Download AP Macro - Sect. 4 PP no bkgd

Sect. 4 - National Income & Price Determination
Module 16 - Income & Expenditure
What you will learn:
• The nature of the multiplier
• The meaning of the aggregate consumption function
• How expected future income and aggregate wealth affect
consumer spending
• The determinants of investment spending
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Sect. 4 - National Income & Price Determination
Module 16 - Income & Expenditure
Marginal Propensity to Consume (MPC) What is the increase in consumer spending when disposable
income rises by $1
MPC = Change in Consumer Spending
Change in Disposable income
Ex: If consumer spending goes up by $6 billion when disposable
income goes up by $10 billion
MPC = $6B = 0.6 ($.60 of every dollar of disp. income)
$10B
Marginal Propensity to Save (MPS) The fraction of additional $1 of disposable income that is saved
MPS = (1 - MPC) EX: 1 - .6 = .4 ($.40 of every dollar)
Autonomous Change in Aggregate Spending An initial rise or fall in aggregate spending that is the cause of a
series of income and spending changes
Multiplier The ratio of of total change in GDP caused by Autonomous
Change in Consumer Spending
Multiplier =
Ex:
1
= 1
(1 - .6)
.4
1
(1- MPC)
=
1
MPS
= 2.5 X $100 billion = $250 billion
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Consumption Function Equation showing how a consumer household’s spending varies
with disposable income
c = a + MPC x Yd
c - consumer spending
a - autonomous consumer spending
MPC - Marginal Propensity to Consume
Yd - current household disposable income
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Consumption Function Equation showing how a consumer household’s spending varies
with disposable income
c = a + MPC x Yd
c - consumer spending
a - autonomous consumer spending
MPC - Marginal Propensity to Consume
Yd - current household disposable income
Autonomous Consumer Spending Amount of money a household would spend if it had no
disposable income
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Aggregate Consumption Function For the economy as a whole - relationship between aggregate
current disposable income and aggregate consumer spending
C = A + MPC x YD
Shifts in Ag. Consumption function
1) Change in Expected Future Disposable Income
2) Change in Aggregate Wealth
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Aggregate Consumption Function For the economy as a whole - relationship between aggregate
current disposable income and aggregate consumer spending
C = A + MPC x YD
Shifts in Ag. Consumption function
1) Change in Expected Future Disposable Income
2) Change in Aggregate Wealth
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Planned Investment Spending Investment spending that businesses intend to undertake during
a given period of time
- effected by the interest rate
Inventory Investment Value of the change in inventories held in the economy in a
given period of time
Actual investment spending
= Planned Investment Spending +
Unplanned Inventory Investment
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Module 17 - Aggregate Demand
What you will learn:
•
How the aggregate demand curve illustrates the relationship
between aggregate price level and quantity of
aggregate output demanded in the economy
• How the wealth effect and interest rate effect the
aggregate demand curve
• What factors can shift the aggregate demand curve
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Module 17 - Aggregate Demand
Aggregate Demand Aggregate Demand curve shows relationship between price
level and quantity of aggregate output demanded
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Module 17 - Aggregate Demand
Aggregate Demand Aggregate Demand curve shows relationship between price
level and quantity of aggregate output demanded
Wealth Effect Change in consumer spending caused by change in
consumers’ purchasing power
Interest Rate Effect Change in investment and consumer spending caused by
change in interest rates
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Shifts of Aggregate Demand Curve Not a movement along the aggregate demand curve due to
change in price level
1. Change in Expectations If consumers and firms become more optimistic about
future - aggregate demand increases (shifts right)
- less optimistic and aggregate demand decreases (shifts left)
2. Change in Wealth Change in the value of household assets changes
aggregate demand
- 1929 Stock Mkt. crash decreased aggregate demand
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3. Change in Existing Physical Capital Investment spending depends on how much physical
capital firms already have - Ex: housing market
4. Fiscal Policy Govt. spending and taxation policies effect aggregate
demand as it effects consumers’ disposable income
5. Monetary Policy The Federal Reserve changes in the money supply and
interest rates effects consumer and investment spending
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Module 18 - Aggregate Supply
What you will learn:
• What factors can shift the aggregate supply curve
• Why the aggregate supply curve is different in the short
run from the long run
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Module 18 - Aggregate Supply
Aggregate Supply Aggregate supply curve shows the relationship between price
level and aggregate output supplied
Sticky Wages Nominal wages that are slow to rise and fall as the economy
rises and falls Short-run Aggregate Supply Curve Relationship between price level and output during a period
when most production costs are fixed
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Shifts of the Short-run Aggregate Supply Curve Not a movement along the aggregate supply curve due to
change in price level
1. Change in Commodity Prices Goods used in production (inputs) and represent a
significant production cost
- input costs can change quickly and significantly
2. Change in Nominal Wages Another significant production cost
3. Change in Productivity Workers produce more with the same inputs
- usually due to technological advances
The Long-Run Aggregate Supply Curve Shows relationship between price level and aggregate output
supplied if all prices were fully flexible (wages, inputs, sale price)
- shows potential aggregate output
The Long-Run Aggregate Supply Curve Shows relationship between price level and aggregate output
supplied if all prices were fully flexible (wages, inputs, sale price)
- shows potential aggregate output
Short Run to Long Run Short-run aggregate supply can be above or below potential
output but over time it will equal long-run potential output
The Long-Run Aggregate Supply Curve Shows relationship between price level and aggregate output
supplied if all prices were fully flexible (wages, inputs, sale price)
- shows potential aggregate output
Short Run to Long Run Short-run aggregate supply can be above or below potential
output but over time it will equal long-run potential output
Module 19 - Equilibrium in Aggregate Demand / Supply
What you will learn:
• The difference between short-run and long-run macroeconomic
equilibrium
• The effects of demand shocks and supply shocks
• How to determine if an economy is experiencing a recessionary
gap or an inflationary gap and how to calculate the size of the
output gaps
Module 19 - Equilibrium in Aggregate Demand / Supply
AD - AS Model The aggregate Demand and Supply curves used together to
analyze economic fluctuations
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Module 19 - Equilibrium in Aggregate Demand / Supply
AD - AS Model The aggregate Demand and Supply curves used together to
analyze economic fluctuations
Demand / Supply Shock An event that shifts the aggregate demand or supply curves left
or right
Shifts of Aggregate Demand: Short-Run As the short-run demand curve shifts it leads to a new
equilibrium price level and output level
- Shift Right = ag price level and GDP increase
- Shift Left = ag price level and GDP decrease
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Module 19 - Equilibrium in Aggregate Demand / Supply
AD - AS Model The aggregate Demand and Supply curves used together to
analyze economic fluctuations
Demand / Supply Shock An event that shifts the aggregate demand or supply curves left
or right
Shifts of Aggregate Demand: Short-Run As the short-run demand curve shifts it leads to a new
equilibrium price level and output level
- Shift Right = ag price level and GDP increase
- Shift Left = ag price level and GDP decrease
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Shifts of Aggregate Supply: Short-Run As the short-run supply curve shifts it leads to a new equilibrium
price level and output level
- Shift Right = ag price level decrease and GDP increase
- Shift Left = ag price level increase and GDP decrease
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Shifts of Aggregate Supply: Short-Run As the short-run supply curve shifts it leads to a new equilibrium
price level and output level
- Shift Right = ag price level decrease and GDP increase
- Shift Left = ag price level increase and GDP decrease
Stagflation The combination of inflation (rising price level) and falling output
- Leads to rising unemployment and rising prices
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Shifts of Aggregate Supply: Short-Run As the short-run supply curve shifts it leads to a new equilibrium
price level and output level
- Shift Right = ag price level decrease and GDP increase
- Shift Left = ag price level increase and GDP decrease
Stagflation The combination of inflation (rising price level) and falling output
- Leads to rising unemployment and rising prices
Long-Run Macro Equilibrium The economy is in long-run equilibrium when the point of
short-run equilibrium is on the long-run supply curve
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Shifts of Aggregate Supply: Short-Run As the short-run supply curve shifts it leads to a new equilibrium
price level and output level
- Shift Right = ag price level decrease and GDP increase
- Shift Left = ag price level increase and GDP decrease
Stagflation The combination of inflation (rising price level) and falling output
- Leads to rising unemployment and rising prices
Long-Run Macro Equilibrium The economy is in long-run equilibrium when the point of
short-run equilibrium is on the long-run supply curve
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Recessionary Gap When aggregate output is below potential output
- initiated by a negative demand shock
Recessionary Gap When aggregate output is below potential output
- initiated by a negative demand shock
Inflationary Gap When aggregate output is above potential output
- initiated by a positive demand shock
Recessionary Gap When aggregate output is below potential output
- initiated by a negative demand shock
Inflationary Gap When aggregate output is above potential output
- initiated by a positive demand shock
Output Gap The difference between actual aggregate output and potential
output
Actual Output - Potential Output
Output Gap =
x 100
Potential Output
If positive = Inflationary Gap
If negative = Recessionary Gap
Recessionary Gap When aggregate output is below potential output
- initiated by a negative demand shock
Inflationary Gap When aggregate output is above potential output
- initiated by a positive demand shock
Output Gap The difference between actual aggregate output and potential
output
Current Output - Potential Output
Output Gap =
x 100
Potential Output
If positive = Inflationary Gap
If negative = Recessionary Gap
Module 20 - Economic Policy & the AD - AS Model
What You Will Learn
• How the AD-AS model is used to formulate policy
• Why fiscal policy is an important tool for managing economic
fluctuations
• Which policies constitute expansionary fiscal policy and which
constitute contractionary fiscal policy
Module 20 - Economic Policy & the AD - AS Model
Stabilization Policy Government policy to reduce the severity of recessions and
expansions - counteract strong economic shocks
Fiscal Policy Govt. use of taxing and spending to influence the economy
- Expand or slow economic growth
John Maynard Keynes Believed that self correcting economy could take too long - govt.
should impose fiscal policy to help economy return to potential
Fiscal Policy
Module 20 - Economic Policy & the AD - AS Model
Stabilization Policy Government policy to reduce the severity of recessions and
expansions - counteract strong economic shocks
Fiscal Policy Govt. use of taxing and spending to influence the economy
- Expand or slow economic growth
John Maynard Keynes Believed that self correcting economy could take too long - govt.
should impose fiscal policy to help economy return to potential
Module 20 - Economic Policy & the AD - AS Model
Stabilization Policy Government policy to reduce the severity of recessions and
expansions - counteract strong economic shocks
Fiscal Policy Govt. use of taxing and spending to influence the economy
- Expand or slow economic growth
Expansionary Fiscal Policy Attempts to increase aggregate demand to return to potential
output (counter negative demand shock)
- involves combination of increasing govt. spending / cutting taxes
Module 20 - Economic Policy & the AD - AS Model
Stabilization Policy Government policy to reduce the severity of recessions and
expansions - counteract strong economic shocks
Fiscal Policy Govt. use of taxing and spending to influence the economy
- Expand or slow economic growth
Expansionary Fiscal Policy Attempts to increase aggregate demand to equal potential
output
- involves combination of increasing govt. spending / cutting taxes
Expansionary Policy
Contractionary Policy Attempts to decrease aggregate demand to return to potential
output (counter positive demand shock)
- involves combination of decreasing govt. spending / raising taxes
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Contractionary Policy Attempts to decrease aggregate demand to return to potential
output (counter positive demand shock)
- involves combination of decreasing govt. spending / raising taxes
Contractionary Policy
Lags in Fiscal Policy Due to the time it takes to initiate fiscal policy, the economy
might have recovered before the policy takes effect
- can make the situation worse
Module 21 - Fiscal Policy & the Multiplier
• Why fiscal policy has a multiplier effect
• How the economy is influenced by automatic stabilizers
Module 21 - Fiscal Policy & the Multiplier
Multiplier Effect of Increase in Govt. Spending Determine how much an increase in govt. spending will actually
increase aggregate output (GDP)
Ex: With a multiplier of 2, Govt. spending of $50 billion would
increase aggregate output by $100 billion
Multiplier Effect of Changes in Govt. Taxes A tax cut will have a smaller effect on aggregate output because
the MPC will cause spending to be less than the tax cut
- a tax increase will function the same way to slow an expansion
Automatic Stabilizers Taxes and transfer payments make fiscal policy automatically
expansionary during economic contractions and contractionary
during expansions
Discretionary Fiscal Policy Policy that is the result of deliberate govt. actions rather than by
automatic stabilizers
Ex: New Deal programs
of the Great Depression
The End
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