Unit 3 - National Income and Price Determination

Flashcards covering key vocabulary and concepts related to Aggregate Demand and Aggregate Supply.

AGGREGATE DEMAND

A schedule or curve that shows the amounts of real output that buyers collectively desire to purchase at each possible price level. The relationship between price level (PL) and amount of real GDP (rGDP) demanded is inverse.

Wealth Effect

Higher price level reduces the real value of the public’s accumulated savings, reducing spending.

Interest-Rate Effect

When price level rises, people need more money, increasing demand for borrowed money and interest rates, discouraging spending.

Foreign Purchases Effect

When the U.S. price level rises, foreign purchases of American goods decrease, and Americans buy more foreign goods, causing imports to increase and exports to decrease.

Aggregate Demand

The total amount of GDP demanded; GDP = C + Ig + G + Xn (Consumer spending + Gross Investment + Government spending + Net Exports)

CONSUMER SPENDING

Spending by households on goods and services. Influenced by consumer wealth, expectations, household indebtedness, and taxes.

GOVERNMENT SPENDING

Spending by the government on goods and services. Increases or decreases directly affect aggregate demand.

NET EXPORT SPENDING

Increase in net exports (Xn) causes an increase in AD; Decrease in Xn causes a decrease in AD; Influenced by national income abroad and exchange rates.

INVESTMENT SPENDING

Increase in investment causes an increase in AD; Decrease in investment causes a decrease in AD; Most volatile component of GDP.

INVESTMENT DEMAND

As real interest rates (rIr) increase, quantity of investment demand decreases; If expected rate of return exceeds the real interest rate, a business should invest.

INVESTMENT DEMAND SHIFTERS

Cost of capital goods, business taxes, technology, expectations of future sales/costs/profits, and excess capacity.

AGGREGATE SUPPLY

A schedule or curve showing the level of real domestic output that firms will produce at each price level. Relationship between price level (PL) and output is direct.

Horizontal Range (Aggregate Supply)

Levels of output below Full Employment (Yf); Per-unit production cost does not increase when output increases; Sticky Prices; Recession.

Intermediate Range (Aggregate Supply)

Levels of output between Yu and Yc; Per-unit production costs increase as output increases; Labor costs, shortage of skilled workers or raw materials, use of older machinery, hiring of less capable workers, decrease in labor productivity.

Vertical Range (Aggregate Supply)

Increases in price level will produce no additional output. The economy is already operating at its full capacity; Bidding wars increase prices.

AGGREGATE SUPPLY SHIFTERS

Input Prices, Resource Availability, Exchange Rates, Tariffs, Market Power, Productivity, Legal-Institutional Environment.

Input Prices (Aggregate Supply)

Higher input prices increase per-unit production costs and decrease AS and vice versa; Changes in resource availability of land, labor, capital, and entrepreneurial ability; Changing prices of imported resources.

Productivity

(total outputs/total inputs)

Legal-Institutional Environment (Aggregate Supply)

Business Taxes and Government Regulation.