AP EXAM: Unit 3 Flashcards
What does the AD curve describe?
The relationship between the price level and the quantity of goods and services demanded in a country
Wealth effect
Higher price levels reduce purchasing power
Real interest rate effect
As price level increased, interest rates increase to ensure payback
Net export effect
A change in the country’s average price level affects exports and imports flow
What do the “effects” do?
They explain the negative slope of the AD curve.
How can the spending multiplier be applied?
Quantifies the size of the change in AD as a result of a change in any component of AD
Spending multiplier
A $1 change to one of the components of AD leads to a further change in total expenditures and output
How does the tax multiplier make sense?
The initial change in taxes is “multiplied” throughout the economy by a factor determined by the amount by which households increase their consumption
Relationship between MPC and spending multiplier
As the MPC decreases, the spending multiplier decreases
Sum of marginal propensities
MPC + MPS = 1
Marginal propensity to save formula
Change in savings over change in income
Marginal propensity to consume formula
Change in consumption spending over change in income
Expenditure multiplier
1 / 1-MPC
Tax multiplier
1 - Expenditure multiplier, or -MPC/MPS
Why is the tax multiplier negative?
Inverse relationship between taxes and spending
Effect of tax multiplier
Change in AD = Initial change in taxes x tax multiplier
Effect of spending multiplier
Change in AD = Initial change in spending x spending multiplier
Sticky wages
Describes SRAS upward sloping curve, occurs because firms are unable to raise and lower wages quickly in response to a macroeconomic shock such as an increase or decrease in AD
Relationship between price level and output/employment
When wages are sticky, there is a direct relationship between the price level and the level of output/employment
Things that shift SRAS
Wage rates, resource costs, energy and transportation costs, government regulation, business taxes and subsidies, exchange rates
Role of sticky wages with inflation and unemployment
Due to stickiness, there is a short run trade-off between inflation and unemployment
What does the LRAS show?
The LRAS curve shows the level of output achieved in an economy when wages and prices are fully flexible and adjust to the economy’s price level
Consequence of flexible long run prices/wages
Lack of a long run trade off between inflation and unemployment
When does short run equilibrium occur?
Short run equilibrium occurs when the aggregate quantity of output demanded and the aggregate quantity of output supplied are equal
What’s a situation in which an economy could produce beyond full employment?
They can produce beyond in short run due to stickiness of wages/input prices
How do you calculate an output gap?
The difference between a curve shift and long run equilibrium
What’s demand pull inflation?
Results when a component of AD increases when economy is at full run equilibrium
What’s cost push inflation?
Results when a factor affecting SRAS causes the costs of production to increase
