Aggregate Demand, Aggregate Supply, and Macroeconomic Policy

Comprehensive vocabulary flashcards covering Aggregate Demand, Short-Run and Long-Run Aggregate Supply, macroeconomic equilibrium, output gaps, fiscal and monetary policies, the Phillips Curve, multipliers, and automatic stabilizers.

Aggregate Demand (AD) Curve

A downward-sloping curve showing the inverse relationship between the aggregate price level and the quantity of aggregate output demanded (Real GDP).

The Wealth Effect

An economic mechanism where a rise in the aggregate price level reduces the real purchasing power of households' nominal assets (cash, checking/savings deposits), leading to reduced consumer spending ($C$) and lower Real GDP demanded.

The Interest Rate Effect

An economic mechanism where a higher aggregate price level reduces the purchasing power of money, causing households and firms to borrow more or sell non-cash assets; this drives up interest rates, raising borrowing costs for investment ($I$) and increasing saving incentives over consumption ($C$).

Short-Run Aggregate Supply (SRAS) Curve

An upward-sloping curve showing a positive relationship between the aggregate price level and Real GDP supplied in the short run, driven by sticky input costs.

Sticky Wages

Nominal wages that are slow to change in the short run due to multi-year union contracts or informal agreements, enabling firm profit per unit to rise when aggregate price levels increase.

Long-Run Aggregate Supply (LRAS) Curve

A vertical line fixed at potential output ($Y_p$ or $Y_f$), reflecting that in the long run, all prices and nominal wages are fully flexible, leaving output unaffected by aggregate price level changes.

Potential Output ($Y_p$)

The level of Real GDP produced when the economy is at full employment, meaning actual unemployment equals the natural rate of unemployment with zero cyclical unemployment.

Short-Run Macroeconomic Equilibrium ($E_{SR}$)

The point where the Aggregate Demand (AD) curve intersects the Short-Run Aggregate Supply (SRAS) curve, determining short-run equilibrium price level ($P_1$) and Real GDP ($Y_1$).

Long-Run Macroeconomic Equilibrium ($E_{LR}$)

The point where the Aggregate Demand (AD), Short-Run Aggregate Supply (SRAS), and Long-Run Aggregate Supply (LRAS) curves all simultaneously intersect ($Y_1 = Y_p$).

Recessionary Gap

An economic state where actual output is less than potential output ($Y_1 < Y_p$) and the AD-SRAS intersection lies to the left of the LRAS curve, resulting in actual unemployment exceeding the natural rate.

Inflationary Gap

An economic state where actual output exceeds potential output ($Y_1 > Y_p$) and the AD-SRAS intersection lies to the right of the LRAS curve, resulting in labor shortages where actual unemployment is below the natural rate.

Self-Correction Mechanism

The process by which flexible nominal wages and production costs adjust over time in response to labor market surpluses or shortages, shifting the SRAS curve back to long-run equilibrium at $Y_p$.

Demand Shock

An event that shifts the Aggregate Demand curve, causing the aggregate price level and Real GDP to move in the same direction.

Supply Shock

An event that shifts the Short-Run Aggregate Supply curve, causing the aggregate price level and Real GDP to move in opposite directions.

Stagflation

A combination of stagnation (falling Real GDP and rising unemployment) and inflation (rising price level), resulting from a negative supply shock that shifts the SRAS curve to the left.

Expansionary Fiscal Policy

Government measures used to close a recessionary gap by increasing government purchases ($G$), increasing transfers, or cutting taxes to shift the AD curve to the right.

Contractionary Fiscal Policy

Government measures used to close an inflationary gap by decreasing government purchases ($G$), decreasing transfers, or raising taxes to shift the AD curve to the left.

Policy Lags

Delays associated with collecting economic data, passing legislation through Congress, and implementing spending, which can lead fiscal policy to arrive after the economy has already begun to self-correct.

Short-Run Phillips Curve (SRPC)

A downward-sloping curve illustrating an inverse short-run trade-off between the inflation rate and the unemployment rate.

Long-Run Phillips Curve (LRPC)

A vertical line positioned at the NAIRU (Nonaccelerating Inflation Rate of Unemployment), which corresponds to the natural rate of unemployment.

NAIRU

The Nonaccelerating Inflation Rate of Unemployment, which is identical to the natural rate of unemployment and marks the location of the vertical Long-Run Phillips Curve.

Marginal Propensity to Consume (MPC)

The fraction of an additional dollar of disposable income that is spent on consumption, expressed as $MPC = \frac{\Delta C}{\Delta Y_d}$.

Marginal Propensity to Save (MPS)

The fraction of an additional dollar of disposable income that is saved, expressed as $MPS = \frac{\Delta S}{\Delta Y_d}$, satisfying the relationship $MPC + MPS = 1$.

Spending Multiplier

The factor quantifying the total change in Real GDP resulting from an initial change in spending ($G$, $I$, $C$, or $X - M$), defined as $\frac{1}{1 - MPC} = \frac{1}{MPS}$.

Tax / Transfer Multiplier

The factor that determines the total change in Real GDP resulting from changes in lump-sum taxes ($-\frac{MPC}{MPS}$) or government transfers ($+\frac{MPC}{MPS}$).

Automatic Stabilizers

Government tax and spending rules—such as progressive income tax brackets and unemployment insurance—that automatically stimulate the economy during recessions and restrain it during expansions without new congressional legislation.