Macroeconomics Unit 3

1. What is the primary reason for the downward slope of the Aggregate Demand curve?

• Interest Rate Effect: the price of borrowing to purchase capital or durable goods (houses, cars, etc)

  • When the price level increases interest rates increase (to cover inflation effects)

• The real Wealth Effect: the "real" is the value or purchasing power of money

  • As prices increase due to inflation it takes more dollars to purchase the same goods (price level increase purchasing power decrease)

• Exchange Rate Effect (or Net Export Effect)

  • As domestic price level increase domestic products are more expensive for foreign buyers and foreign goods are less expensive for domestic consumers to buy

2. How does an increase in the domestic price level affect net exports?

• Decrease. Domestic products are more expensive for foreign buyers and foreign goods are less expensive for domestic consumers to buy

3. When measuring Real GDP, what does a price level increase from PL to PL1 result in?

• A decrease in real GDP from Y to Y1

4. Which of the following best describes Real GDP?

• A dollar value that is equal to aggregate output

5. How do consumer expectations of improved economic conditions affect consumption?

• When consumers expect economic conditions to improve they buy more goods/services

6. What is the relationship between interest rates and investment spending?

• Inverse relationship between interest rates and investment spending: lower interest rates encourage businesses to borrow and invest more, while higher rates make borrowing more expensive, leading to reduced investment. 

7. How do unplanned increases in business inventories affect investment spending?

• Decrease spending on capital goods to produce less Ig

8. What is the formula for the Marginal Propensity to Consume (MPC)?

• The additional spending that results when a consumer receives an additional disposable income. MPC = C/DI

9. If the MPC is 0.8, what is the spending multiplier?

• 1/(1-MPC) = 5

10. What is the relationship between the tax multiplier and the spending multiplier?

• - MPC/MPS = - MPC * spending multiplier

11. What characterizes the Short-Run Aggregate Supply curve?

• Shows the relationship between real GDP and the price level. Positive relationship between the price level and the quantity of goods and services firms are willing to supply in the short-run, where prices and wages are assumed to be "sticky".

• The short run is how long it takes for input prices to catch up with the changes in price level. When wages or other inputs lag behind the price level changes they are referred to as "sticky"

12. Which factor would cause a rightward shift in the SRAS curve?

• Anything that makes it either CHEAPER or EASIER to produce goods/services will increase SRAS and result in a rightward shift in the curve

  • Decrease in input costs

  • Increase in productivity

13. What distinguishes Long-Run Aggregate Supply from Short-Run Aggregate Supply?

• SRAS:

  • One input remains fixed

  • Characterized by sticky wages and prices

  • Producers increase/decrease production in response to change in price level

• LRAS:

  • All input prices are variable

  • There are NO trade offs between inflation and unemployment

14. What defines a recessionary gap?

• Price levels remain static because input prices are so sticky that an increase in demand for goods/services leads to no increase in input prices and a horizontal supply curve.

15. What is demand-pull inflation caused by?

• Caused due to an increase in AD

16. How does the economy self-adjust to an inflationary gap?

• SRAS shifts to the left INCREASING inflation AND unemployment

• Output decreases and the price level increases.

17. Which fiscal policy measure would be appropriate for closing a recessionary gap?

• Government can stimulate the economy through increased spending OR decreasing taxes in order to INCREASE AD

18. What is an automatic stabilizer?

• Assist with fixing or mitigating the issues with output gaps that occur automatically without policy change

19. Which type of lag occurs when policymakers debate and pass legislation?

• Legislative lag

20. How does the multiplier affect government spending to close a gap?

• Tells us how much more or less spending is needed to close an output gap. The change in government spending times the multiplier should equal the size of the gap.