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UNIT 3: NATIONAL INCOME AND PRICE DETERMINATION

AP MACROECONOMICS AP EXAM WEIGHTING: 17-27%Instructor: Mr. N2024-25

AD-AS Model Overview

Aggregate Market Definition: Economy-wide dynamics of all buyers and sellers of final-use products.

Axes of the AD-AS Model

• Y-Axis: Price Level (PL), measured by CPI or GDP Deflator. Higher PL = more expensive goods/services.

• X-Axis: Real GDP (RGDP), total quantity of goods/services produced. Higher RGDP = more economic output; lower RGDP = less output (recession).

Aggregate Demand (AD)

Definition: Total quantity of goods and services demanded at various price levels.

• Negative Slope Reasons:

  • Real Wealth Effect: Higher prices = lower consumer purchasing power, reducing consumption.

  • Interest Rate Effect: Higher prices = increased money demand, raising interest rates and reducing borrowing.

  • Exchange Rate Effect: Higher domestic prices reduce exports and increase imports.

Shifters of the AD Curve

• Components of AD:

  1. Consumer Spending (confidence, wealth, interest rates).

  2. Investment Spending (business sentiment, interest rates, technology).

  3. Government Spending (fiscal policy changes).

  4. Net Exports (foreign income and exchange rates).

Spending Multiplier

Key Concepts:

• Multiplier Effect: $1 of spending leads to more than $1 in economic impact.

• Marginal Propensity to Consume (MPC): Proportion of an additional dollar spent.

• Calculation Formula: Multiplier = 1 / Marginal Propensity to Save (MPS).

• Total Change: Total Change = Multiplier x Spending Increase.

Short-Run Aggregate Supply (SRAS)

Definition: Relationship between PL and RGDP supply in the short run.

• Key Idea: Higher PL = more production.

Factors Affecting SRAS

• Sticky Wages: Wages adjust slowly, benefiting firms.

• Resource Costs: Changes in wages/raw material prices.

• Productivity/Technology Changes: Improvements shift SRAS right.

• Government Policies: Taxes/regulations can influence SRAS.

• Supply Shocks: Unexpected events impacting production.

Long-Run Aggregate Supply (LRAS)

Characteristics: LRAS is vertical; output determined by resources, technology, and productivity.Adjustment: Economy returns to output via wage/input cost adjustments.

Shifters of LRAS

Changes in resources, technology, and government policies.

Equilibrium in the AD-AS Model

Long-Run Equilibrium Conditions: Full employment, output equals long-run potential, stable inflation.

Changes in the AD-AS Model

• Positive Demand Shock: Increases in AD lower unemployment, raise inflation.

• Negative Demand Shock: Decreases in AD increase unemployment, potential deflation.

• Positive Supply Shock: Lowers prices, increases output.

• Negative Supply Shock: Causes stagflation (inflation + unemployment).

Historical Examples

• COVID-19 Stimulus Checks: Increased demand led to inflation.

• 1990s Tech Boom: Innovations boosted GDP with low inflation.

• 1970s Oil Crisis: High oil prices caused inflation.

• 2008 Great Recession: Significant AD drop led to a recessionary gap.

Long-Run Self-Adjustment

Absence of intervention allows the economy to adjust back to equilibrium over time.

Fiscal Policy Influence

Keynesian Perspective: Advocates for active government intervention in downturns due to slow self-correction processes.