Unit 3 Macroeconomics

Aggregate

“adding all together”

Aggregate demand

All the goods and services (real GDP) that buyers are willing and able to purchase ar different price levels.

The Demand for everything by everyone in the U.S.

What is the relation between price level and Real GDP

Inverse, so downward

Increase in price (inflation),

Then real GDP demanded falls

Decrease in price level (deflation),

The real GDP demanded increases

Change in price level…

Does NOT shift the curve, causes a move along

What does shift the curve?

Change in price level

Why is AD downward sloping? 1. The Wealth Effect (Real Balance Effect)

• Higher price levels reduce purchasing power of money. This decreases quantity of expenditures.

• Lower price levels increasing purchasing power and increases expenditures.

Why is AD downward sloping? 2. Interest Rate Effect

• When price level increases, lenders need to charge higher interest rates to get a REAL return on their loans.

• Higher interest rates discourage consumer spending and business investment.

Why is AD downward sloping? 3. Foreign Trade Effect

• When US price level rises, foreign buyers purchase fewer US goods and Americans buy more foreign goods.

• Exports fall and imports rise causing real GDP demanded to fall (Xn decreases)

Shifters of Aggregate Demand

1. Change in consumed spending

2. Change in investment spending

3. Change in government spending

4. Change in net exports

AD = GDP = C + I + G + Xn

Total Change in GDP =

Multiplier × Initial change in spending

The Multiplier Effect

An initial change in spending will set off a spending chain that is magnified in the economy.

Shows how spending is magnified in the economy.

Effects of Government Spending: If the government spends $5 million, will AD increase by some amount?

No, AD will increase even more as government spending becomes income for other consumers.

Consumers will take that money and spend, this increasing AFD

Marginal Propensity to Consume (MPC)

• how much people consume rather than save when there is a change in disposable income

• Always a fraction and/or decimal

• Change in consumption/change in disposable income

MPC Equation

Change in consumption/change in disposable income

Marginal Propensity to Save (MPS)

• how much people save rather than consume when there is a change in disposable income

• Always a fraction (decimal)

• Change in savings/change in disposable income

MPS Equation

Change in savings/change in disposable income

MPS =

1 - MPC

Why? Because people can either save or consume.

As the Marginal Propensity to Consume falls, the Multiplier Effect…

Lessens

What about tax cuts?

• the multiplier effect also applies when the government cuts or increases taxes

• But, changing taxes has less of an impact than government spending

Simple Tax Multiplier

MPC\MPS or MPC × 1/MPS

Total Change in GDP with tax multiplier

= Tax Multiplier × Initial change in taxes

Spending multiplier =

1/MPS or 1/1-MPC

Aggregate supply

The amount of goods and services (real GDP) that firms will produce in an economy at different price levels. The supply for everything by all firms.

Aggregate supply differentiates between…

Short run and long run

Short-run aggregate supply

Wages and resource prices are sticky and WILL NOT change as price levels change

Long-Run Aggregate Supply

Wages and resource prices are flexible and WILL change as price levels change

When price level goes up,

Businesses have an incentive to produce more in the short-run, so direct relationship → upward

Shifters of Aggregate Supply

1. (R) Change in Resource Prices

   1. Prices of Domestic and Imported resources, supply shocks, inflationary expectations

   2. If consumers and producers expect higher prices in future, workers will demand higher wages and cost will increase.

2. (A) Change in Actions of that Government (NOT government spending)

   1. Taxes on producers, subsidies for domestic producers, government regulation

3. (P) Change in Productivity

   1. Technology

MPC, simply is

The change in spending

MPS, simply is

Change in saving

Full equilibrium on graph =

SRAS and AD intersect on the LRAS, also known as NRU

Inflationary gap on graph

SRAS and AD curves intersect to the right of the LRAS

Recessionary gap on graph

Cyclical unemployment exists, the SRAS and AD curves intersect to the left of the LRAS

Recessionary gap, UE

Increases

Recessionary gap, employment

Decreases

Inflationary gap, UE

Decreases

Inflationary gap, employment

Increases

Investment spending for AD is paired with…

Interest rates

As interest decreases,

Capital investment increases

As interest increases,

Capital investment decreases

TM stands for

Tax/Transfer Multiplier

Investment is NOT answer for…

Stocks, stocks change consumer spending

Wages do not equal

Income!!!

Wages count as an…

Input cost

Investment is the only thing in a free economy to…

Bring economic growth, so causes double shift + LRAS shift in the long term

In a recessionary gap, economy corrects itself in the long-term by

Decreases wages

In an inflationary gap, economy corrects itself in the long-term by

Increases wages

LRAS =

PPC, anything that changes one effects the other

The economy can only be in one of three places

1. Negative outout gap

2. Positive output gap

3. Full Employment/NRU

Hyperinflation

Inflation over 50% in a month

Increase in money support equals

An increase in output and increase in price

More money printed →

More inflation

Velocity of money:

Number of times a dollar is spent in a year.

Expectation so higher prices →

Higher prices → expectations… and so on

Depression

When real GDP falls and falls for a long time causing unemployment to rise, income to fall, and prices to fall

Lower interest rates can encourage loans in a depression but expectations…

Can hurt this

Liquidity trap

Cycle or expectations of lower prices → lower pricean

Borrowing money…

Isn't helpful during a depression

Stagflation

Stagnant economy

Causes of Inflation

1. Demand - Pull Inflation - Total spending in economy (aggregate demand) increases faster than the economy's ability to produce goods and services.

2. Cost-push inflation - production costs increase, makinf it more expensive for dorms to produce goods and services (SRAS decreases)

Demand-Pull Inflation

Total spending in economy (aggregate demand) increases faster than the economy's ability to produce goods and services.

Cost-Push Inflation

Production costs increase, makinf it more expensive for dorms to produce goods and services (SRAS decreases)

A negative supply shock…

Reduces economy's ability to produce goods and services

Increase in discount rate =

Money more expensive

If the government does NOTHING,

AS curve will ALWAYS move in the long run through wages

Short - run → wages NOT moving →

Sticky

Output is also known as…

GDP and national income