AP Macro U3W2 SlideDeck

Overview

• This slide deck pertains to Aggregate Demand (AD) and Aggregate Supply (AS) concepts, including multipliers and the roles of government policy in economic stabilization.

Key Components of Aggregate Demand

• Aggregate Demand (AD) is composed of four main components:

  • Consumption (C)

  • Investment (I)

  • Government Spending (G)

  • Net Exports (NX)

• Formula: AD = C + I + G + NX

Marginal Propensity to Consume (MPC)

• The Marginal Propensity to Consume (MPC) measures the change in consumption resulting from a change in disposable income.

• Formula: MPC = Consumer Spending / Disposable Income

• Values of MPC:

  • Ranges from 0 to 1 (0 ≤ MPC ≤ 1)

  • The Marginal Propensity to Save (MPS) is defined as 1 - MPC.

Multipliers

• Definition: Multipliers amplify the effect of a change in spending or taxes on the overall economy.

• Expenditure Multiplier:

  • Formula: 1 / (1 - MPC)

• Tax Multiplier:

  • Formula: - MPC / (1 - MPC)

Helpful Hints

• Different values of MPC and their corresponding expenditure and tax multipliers:

  • MPC = 0.9:

    • Expenditure Multiplier: 10

    • Tax Multiplier: -9

  • MPC = 0.8:

    • Expenditure Multiplier: 5

    • Tax Multiplier: -4

  • MPC = 0.75:

    • Expenditure Multiplier: 4

    • Tax Multiplier: -3

  • MPC = 0.6:

    • Expenditure Multiplier: 2.5

    • Tax Multiplier: -1.5

The Aggregate Supply (AS) Curve

• The AS Curve illustrates the relationship between the economy's aggregate price level and the amount of output supplied:

  • Short-Run Aggregate Supply (SRAS): Upward sloping curve.

    • Higher prices lead to higher output due to sticky wages.

  • Long-Run Aggregate Supply (LRAS): Vertical curve.

    • No impact of price levels on aggregate output in the long run.

Economic Principles

10 Principles of Economics (Mankiw):

• 1: People face trade-offs.

• 2: The cost of something is what you give up to get it.

• 3: Rational people think at the margin.

• 4: People respond to incentives.

• 5: Trade can make everyone better off.

• 6: Markets usually organize economic activity well.

• 7: Governments can improve market outcomes.

• 8: A country's standard of living depends on its ability to produce.

• 9: Prices rise when the government prints too much money.

• 10: Society faces a trade-off between inflation and unemployment.

Inflation and Unemployment

• There is a short-run trade-off between inflation and unemployment.

• As price levels increase, output rises, and unemployment falls.

• To reduce inflation, higher unemployment may occur.

Shifters of SRAS

• Changes in production costs can shift the SRAS inwards or outwards:

  • Lowered commodity prices increase output.

  • Factors influencing shifts:

    • Commodity prices, nominal wages, productivity, inflation expectations.

Long Run vs Short Run: Aggregate Supply

• LRAS shows potential output at full employment.

• No relationship exists between aggregate price levels and output in the long run.

Government Policy and Output Gaps

• Fiscal Policy: Government uses policies to shift AD to close recessionary or inflationary gaps.

• Expansionary Policy: Aimed at increasing AD.

• Contractionary Policy: Aimed at decreasing AD.

• Automatic Stabilizers: Policies (e.g., taxes and transfers) that automatically adjust to economic conditions.

Lag Effects in Fiscal Policy

• The time involved in identification, design, implementation, and impact can result in lagged policy responses that may not meet current economic conditions.

Adjusting to Demand Shocks

Negative Demand Shock:

• Adjustments can occur through:

  • LR Self-Adjustment: Invisible Hand and flexible wages push SRAS outward.

  • Active Fiscal Policy: Government intervention can stimulate AD.

  • Automatic Stabilizers: Tax and transfer adjustments that naturally buffer the economy.

Positive Demand Shock:

• Outcomes and adjustments must consider shifts in equilibrium and stabilization measures.