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AP Macroeconomics
Unit 3
AP Macroeconomics
Unit 3
Lesson 1
Aggregate Demand

Schedule showing
quantity demanded for all
goods/services
(measured as Real GDP)
in the economy at each
price level (measured
with a price index).
Aggregate Demand
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
Why is the aggregate
demand curve
downward sloping?
Wealth Effect: “If price
levels go down, the
money I have has more
purchasing power, so I
buy more stuff.”
Aggregate Demand




Why downward sloping?
Interest-Rate Effect:**
“As price levels rise,
bank acct. balances fall,
and interest rates…
rise, which lowers
investment, causing
Real GDP to…
FALL!”
Aggregate Demand


Why downward sloping?
Foreign Purchases
Effect: “As U.S. price
levels rise relative to
other countries, they
demand less of our
stuff, causing real GDP
to fall.”
Aggregate Demand

The components of aggregate
demand are the variables from the
GDP expenditure model:

GDP=C+I+G+(X-M)
What causes AD to shift?

Changes in C,I,G, or Nx

Consumer Spending





consumer expectations
wealth(change in stock P’s)
debt
affect DI
taxes (fiscal policy)
interest rates (monetary policy)
What causes AD to shift?

Investment Spending





interest rates (monetary)
profit expectations
business taxes
technology
production capacity (excess
causes I , AD shifts left)
What causes AD to shift?



Interest rates
are correlated
inversely with
Investment.
Sketch this out!
So, ceteris
paribus, when i
goes up, I goes
down, bringing
AD down also.
Investment
Demand Curve
What causes AD to shift?



What causes AD to shift?
Changes in
Gov’t Spending

ceteris paribus, if G
increases, AD increases
Aggregate Demand



What causes AD to shift?
Changes in
Net Exports


an increase in foreign income
will cause their demand for
our stuff to increase, Nx ,
AD shifts right
exchange rates: if the value
of USD falls relative to other
currencies, Nx , AD shifts
right

a23b
AP Macroeconomics
Unit 3
Lesson 2
Aggregate Supply

Schedule showing
the amount of
goods/services
firms will produce
at various price
levels.
Aggregate Supply



Three Views of
A.S.:
The vertical area
represents full
employment
(Classical range).
The flat area
represents unused
resources (Keynesian
range).
Aggregate Supply


In the short-run, wages and prices
are “sticky”.
Examples:


Even if prices are falling, workers are
usually not very open to having their
wages cut.
Many businesses try to keep their
prices stable. Frequently changing
prices can make consumers mad.
Aggregate Supply



Long-run aggregate-supply
is vertical b/c, in the longrun, wages/prices are
flexible (Classical).
Also, in the long-run, a
country’s production
depends on its supplies of
productive resources &
technology; not price
levels!
LRAS represents full
employment.
Can production
occur beyond
LRAS? How?
Aggregate Supply

Economic growth shifts LRAS
rightward.

From this point on we will use a
“regular” AS curve.
Aggregate Supply


What causes AS to shift?
Changes in:




Input costs
Productivity
Producer expectations
Gov’t involvement
Regulations
 Business Taxes
 Subsidies


a24b
AP Macroeconomics
Unit 3
Lesson 3
Macroeconomic Equilibrium

-is where shortrun aggregate
supply and
aggregate
demand meet.
Macroeconomic Equilibrium


Remember, business taxes cause
AD to shift. Why?
So, how would an increase in
business taxes affect AD? AS? PL?
RGDP?

A25 b,c
Macroeconomic Equilibrium


Long-run
macroeconomic
equilibrium
-is where short-run
aggregate supply,
aggregate demand,
and long-run
aggregate supply
meet.
Macroeconomic Equilibrium



In the long run, the economy
always (and naturally)
gravitates towards full
employment levels of real
GDP.
SRAS (eventually) naturally
shifts to bring equilibrium to
full employment levels.
But sometimes, we don’t
want to wait around for this
to occur!
Inflation Revisited


Demand-Pull
Inflation: an increase
in AD “pulls” up the
price level.
Cost-Push Inflation: a
decrease in AS
“pushes” up the price
level.
Fiscal Policy

Taxing/Spending for the purposes of
affecting the economy. Typically, this
results in a shift in the AD curve.




expansionary: more spending, less taxes
contractionary: less spending, more taxes
discretionary: deliberate changes made by
congress & president (i.e. stimulus bill)
automatic: “built-in” stabilizers that are
expansionary during recessions and/or
contractionary during inflation
(unemployment compensation)



a28
a30b(fiscal policy), a31 (1 page)
hw: ch20pa (1,2,)
AP Macroeconomics
Unit 3
Lesson 4
“Multiplier” and “Crowding Out”
Effects



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
Disposable income has a big effect on AD.
Higher disposable income = higher AD...
...because the biggest determinant of
consumption is disposable income.
Q: What do people do with their income?
A: Spend it or save it
“Multiplier” and “Crowding Out”
Effects









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

Gross Domestic Product
- Consumption of fixed capital
Net Domestic Product
+ Net American income earned abroad
- Indirect business taxes (sales taxes)
National Income (Income Earned)
- Social Security Contributions
- Corporate Income Taxes
- Undistributed corporate profits
+ Transfer payments
Personal Income (Income Received)
- Personal Taxes
Disposable Income
“Multiplier” and “Crowding Out”
Effects


Consumption (C) + Savings (S) =
Disposable Income (DI)
The relationship between C, S & Y goes
like this:




As Y increases, C & S increase, but
C increases at a slower rate and
S increases at a faster rate
Dissaving if C > DI. (S is negative)
“Multiplier” and “Crowding Out”
Effects

Average Propensity to Consume (APC)=C/Y


Average Propensity to Save (APS)= S/Y


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

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This is the fraction of total income consumed
This is the fraction of total income that is saved.
APC + APS = 1
Marginal Prop. to Cons. -the fraction of
additional Y consumed rather than saved.
MPC = C/ Y
MPS = S/ Y
MPC + MPS = 1
“Multiplier” and “Crowding Out”
Effects

Consumption Schedules

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
link
Search for: consumption schedule graph
Things other than income affect
consumption, and shift the consumption
line up or down.




i
wealth/indebtedness
consumer confidence/expectations
PL
“Multiplier” and “Crowding Out”
Effects
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Consumption Schedules assignment


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When the consumption schedule shifts upward,
what happens to the savings schedule?
Why?
When the slope of the consumption line
increases (becomes more steep), what happens
to the slope of the savings schedule?
What terms do we use for these two slopes?
“Multiplier” and “Crowding Out”
Effects
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The Multiplier Effect
Individual components of AD have a
multiplier effect on AD; when one increases
by a $, AD increases by > $.
Who benefits when the gov’t buys $20
billion in planes from Boeing?
Multiplier = 1 / (1-MPC)
When C, I, G, or Nx change by X, AD
changes by
X [1/(1-MPC)]
“Multiplier” and “Crowding Out”
Effects

The Multiplier Effect
Taxes have a different multiplier, b/c taxes
affect income.
Tax multiplier: -MPC/(1-MPC)

Balanced budget multiplier



What happens when the gov’t spends the same
amount as it taxes?
“Multiplier” & “Crowding Out”
Effects
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A new graph (sort of)!
The Money Market shows
how the “price” of money,
the interest rate, adjusts
to balance the supply of
and demand for money.
The money supply is fixed
at any one point in time,
and therefore is
represented by a vertical
line.
The Money Market
“Multiplier” & “Crowding Out”
Effects


Remember the interestrate effect?
Can it be explained
through the money
market?
The Money Market
“Multiplier” & “Crowding Out”
Effects



Several things can cause
Dm to shift, but for now
we’ll just focus on one; G.
Q: If gov’t increases
spending but doesn’t
collect enough taxes to
cover the spending, where
does it get the money?
A: By borrowing (mostly)
The Money Market
“Multiplier” & “Crowding Out”
Effects


Q: When the government
borrows, what happens in
the money market?
A: Dm shifts right, and
interest rates rise.
The Money Market
“Multiplier” & “Crowding Out”
Effects



Q: Are there portions of
output (RGDP) that are
influenced by interest
rates?
A: I, and to a lesser
extent, C
We call these “interest
rate-sensitive investment
and consumption.”
The Money Market
“Multiplier” & “Crowding Out”
Effects





The Crowding Out Effect
Gov’t spending “crowds
out” i-sensitive I & C .
Implications for AD?
GDP = C+I+G+Xn
The crowding out effect
partially offsets the
impact of the increase in
G.
“Net Export” Effect

If the government enters the money
market to finance the deficit,
interest rates will rise. The higher
interest rate causes the dollar to
appreciate. Therefore, net exports
decline, and aggregate demand
decreases, which offsets the effects
of expansionary fiscal policy.

Done!