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Unit-3 Macro Review AD/AS Model & Multipliers LRAS1 Price Level P1 ----------------- SRAS1 E1 AD1 Y1 Real GDP AD/AS Model • Short run AS curve is upward sloping – Prices/wages are sticky • Long Run AS curve is vertical LRAS1 Price Level – Prices/wages are flexible – At full employment output level P1 ----------------- SRAS1 E1 AD1 AD = C + I + G + NX • Consumption: – The Wealth Effect Y1 3 reasons AD slopes downward => • Investment: – The Interest Rate Effect • Net Exports: – The Exchange-Rate Effect Real GDP Recessionary Gap Inflationary Gap Economy below full output Economy above full output LRAS1 Price Level SRAS1 Price Level ----------- E1 ---------- P1 Y1 -------------------- -------------- P1 LRAS1 AD1 Y* Real GDP Unemployment high, output low Below PPF, Actual Px level < Expected Y* SRAS1 E1 Y1 AD1 Real GDP Unemployment very low, output high Above PPF, Actual Px level > Expected Shifts in LRAS & SRAS • If PPF goes right => LRAS shifts right – – – – – – – Expected Price Level Input Prices Labor Capital Natural resources Technology Gov’t Incentives Shift SRAS ONLY (not LRAS) Will shift BOTH curves (LRAS & SRAS, & PPF) MPC, MPS & Multipliers • Disposable Income (DI) = Gross Income – Net Taxes – DI = Consumption + Savings – MPC + MPS = 1 (assuming no Gov’t taxes or transfers) • Multipliers: – Spending Multiplier = 1/MPS – Tax Multiplier = -MPC/MPS – Balanced Budget Multiplier = 1 (always 1 less than spending) 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) Practice Questions 1 E 14 B 2 C 15 B 3 C 16 B 4 C 17 A 5 D 18 6 A 19 7 B 20 8 A 21 B 9 D 22 D 10 B 23 D 11 D 24 C 12 C 25 B 13 D