Macro Unit 3 Flashcards
Aggregate Demand
The demand for every product by everyone in the U.S.
AD = GDP = C + I + G + Xn
Aggregate Demand Curve
- 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
3 Reasons why Aggregate Demand is downward sloping
- Wealth Effect
- Interest Rate Effect
- Foreign Trade Effect
Wealth Effect
as the price level goes up, the value of people’s assets goes down (GDP demanded goes down)
Interest Rate Effect
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.
Foreign Trade Effect
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)
Shifters of AD
- Change in consumer spending
- Change in investment spending
- Change in government spending
- Change in net exports
Change in Consumer Spending
- Increase in disposable income
- Consumer expectations
- Household indebtedness
Changes in Investment Spending
- Real interest rates (price of borrowing $)
- Future business expectations
- Productivity and technology
Changes in Government Spending
Government expenditures either increase or decrease the AD
Change in Net Exports
- Exchange rates
- National income compared to abroad (recessions)
Aggregate Supply
The supply of everything by all firms; Aggregate supply differentiates between short run and long run and has two different curves.
Short Run Aggregate Supply
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.
Long Run Aggregate Supply Curve
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.
Shifters of (SR) Aggregate Supply
- Change in Resource Prices
- Change in Actions of the Government
- Change in Productivity
RAP!
Change in Resource Prices
- 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
Changes in Actions of the Government
- Taxes on producers
- Subsidies for domestic producers
- Government regulations (stricter vs less strict)
Changes in Productivity
- Technological improvements
Classical economic theory
with no government involvement, wages will rise/fall which shifts aggregate supply and brings the economy back to full employment.
Keynesian economic theory
the government should raise/lower government spending and income taxes to shift aggregate demand and bring economy back to full employment
Discretionary fiscal policy
congress creates a new law that is designed to change aggregate demand through spending and taxation
Non-discretionary fiscal policy
(aka automatic stabilizers) permanent spending/taxation enacted to work counter to cyclical and stabilize the economy.
Expansionary fiscal policy
laws designed to reduce unemployment and increase GDP (close recessionary gap)
- government spending increases
- taxes decrease (promoting consumer spending)
Contractionary fiscal policy
laws designed to reduce inflation and decrease GDP (close inflationary gap)
- government spending decreases
- taxes increase
Positive supply shock
A sudden increase in the availability of a resource (shifts aggregate supply)
Negative supply shock
A sudden decrease in the availability of a resource (shifts supply)
Stagflation
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
Autonomous consumption
Consumers will spend a certain amount no matter what, regardless of their income (taxes and necessities)
Disposable income
The amount of cash a person has available to spend (shifter of aggregate demand, consumer spending)
What is the Multiplier Effect?
Shows how spending is magnified in the economy
Simple spending multiplier
1/MPS
Tax multiplier
MPC/MPS or Spending multiplier minus 1
Marginal propensity to consume (MPC)
The portion of new income that is spent expressed as a decimal.
MPC= amount spent / new income
Marginal propensity to save (MPS)
How much of new income is saved rather than spent expressed as a decimal.
MPS= amount saved / new income
Problems with fiscal policy
- Deficit spending
- Time lags
- Crowding out
Deficit spending
When a country spends more than it brings in (debt)
Time lags
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
Crowding out
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
How to calculate total change in GDP
Total change in GDP = Multiplier x initial change in spending
total change in GDP = Tax multiplier x initial change in taxes
Why will amount of tax cuts needed to fix economy always be greater than amount of government spending needed to fix economy?
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.
