Unit 3 - slides - APMAC

APMAC - Unit 3 National Income and Price Determination

Topic 3.1 - Aggregate Demand

• Definition: Demand for all finished goods and services at various price levels in a given period of time.

• Components of Aggregate Demand (AD):

  • Consumer spending on goods

  • Investment spending by businesses

  • Government spending on goods and services

  • Net exports

• Relationship with GDP: As demand for certain goods rises, the quantity produced increases, impacting GDP positively, and vice versa.

Aggregate Price Level

• The AD Curve

  • AD Curve Explanation:

    • Increased price level leads to reduced aggregate output.

    • Decreased price level leads to higher aggregate output.

  • Price Levels (PL): PL1, PL2, PL3, where R1, R2, R3 denote real GDP values corresponding to different prices.

Factors Influencing AD Movement Along the Curve

• Wealth Effect: Price changes affect the real purchasing power of households.

• Real Interest Rate: Influences consumer spending and business investments.

• Net Export Effect: Price level changes alter the attractiveness of domestic goods for foreign buyers.

Shifts in Aggregate Demand Curve

• AD Components Interaction: Any change in components (C+I+G+Xn) shifts the entire AD curve.

  • Increase in components shifts curve to the right.

  • Decrease shifts curve to the left.

Movement Along the Curve

• Movement Up Along the Curve: Indicative of demand-side economics.

• Movement Down Along the Curve: Indicates decreasing demand.

Case Studies:

• Decline in gross investments due to decreased business confidence.

• Economic boom in major trade partners leading to increased net exports.

Topic 3.2 - Multipliers

• Multiplier Concept: Examines effects of fiscal injections or decreases on money supply and economic output (GDP).

Propensities to Consume and Save

• Consumption vs. Saving:

  • Individuals either consume (spending) or save (investments).

  • Average Propensity to Consume (APC): Ratio of spending to income.

  • Average Propensity to Save (APS): Ratio of saving to income.

• Relationship: APC + APS = 1

Examples of Calculating APC and APS

• Given income figures, calculate APC and APS using defined formulas.

  • Example 1: Amy spends $400 from $500 income → APC = 0.8

  • Example 2: Vihn spends $700 from $1000 income → APS = 0.3

Spending and Income Relationship

• Spending Creates Income: One person's expenditure generates income for another, creating additional spending.

  • Example: Finding $100 leads to a broader increase in income across the economy.

Marginal Propensity to Consume (MPC) and Save (MPS)

• Definitions:

  • MPC: Proportion of each new dollar of disposable income spent.

  • MPS: Proportion of each new dollar of disposable income saved.

  • MPC + MPS = 1

Practice Set Calculations

• Example Questions: To calculate MPC or MPS given certain income and spending changes.

Topic 3.3 - Government Fiscal Influence

• Economic Impact of Government Actions

  • Keynesian Economics: Argues that government intervention is necessary during recessionary gaps; suggests increasing spending or cutting taxes.

Effects of Government Spending and Taxes

• Expansionary Fiscal Policy: Intended to increase AD by increasing government spending or cutting taxes; affects real GDP positively.

• Contractionary Fiscal Policy: Aimed at reducing overheating in the economy by decreasing spending or raising taxes; can help lower inflation.

Topic 3.4 - Automatic Stabilizers

• Definition: Established policies that automatically adjust to economic shifts.

• Examples: Unemployment insurance and progressive tax systems that increase taxes in good times and decrease during downturns.

Role of Automatic Stabilizers in Economic Corrections

• Inflationary Gap: Automatic adjustments increase tax burden, cooling down the economy.

• Recessionary Gap: Automatic supports like unemployment insurance increase consumption, aiding economic recovery.

Topic 3.5 - Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply (LRAS)

• Short-Run Aggregate Supply (SRAS):

  • Relationship with price levels and the quantity of goods supplied in the short run.

  • Decreases in production costs can shift the SRAS to the right.

• Long-Run Aggregate Supply (LRAS):

  • Represents the economy's potential output when all resources are fully employed.

  • Determined by factors such as technology, resources, and labor productivity.

• Differences between SRAS and LRAS:

  • SRAS can be affected by price levels, while LRAS is vertical and shows full employment output.

Topic 3.6 - Economic Fluctuations

• Causes of Economic Fluctuations:

  • Shifts in AD and SRAS curves leading to business cycles.

  • Demand shocks and supply shocks can lead to recessions or booms.

• Consequences of Economic Fluctuations:

  • Impact on GDP, employment, and inflation rates.

  • Fluctuations often lead to economic policies aimed at stabilization.

Topic 3.7 - The Role of Expectations

• Expectations: Impact decision-making of consumers and businesses.

• Future Price Expectations:

  • If consumers expect future prices to rise, they may spend more now, shifting AD curve right.

  • Expectations about future economic conditions can lead to variation in business investments.

• Inflation Expectations: Can contribute to wage and price-setting behavior, influencing SRAS.

Topic 3.8 - The Phillips Curve

• Definition: Illustrates the inverse relationship between inflation and unemployment.

• Short-Run Phillips Curve (SRPC): Shows that lower unemployment can lead to higher inflation.

• Long-Run Phillips Curve (LRPC): Vertical representation implying that in the long run, inflation does not impact unemployment.

• Expectations and the Phillips Curve:

  • Adaptive Expectations: Past inflation influences future inflation expectations, shifting the SRPC.

  • Policy Implications: Understanding the trade-off impacts monetary and fiscal policy decisions to manage inflation and unemployment effectively.