AP Macro Unit 3: National Income & Price Determination

Define AD

all the goods and services (real GDP) that buyers are willing and able to buy at different price levels

What are the 3 reasons for why AD is downard is sloping

1) Wealth Effect: Price level relationship (higher price level means lower rGDP since purchasing power is reduced)

2) Interest Rate Effect: Higher interest rates discourage consumer spending and business investments

3) Foreign Trade Effect: Exports fall and imports rise causing rGDP demanded to fall

What are the Shifters of AD

C + I + G + (X-M)

Effects of “U.S. dollar appreciates against a foreign currency”

U.S. goods more expensive so exports decrease which means AD decreases

Define MPC

how much ppl spend rather than save when there is disposable income

Formula for MPC

change in consumption / change in DI

Define MPS

how much ppl save rather than spend when there is DI

Calculate MPS

change in savings / change in DI

How to calculate the spending multiplier

1 / 1 - MPC OR 1 / MPS

equation that uses the spending multiplier

change in rGDP = mult * change in spending

As the MPC falls, multiplying ____

falls too

Are tax cuts as effective as government spending?

No, they are not because tax cuts rely on consumers spending rather than saving - which might not be the case - where as government expenditures guarantees an increase in AD which means consumer spending also increases.

How to calculate the tax multiplier

MPC / MPS OR 1 less than spending multiplier

What must one remember about the tax multiplier

An increase in taxes decreases AD which makes the multiplier negative

Define AS

the amount of goods and services that firms will produce in an economy at diff. price levels

SRAS vs. LRAS

SR: wages and resource prices are sticky and will not change as price levels change

LR: wages and resource prices are flexible and will change as price levels change

Shifters of SRAS

1) Resource prices

2) Government Action

3) Productivity

What happens in the long run?

In the long-run, workers demand higher wages to match higher price levels

what does the LRAS curve suggest

price levels increases, but GDP doesn’t

shifters of LRAS

same as the shifters of PPC:

1) Change in resource quantity/quality

2) change in technology

** basically inc/dec in human & physical capital

What are the 3 output gaps, and describe their graphs

1) Full Employment: every curve at equilibrium

2) Inflationary: LRAS left of AD=AS

3) Recessionary: LRAS right of AD=AS

Define Stagflation and what causes it

Stagflation is when there is inflation and low output.

This results from shifting SRAS to the left as price levels increase (inflation) and output decreases

What are the causes of inflation

1) Demand Pull Inflation (AD increase)

2) Cost-Push Inflation (AS decrease)

Assume an economy is in long run equilibrium, what will happen in the SR and the LR is consumer spending increases?

SR: AD Increase

LR: AS decrease bc wages and resource prices will increase to match higher prices levels

Assume an economy is in long run equilibrium, what will happen in the SR and the LR is investments increase?

SR: AS increase

LR: LRAS increase bc capital stock increases which is a shifter for LRAS

What causes economic growth?

Increases in investments cause economic growth because it also increases capital stock

What is Fiscal policy

government spending and taxes

Discretionary v.s. Non- Discretionary Fiscal Policy

Dis = direct actions by Congress (passing new bills)

Non = non-direct actions (income taxes)

Contractionary v.s. Expansionary Fiscal Policy

Contra: Closes inflationary gap by decreasing spending and increasing taxes

Expan.: closes recssioary gap by increasing spending and decreasing taxes

Automatic Stabilizer

they are non - discretionary fiscal policies - they are Expansionary during a downturn in the economy and contractionary during an expansionary period

Transfer Payments act as _____ but uses _____

act as government spending but uses tax multiplier.

According to the expenditure multiplier, if the marginal propensity to consume is greater than zero, a one-dollar change in autonomous expenditures will result in which of the following?

A greater than one dollar increase in aggregate demand for goods and services

If nominal wages are fixed by labor contracts, then which of the following explains why the aggregate supply curve is upward sloping?

An increase in the price level will increase profits and production, to which firms respond by hiring more workers and increasing production

Correlation between tax revenues and GDP

direct - if one increases then so does the other

Describe how the economy will self adjust in the long run when there is a negative output gap

resource prices and wages will decrease so the SRAS shifts right

Describe how the economy will self adjust in the long run when there is a positive output gap

resource prices and wages will increase so the SRAS shifts left