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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