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Unit-3 Macro Review AD/AS Model & Multipliers LRAS1 Price Level P1 ----------------- SRAS1 E1 AD1 Y1 Real GDP Calculating GDP: Business Investment, Consumer/Business Construction, & Change in Inventories. (new houses count as investment!) GDP = C + I + G + (X-M) What Counts? Only NEW & FINAL goods Domestic Products What does not Count? Used goods International products Financial transactions Non-market transactions Gov’t Transfers (i.e. welfare, social security) GDP does not measure: mix of goods, quality of products, quality of life, leisure time AD/AS Model • Short run AS curve is upward sloping – Prices/wages are sticky • Long Run AS curve is vertical – Prices/wages are flexible – At full employment output level LRAS1 Price Level P1 ----------------- SRAS1 E1 AD = C + I + G + NX AD1 A change in component shifts AD curve Y1 Real GDP AD Downward Slope Price Level 3-Factors make it downward sloping • Consumption: – The Wealth Effect • Investment: – The Interest Rate Effect P • Net Exports: – The Exchange-Rate Effect P2 1. A decrease in the price level . . . 0 AD Y Y2 2. . . . increases the quantity of goods and services demanded. Real GDP Shifts in AS • Shifts occur when you have a change in: – – – – – – – Expected Price Level Input Prices Labor Capital Natural resources Technology Gov’t Incentives Shift SRAS but not LRAS Will shift BOTH curves (LRAS & SRAS) Recessionary Gap Inflationary Gap Economy below full output Economy above full output Price Level LRAS1 SRAS1 Price Level LRAS1 SRAS1 AD1 AD1 Real GDP Unemployment high, output low Below PPF, Actual Px level < Expected Real GDP Unemployment very low, output high Above PPF, Actual Px level > Expected Disposable Income & MPS/MPC • Disposable Income (DI) = Gross Income – Net Taxes • DI = Consumption + Savings (assuming no Gov’t taxes or transfers) • MPC + MPS = 1 Savings [S] MPS FIRMS Consumption [C] MPC HOUSEHOLDS Aggregate Income [Y] 3 Multipliers & Fiscal Policy 1) Gov’t Spending or Investment Multiplier = – 1/MPS – 1/.20 = 5 2) Tax Multiplier: – -MPC/MPS – -.80/.20 = -4 MPC = .80 MPS = .20 LRAS1 Price Level SRAS1 AD1 Tax Multiplier is always 1 smaller 3) Balanced Budget Multiplier is always = 1 Real GDP Expansionary Fiscal Policy: • Gov’t Spending 1 billion • MPS = .25 • AD shifts right by 4 billion (multiplier = 4) Goal of an Economy: Shift LRAS Right PPF Graph Price Level LRAS1 Y1 LRAS2 Y2 Real GDP Technology allowed USA to maintain high GDP & low inflation in 1980’s & 1990’s
