Macro Unit 3

Question 1

Aggregate Demand

Answer 1

The demand for every product by everyone in the U.S.

AD = GDP = C + I + G + Xn

Question 2

Aggregate Demand Curve

Answer 2

• Curves downward just like the regular demand curve
• Price Level is Y axis, real GDP is X axis
• changes in price level cause a slide along the curve

Question 3

3 Reasons why Aggregate Demand is downward sloping

Answer 3

1. Wealth Effect
2. Interest Rate Effect
3. Foreign Trade Effect

Question 4

Wealth Effect

Answer 4

as the price level goes up, the value of people’s assets goes down (GDP demanded goes down)

Question 5

Interest Rate Effect

Answer 5

Occurs when a change in the price level leads to a change in interest rates and therefore a change in the quantity of aggregate demand.

Question 6

Foreign Trade Effect

Answer 6

When the U.S. price level rises, foreign buyers purchase fewer U.S. goods and americans buy more foreign goods.

Exports fall and imports rise causing real GDP demanded to fall (Xn decreases)

Question 7

Shifters of AD

Answer 7

• Change in consumer spending
• Change in investment spending
• Change in government spending
• Change in net exports

Question 8

Change in Consumer Spending

Answer 8

• Increase in disposable income
• Consumer expectations
• Household indebtedness

Question 9

Changes in Investment Spending

Answer 9

• Real interest rates (price of borrowing $)
• Future business expectations
• Productivity and technology

Question 10

Changes in Government Spending

Answer 10

Government expenditures either increase or decrease the AD

Question 11

Change in Net Exports

Answer 11

• Exchange rates
• National income compared to abroad (recessions)

Question 12

Aggregate Supply

Answer 12

The supply of everything by all firms; Aggregate supply differentiates between short run and long run and has two different curves.

Question 13

Short Run Aggregate Supply

Answer 13

Resembles typical supply curve (curves up to the sky) with Price Level (PL) on the Y-axis and Real GDP (GDPr) on the X-axis. Curves upward because in the short run, wages and resource prices stay the same as price levels increase, and real profits increase providing businesses with incentive to increase production.

Question 14

Long Run Aggregate Supply Curve

Answer 14

Vertical line on graph; This is because in the long run, wages and resource prices are flexible and will increase as price levels increase (bc workers will demand higher wages to match the increase in prices) causing nominal profits to apparently increase and real profits to stay the same. If the real profit doesn’t change, the firm has no incentive to increase output.

Question 15

Shifters of (SR) Aggregate Supply

Answer 15

• Change in Resource Prices
• Change in Actions of the Government
• Change in Productivity

RAP!

Question 16

Change in Resource Prices

Answer 16

• Supply shocks (when the supply of a certain key resource suddenly increases or decreases)
• Worker wages (workers are a resource! workers getting raises decreases AS because less money is available to go into other production costs if workers are getting paid more)
• Prices of domestic and imported resources

Question 17

Changes in Actions of the Government

Answer 17

• Taxes on producers
• Subsidies for domestic producers
• Government regulations (stricter vs less strict)

Question 18

Changes in Productivity

Answer 18

• Technological improvements

Question 19

Classical economic theory

Answer 19

with no government involvement, wages will rise/fall which shifts aggregate supply and brings the economy back to full employment.

Question 20

Keynesian economic theory

Answer 20

the government should raise/lower government spending and income taxes to shift aggregate demand and bring economy back to full employment

Question 21

Discretionary fiscal policy

Answer 21

congress creates a new law that is designed to change aggregate demand through spending and taxation

Question 22

Non-discretionary fiscal policy

Answer 22

(aka automatic stabilizers) permanent spending/taxation enacted to work counter to cyclical and stabilize the economy.

Question 23

Expansionary fiscal policy

Answer 23

laws designed to reduce unemployment and increase GDP (close recessionary gap)

• government spending increases
• taxes decrease (promoting consumer spending)

Question 24

Contractionary fiscal policy

Answer 24

laws designed to reduce inflation and decrease GDP (close inflationary gap)

• government spending decreases
• taxes increase

Question 25

Positive supply shock

Answer 25

A sudden increase in the availability of a resource (shifts aggregate supply)

Question 26

Negative supply shock

Answer 26

A sudden decrease in the availability of a resource (shifts supply)

Question 27

Stagflation

Answer 27

When there is simultaneous inflation and slowing of the economy (recession)

• when price level is high but GDP is low
• technically considered a recessionary gap because Qe is below Qy

Question 28

Autonomous consumption

Answer 28

Consumers will spend a certain amount no matter what, regardless of their income (taxes and necessities)

Question 29

Disposable income

Answer 29

The amount of cash a person has available to spend (shifter of aggregate demand, consumer spending)

Question 30

What is the Multiplier Effect?

Answer 30

Shows how spending is magnified in the economy

Question 31

Simple spending multiplier

Answer 31

1/MPS

Question 32

Tax multiplier

Answer 32

MPC/MPS or Spending multiplier minus 1

Question 33

Marginal propensity to consume (MPC)

Answer 33

The portion of new income that is spent expressed as a decimal.

MPC= amount spent / new income

Question 34

Marginal propensity to save (MPS)

Answer 34

How much of new income is saved rather than spent expressed as a decimal.

MPS= amount saved / new income

Question 35

Problems with fiscal policy

Answer 35

• Deficit spending
• Time lags
• Crowding out

Question 36

Deficit spending

Answer 36

When a country spends more than it brings in (debt)

Question 37

Time lags

Answer 37

Recognition lag- congress must react to economic indicators before it’s too late
Administrative lag- congress takes time to pass legislation
Operational lag- spending/planning takes time to organize and execute

Question 38

Crowding out

Answer 38

When the government deficit spends, it raises demand for loanable funds which raises interest rates. This could decrease investment and lead to less future growth.

• called crowding out because the government is making it harder for businesses to take out loans

Question 39

How to calculate total change in GDP

Answer 39

Total change in GDP = Multiplier x initial change in spending

total change in GDP = Tax multiplier x initial change in taxes

Question 40

Why will amount of tax cuts needed to fix economy always be greater than amount of government spending needed to fix economy?

Answer 40

Because when the government cuts income taxes and increases the disposable income of consumers, they are going to save a portion of that new income so the government will have to increase the amount of tax cuts in order to increase consumer spending enough to close the recessionary gap.