Aggregate Demand and Supply Flashcards
multiplier effect
when change in spending leads to a much larger change in real GDP
EX: gov spends $100
real GDP increases $400
change in autonomous spending
changes in spending that happens in response to something BESIDES increase in income
NOT HAPPENING because INCREASE IN INCOME
Marginal propensity to consume (MPC)
proportion of any additional ** income that is spent
the money you spend
marginal propensity to save (MPS)
the proportion of any additional income that is saved
MPC + MPS = 1
expenditure multiplier
the magnitude of how much real GDP will change in response to an autonomous change in aggregate spending
tax multiplier
ratio of the total change in real GDP caused by a change in taxes
MPC equation
MPC = (change in spending)/(change in income)
MPS equation
MPS = 1 - MPC
Expenditure multiplier (and equation)
used to find a number that represents HOW BIG of a change in AD will occur in result of a change in a AD component
= 1 / (1-MPC)
Tax multiplier
= (-MPC)/(MPS)
And equation that gives the
final impact on GDP
= multiplier x autonomous change
A price change in a component of AD will result…
in a larger price change in AD than originally due to the MULTIPLIER EFFECT
short run aggregate supply (SRAS)
a graph that shows the positive relationship between aggregate price level and amount of aggregate supplied in an economy
short-run
a period in which the price of at least ONE FACTOR OF PRODUCTION cannot change
sticky prices/wages
the idea that some prices and wages are not fully flexible and cannot completely respond to changes such as inflation or deflation
menu costs
a IDEA that firms might not change their prices when there is a change in the price level because it is costly to do so
one of the reasons prices are “sticky” in the economy
determinants of SRAS (2)
prices of any factors of production change
firms expect prices to change
aggregate supply shock
when the SRAS curve shifts
shocks that shift SRAS (5)
Subsides for business **
Productivity
Input prices
Taxes on businesses
Expectations about inflation
SHORT RUN AGGREGATE SUPPLY
What happens when there is a shift to the right of the SRAS curve
inflation increases
output increases
increase in output means that there is a DECREASE in unemployment
What is a relationship that is illustrated in the short-run aggregate supply (SRAS) curve
Explicitly shows the positive relationship between the price level and output
price level increases
output increases
output increases
unemployment decreases
TRADEOFF BETWEEN INFLATION AND UNEMPLOYMENT
long-run
a sufficient period of time for nominal wages and other input prices to change in response to a change in price level **
long-run aggregate supply (LRAS)
a curve that shows the relationship between price level and real GDP that would be supplied if all prices, including nominal wages, were fully flexible
Price can change along LRAS
BUT OUTPUT CANNOT
full employment output (potential output)
the amount of real GDP that an economy WOULD produce if it is using all of its factors of production
what does LRAS represent in terms of the PPC?
LRAS represents a point on the PPC, but it is translated as a vertical line in the AD-AS model
Why is LRAS vertical
the price level has nothing to do with how much an economy can produce
nominal wages eventually adjust to changes in the price level**
The differences between short-run aggregate supply and long-run aggregate supply?
There is a trade-off between inflation and unemployment in the SRAS curve while LRAS does not
SRAS: wages are fixed
LRAS: wages are fully flexible
**
Aggregate supply
total quantity of output firms will produce and sell
real GDP
Aggregate demand
amount of total spending on domestic goods/services in an economy
AD-AS model
graph used to understand economic fluctuations
includes:
AD (aggregate demand), SRAS (short-run aggregate supply)
LRAS (long-run aggregate supply)
short-run macroe. equilibrium
quantity of aggregate output supplied is equal to the quantity of aggregate output demanded
recessionary gap
when the current output is LESS than potential output
long-run macroecon. equilibrium
when the output is equal to potential output
what describes a short-run equilibrium that is NOT also a long-run equilibrium
output and price level which intersects AD and SRAS
to what direction is the LRAS of the full employment output when economy has a positive output gap
to the left of the full employment output
what determines real GDP in the AD-AS model
short-run equilibrium
shock
unexpected change that will shift either AD or SRAS curve
has to be unexpected to cause a change
supply shock
an unexpected change that shifts SRAS
positive supply shock INCREASES SRAS
negative supply shock DECREASES SRAS
demand shock
an unexpected change that shifts AD
positive demand shock INCREASES AD
negative demand shock DECREASES AD
stagflation
combination of a stagnating (falling) aggregate output and a higher price level (inflation)
STAGFLATION OCCURS when SRAS decreases
Positive Demand Shock will impact
rGDP
impact on unemployment
impact on price level
real GDP will go UP
unemployment rate will go DOWN
price levels GO UP
Negative Demand Shock will impact
rGDP
impact on unemployment
impact on price level
real GDP will go DOWN
unemployment rate will go UP
price levels will GO DOWN
change in what components CAUSES AD to shift?
how?
C
I
G
Net Exports
anything increasing of the above will cause a SHIFT TO THE RIGHT
anything decreasing of the above will cause a SHIFT TO THE LEFT
Negative Supply Shock will impact
rGDP
impact on unemployment
impact on price level
real GDP will go DOWN
unemployment rate will go UP
price levels will GO UP
Positive Supply Shock will impact
rGDP
impact on unemployment
impact on price level
real GDP will go UP (lower inflation)
unemployment rate will go DOWN
price levels GO DOWN **
SPITE is?
what causes a shift in SRAS
Subsidies for businesses
Productivity
Input prices
Taxes on businesses
Expectations about future inflation
What happens to SRAS when GDP deflator increases
when GDP deflator increases –> inflation
Inflation happens when SRAS decreases –> decrease in real GDP
long-run self-adjustment
process through an economy will return to full employment output (no gov intervention)
economic growth
an increase in an economy s ability to produce goods/services
where is economic growth represented in AD-AS model
an increase in LRAS represents economic growth
(shifting to the right)
stabilization policy
use of policy
- expansionary or monetary
to REDUCE the SEVERITY of recessions and excessively strong expansions
goal is to smooth out the business cycle
fiscal policy
using taxes, give spending, gov transfers to STABILIZE an economy
discretionary fiscal policy
fiscal policy that NEEDS an action from the government
government passes a law **
monetary policy
using changes in money supply or interest rate to affect key macro economical variables **
policy of the central banks
lump-sum taxes
taxes that do not depend on taxpayer income
expansionary fiscal policy
using fiscal policy to expand economy by INCREASING aggregate demand
FIXES RECESSIONS
what happens when expansionary fiscal policy takes place? (3)
leading to….
increased output
decreased unemployment
higher price level
FIXES RECESSIONS
contractionary fiscal policy
using fiscal policy to DECREASE aggregate demand
fix BOOMS
what does the contractionary fiscal policy lead to
leads to…
lower output
higher unemployment
lower price lever
fix BOOMS
lag
**
data lag**
recognition lag**
decision lag **
implementation lag **
deficit
when expenditures exceeds income
debt
accumulated deficits over time
balance budget multiplier
spending multiplier will exist when any change in gov spending is offset entirely by an equal change in taxes **
What does the balanced budged multiplier equal?
1
The four lags that complicate fiscal policy (in the real world)
**
Data lag
Recognition lag
Decision lag
Implementation lag
What is the tax change need equation
tax change needed = (size of gap to close)/(tax multiplier)
What is the spending need equation
(size of gap to close)/(gov spending multiplier)
define crowding out
How does government spending and taxes affect Aggregate Demand
Gov Spending DIRECTLY affects AD
Taxes INDIRECTLY affects AD
