AP Macroeconomics Unit 3: National Income and Price Determination | Notes and practice

Notes

AD slopes downward because of the wealth effect, the interest rate effect, and the exchange rate (foreign purchases) effect.
AD shifts with changes in $C$, $I$, $G$ or $X_n$: consumer confidence, taxes, interest rates, government spending, and foreign incomes.

Marginal propensity to consume (MPC) + MPS = 1.
Spending multiplier $\displaystyle = \frac{1}{1 - MPC} = \frac{1}{MPS}$. A change in spending changes GDP by multiplier × change.
Tax multiplier $\displaystyle = -\frac{MPC}{MPS}$ (one less than the spending multiplier, and negative).

Short-run AS (SRAS) slopes upward because wages and some prices are sticky. It shifts with input prices (oil), productivity, taxes on businesses, and supply shocks.
Long-run AS (LRAS) is vertical at full-employment output (potential GDP).

Equilibrium is where AD meets SRAS.
Recessionary gap: output below full employment (high unemployment). Inflationary gap: output above full employment (high inflation).
In the long run, without policy, wages adjust: in a recessionary gap, wages fall and SRAS shifts right; in an inflationary gap, SRAS shifts left.
Stagflation: a negative supply shock shifts SRAS left, causing both higher prices and lower output.

A recessionary gap: output is below full employment (Yf).

Expansionary fiscal policy (more government spending or lower taxes) fights recessions. Contractionary policy (less spending or higher taxes) fights inflation.
Automatic stabilizers (unemployment benefits, progressive taxes) work without new laws.
Lags, politics and crowding out can limit fiscal policy.

The MPC is 0.8. What is the spending multiplier?

With an MPC of 0.8, a 10 billion dollar increase in government spending can increase real GDP by up to:

With an MPC of 0.8, what is the tax multiplier?

Which shifts aggregate demand to the right?

A sharp rise in oil prices shifts:

The long-run aggregate supply curve is vertical because:

To close a recessionary gap, the government could:

Unemployment benefits that rise automatically during a recession are:

Write your answer first, then open the scoring guide.

Free-response question

An economy is in a recessionary gap.

(a) Describe the relationship between current real output and full-employment output.

Show the answer and scoring guide

Current real output is less than full-employment (potential) output, so unemployment is above its natural rate.

Check off the points you earned:

(b) Identify ONE fiscal policy that could close the gap, and explain its effect on aggregate demand.

Show the answer and scoring guide

Increase government spending (or cut taxes). This shifts AD to the right, raising real output and employment.

Check off the points you earned:

(c) If the MPC is 0.75 and the gap is 40 billion dollars, how much should government spending increase to close it?

Show the answer and scoring guide

Multiplier $\displaystyle = \frac{1}{0.25} = 4$, so spending should rise by $\displaystyle \frac{40}{4} = 10$ billion dollars.

Check off the points you earned: