farta

what does the aggregate demand graph represent?

all the goods and services that are demanded in an economy at a certain price level

why does the aggregate demand graph go down and to the right?

1. wealth effect. when the price level goes up, people's dollar doesn't go as far and they feel less wealthy, so they buy less.

2. interest rate effect. higher price levels mean more demand for money/loans. because of this, banks have to increase their interest rates. this results in less business investment and consumption

3. foreign purchases effect. the higher the price level, the less exports demanded by foreign consumers. this makes Xn go down, which makes the GDP at this spot less.

what shifts the aggregate demand curve?

consumption, business investment, government spending, net exports.

more of any of these things results in a rightward shift. less of any of these things results in a leftward shift.

What is APC?

average propensity to consume. tells you the average amount of a household's total income that spent by showing ratio of consumption to disposable income

What is APS?

average propensity to save. tells you the average amount of a household's total income that is saved by showing the ratio of savings to disposable income

how is APC calculated

C/DI

how is APS calulated

savings/DI

note: APC+APS=1

what is MPC?

marginal propensity to consume. tells you the fraction spent of any change in disposible income

what is MPS?

marginal propensity to save. tells you the fraction saved of any change in disposible income

how is MPC calculated?

change in consumption over change in disposable income

how is MPS calculated?

change in savings over change in disposable income

note: MPC+MPS=1

what is the mulitplier effect?

the idea that one person/industry spends a certain percentage of their income, which then goes to the person/industry they spent it on. this person/industry then spends a certain amount of their income (which was just made greater) and the circle repeats.

how is the spending multiplier calculated?

1/MPC

how to found the change in real GDP with multiplier?

Change in real GDP = initial change in spending TIMES the spending multiplier

how is the tax multiplier calculated?

-MPC/MPS

always one less than the spending multiplier, but negative

what does the tax multiplier actually mean??

what does the SRAS represent?

the amount of an economy's output or real GDP that is produced by an economy's firms at a certain price level.

why does the SRAS go up and to the right?

at a higher price level, the goods that firms are producing can be sold for more, thus increasing the value of everything that is produced, thus making GDP larger. Also, companies have an incentive to produce more when the PL is higher.

what shifts the SRAS?

resource prices (when the price of factors of production increases, SRAS shifts left and vice versa)

productivity (when an economy becomes more productive - usually due to new tech - the SRAS shifts right and vice versa)

gov (if the gov impedes productivity with a tax or regulation, the SRAS shifts left and vice versa)

negative supply shocks (cause the supply of a product to decrease, makes the SRAS shift left)

positive supply shocks (cause the supply of a product to increase, makes the SRAS shift right)

why is the LRAS a vertical line

say something happens and we expereince a move (not a shift) on the SRAS where price level goes up. consumer expectations of inflation cause the prices of factors of production to increase, making the SRAS go left

say something happens and we expereince a move (not a shift) on the SRAS where price level goes down. consumer expectations of deflation cause the prices of factors of production to decrease, making the SRAS go right

both of these scenarios make the SRAS move further away from where it was originally. therefore, when you kind of average the SRAS to view it in the long run, its just a vertical line. this averaged movement is also why we say the LRAS has flexible prices

LRAS and buisness cycle and the PPC?

The LRAS is the potential GDP line in the buisness cycle graph, and is also the curve on the PPC!

what can shift the LRAS?

the same things that shift the PPC! improved tech, more resources, more capital goods, trade with other economies

review: what is short run equilibrium?

"x marks the spot". where SRAS and AD meet (LRAS doesn't matter)

when does the economy have a surplus of goods, in regard to short run equilibrium?

when supply > demand

when does the economy have a shortage of goods, in regard to short run equilibrium?

when demand > supply

what happens when the AD line goes left in the aggregate model? also, how is this self corrected?

a recessionary gap (aka negative output gap). PL and GDP both decrease. Unemployment increases.

self corrected: because price levels went down, people's real wages theoretically increased because their dollar goes further. bc of this, people are willing to agree to lower nominal wages. this results in factors of production decreasing in price, which allows the SRAS to shift right and meet where the AD and LRAS lines intersect (thereby restoring long run equilibrium that is at a slightly lower price level)

what happens when the AD line goes right in the aggregate model? also, how is this self corrected?

demand pull inflation (aka inflationary gap or positive output gap) PL and GDP both increase. less unemployment.

self correction: because PL is higher, people's real wages are lower. because of this, a lot of people will ask their bosses for raises in order to keep up with the increased cost of living. when bosses give out these raises, factors of production increase in cost. this causes the SRAS to shift left and meet where the AD and LRAS lines intersect (thereby restoring long run equilibrium that is at a higher price)

what happens when SRAS goes left in the aggregate model? also, how is this self corrected?

cost push inflation/stagflation occurs. PL increases, GDP decreases. unemployment increases.

really cannot self correct. just have to wait for it to run it's course. (can't really correct with fiscal policy either without making it worse.) this is why stagflation is one of the most detrimental things to occur in an economy

what happens when the SRAS goes right in the aggregate model? also, how is this self-corrected?

positive supply shock. suddenly the economy has a ton more goods for a lower price...this causes consumer spending to go up, making the AD line shift right naturally, creating a new short term equilibrium. this new short run equilibrium is way to the right of the old one. this causes the LRAS to move right with it, thereby creating a long run equilibrium that was previously unattainable. yay, economic growth! ppc moves out

don't wanna correct this, its a good thing.

what were the assumptions made by the classical economists that came up with the "self-correction" theories?

1. no government intervention is occurring in the economy.

2. input prices (wages, rent, interest) are flexible and not sticky.

what is the definition of fiscal policy

the use of government spending and tax collecting to influence the economy

who makes fiscal policy

the president and congress ONLY

what is the federal budget

a plan for the government's tax revenues and spending for the coming year.

balanced budget when the gov's expenditures and income are equal

budget surplus when the gov's income exceeds its expenditures

budget deficit when the gov's expenditures exceed its income (this is what the US is usually in)

mandatory vs discretionary spending

mandatory spending=money that is guaranteed by the government to certain programs (social security, welfare, unemployment insurance)

discretionary spending=money that the government can vote to spend or not spend on programs.

what is the goal of expansionary fiscal policies?

what are some common examples of expansionary fiscal policies?

these want to bring the AD line to the right! used when we are in a recessionary gap and need to fix that.

increase government spending via creating jobs or increasing transfer payments (via the multiplier effect, this causes people to spend more, which increases AD)

cut taxes (also causes people to spend more)

what is the goal of contractionary fiscal policies?

what are some common examples of contractionary fiscal policies?

goal is to bring the AD left! used when we are in an inflationary gap and need to fix that.

decrease government spending. increase taxes

what are some issues with fiscal policy?

1. there is a lag time due to the delayed results of the multiplier effect

2. it is difficult to predict the future, and sometimes policy makers mess up and end up doing something that hurts more than helps. (ex: Bush increased government spending by a ton during his presidency. he did it with the intention of improving life in america, but it backfired when 9/11 happened and we needed money for the newly increased military costs)

3. there is a political pressure for presidents and congresspeople to make voters happy so they get reelected. bc of this, they may not increase taxes when the country needs it.

what are automatic stabilizers?

government programs that we've established over the years that automatically kick in during recessionary/inflationary gaps. they increase/decrease gov spending when needed.

what are the big three examples of automatic stabilizers and how do they work?

1. progressive tax rates. these ensure that poor people do not get taxed too much. also ensures that if everyone suddenly gets richer, they will be paying more taxes (this is important because it prevents demand pull inflation. similar to contractionary fiscal policy)

2. welfare programs (ex: SNAP, which provides food stamps. These automatically increase government spending when lots of people are below the poverty line. this thereby prevents a recessionary gap (similar to expansionary fiscal policy)

3. unemployment insurance. This automatically increases government spending when lots of people are unemployed. this thereby prevents a recessionary gap (similar to expansionary fiscal policy)