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National Income and Price Determination
Review of Key Concepts, Skills and Graphs
1. The marginal propensity to consumer (MPC) is the additional consumption spending from an additional
dollar of income. The marginal propensity to save (MPS) is the additional savings from an additional
dollar of income.
 MPC + MPS = 1
2. The spending multiplier shows the relationship between changes in spending and the maximum
resulting changes in GDP.
 Spending multiplier = ______1______ = __1__
1 – MPC
MPS
3. Aggregate demand is determined by the spending of domestic consumers, businesses, government and
foreign buyers
4. A change in the price level causes a change in the amount of aggregated spending and therefore a
change in the amount of real GDP. This is represented by a movement along the AD curve. If one of the
determinants of demand changes it will cause the entire curve to shift.
5. The aggregate demand curve is down sloping because of the:
 Real-balances effect – inflation reduces the real value or purchasing power of fixed value
financial assets held by households, causing cutbacks in consumer spending
 Interest rate effect – with a specific supply of money, a higher price level increases the demand
for money, thereby raising the interest rate and reducing investment purchases
 Foreign purchases effect – an increase in one country’s price level relative to the price level in
other countries reduces the net export component of that nation’s aggregate demand
6. Aggregate supply is divided into
 Short Run Aggregated supply (SRAS) is upward sloping because all input costs are fixed in the
short run (sticky wages) so more sales means more profit
 Long Run Aggregate Supply (LRAS) is vertical at potential output because in the long run all
costs are variable.
7. A change in price level causes a movement along the SRAS. A change in one of the determinants of
SRAS (input prices, productivity, quantity of available resources) will cause the entire SRAS curve to
shift to the right or to the left.
8. Short run equilibrium occurs at the intersection of AD and SRAS curves. This may or may not be at the
potential GDP (LRAS intersection). Eventually the economy will self adjust to long run equilibrium
which occurs at the intersection of AD, SRAS and LRAS curves.
Short Run Equilibrium
Long Run Equilibrium