AP Macroeconomics Notes

Definition: The total quantity of all goods and services demanded in the economy at various price levels.
Components of AD: AD = C + I + G + (X - M)
- C: Consumption Expenditure (households)
- I: Investment Spending (businesses)
- G: Government Spending
- (X - M): Net Exports (Exports - Imports)
Why the AD Curve is Downward Sloping:
1. The Wealth Effect: A lower price level increases the real value of money, increasing purchasing power and consumption.
2. The Interest Rate Effect: Lower price levels lead to lower interest rates, which stimulates investment spending.
3. The Foreign Trade Effect: Lower domestic price levels make domestic goods cheaper for foreigners, increasing exports and reducing imports.

MPC & MPS:
- Marginal Propensity to Consume (MPC): \text{MPC} = \frac{\Delta \text{Consumption}}{\Delta \text{Disposable Income}}
- Marginal Propensity to Save (MPS): \text{MPS} = \frac{\Delta \text{Savings}}{\Delta \text{Disposable Income}}
- Key Identity: MPC + MPS = 1
Spending Multiplier:
- Formula: \text{Spending Multiplier} = \frac{1}{MPS} = \frac{1}{1 - MPC}
- Total Change in GDP: \Delta \text{GDP} = \text{Initial Spending Change} \times \text{Spending Multiplier}
Tax Multiplier (negative because taxes and spending move in opposite directions):
- Formula: \text{Tax Multiplier} = -\frac{MPC}{MPS}
- Total Change in GDP: \Delta \text{GDP} = \Delta \text{Tax} \times \text{Tax Multiplier}

Definition: The relationship between the price level and the total output produced by firms in the short run.
Characteristics: Upward sloping because nominal wages and resource prices are "sticky" (slow to adjust) in the short run.
Shifters (I.R.A.P.):
- I: Inflationary Expectations
- R: Resource Prices (e.g., wages, oil prices)
- A: Actions of the Government (taxes on production, subsidies, regulation)
- P: Productivity (Technology improvements)

Definition: A vertical line at the full-employment level of output (Y_f).
Significance: Represents potential GDP; in the long run, wages and prices are flexible.
Shifters: Changes in the quality or quantity of resources/technology.

Short-Run Equilibrium: Where AD intersects SRAS.
Gaps:
- Recessionary Gap: Equilibrium output (Y1) is less than Yf. Characterized by high unemployment.
- Inflationary Gap: Equilibrium output (Y1) is greater than Yf. Characterized by low unemployment and price level pressure.

From a Recession: High unemployment leads to lower nominal wages. Production costs fall, shifting SRAS to the right until output returns to Y_f.
From an Inflationary Gap: Low unemployment leads to higher nominal wages. Production costs rise, shifting SRAS to the left until output returns to Y_f.

Expansionary Policy (Fixes Recessionary Gaps): Increase Government Spending (G \uparrow) or Decrease Taxes (T \downarrow).
Contractionary Policy (Fixes Inflationary Gaps): Decrease Government Spending (G \downarrow) or Increase Taxes (T \uparrow).
Crowding Out: A limitation of expansionary fiscal policy. Government borrowing increases interest rates, which reduces private investment (I \downarrow).

Definition: Mechanisms that automatically trigger changes in the budget without specific action by policymakers.
Examples: Progressive income taxes and transfer payments (like unemployment insurance).

If the Marginal Propensity to Consume (MPC) is 0.8, what is the spending multiplier and the maximum change in GDP if government spending increases by \$20 billion?
- A) Multiplier: 4; Change in GDP: \$80 billion
- B) Multiplier: 5; Change in GDP: \$100 billion
- C) Multiplier: 1.25; Change in GDP: \$25 billion
- D) Multiplier: 5; Change in GDP: \$16 billion
Which of the following events would cause a rightward shift in the Short-Run Aggregate Supply (SRAS) curve?
- A) An increase in inflationary expectations.
- B) A decrease in corporate subsidies.
- C) A decrease in the cost of raw materials (resource prices).
- D) An increase in the marginal tax rate for households.
If an economy is in an inflationary gap, which of the following fiscal policy actions would be most appropriate to return the economy to full employment?
- A) Increase transfer payments.
- B) Decrease government spending and increase taxes.
- C) Decrease interest rates to stimulate investment.
- D) Increase government spending on infrastructure.
The "Crowding Out" effect suggests that:
- A) Increased government spending leads to lower taxes.
- B) Government deficit spending increases interest rates, which reduces private investment.
- C) High inflation causes consumers to save more money.
- D) A decrease in exports leads to a decrease in domestic production.

Scenario: Assume the United States economy is currently operating at an equilibrium level of output below the full-employment level of output.

Draw a correctly labeled graph of the Aggregate Demand, Short-Run Aggregate Supply, and Long-Run Aggregate Supply (AD-AS) model.
- Label the current equilibrium price level as PL1 and the current output as Y1.
- Label the full-employment output level as Y_f.
Identify the Gap: State whether the economy is experiencing a recessionary gap or an inflationary gap.
Fiscal Policy Action: On your graph, show the impact of an expansionary fiscal policy.
- Label the new equilibrium price level as PL2 and output as Y2.
Long-Run Self-Correction: If the government did not intervene, explain the process by which the economy would return to full employment in the long run. Specifically, mention what happens to nominal wages and which curve shifts.