent the total output an economic system will produce over a set period of time if all resources are fully employed

Short-run equilibrium

occurs when aggregate quantity of output demanded equals aggregate quantity of output supplied; intersection of AD and SRAS curves

Long-run equilibrium

occurs when SRAS and AD curves intersect on LRAS curve; short run equilibrium exists at full employment level of real output

Short-run output gaps

positive: inflationary, negative: recessionary occurs when short run equilibrium output is above or below full-employment level of output

Positive demand shock

output, employment, and price level rise in short-run

negative demand shock

output, employment, and price level fall in short-run

positive supply shock

output and employment rise and price level falls in short-run

negative supply shock

output and unemployment fall and price level rises in short-run

demand-pull inflation

caused by changes in aggregate demand

cost-push inflation

caused by changes in aggregate supply