Unit 3: Top 10 AD/AS & Fiscal Policy Concepts to Know (Macro)
Unit 3: Top 10 things you must know for the aggregate demand and aggregate supply model, fiscal policy, spending and tax multipliers, and self-correction in the long run. This is geared toward college-level principles of macro and micro courses and students enrolled in AP Economics. Top 10 concepts covered in this video: #1. AD/AS Long-Run Equilibrium,
#2. AD/AS Recession in Short Run,
#3. AD/AS Recession in Long Run,
#4. AD/AS Inflation in Short Run,
#5. AD/AS Inflation in Long Run,
#6. Fiscal Policy and Budget Deficits,
#7. Expansionary Fiscal Policy in Short Run,
#8. Contractionary Fiscal Policy in Short Run,
#9. Spending Multiplier,
#10. Tax Multiplier,
3.1 Expansionary Fiscal Policy (Macro)
1. Students will be able to list and explain the tools of an expansionary fiscal policy.
2. Students will be able to illustrate an expansionary fiscal policy using the AD/AS model.
3. Students will be able to identify the outcomes of an expansionary fiscal policy.
3.2 Contractionary Fiscal Policy (Macro)
1. Students will be able to list and explain the tools of a contractionary fiscal policy.
2. Students will be able to illustrate a contractionary fiscal policy using the AD/AS model.
3. Students will be able to identify the outcomes of a contractionary fiscal policy.
The Aggregate Demand (AD) and Aggregate Supply (AS) curves are used to illustrate changes in real output and the price level of an economy.
Aggregate Demand curve is downward and can be explained by the wealth effect, the income effect, and the foreign purchases effect.
Determinants of AD are changes in consumer spending, investment spending, government spending, and net export spending. Changes in these areas will shift the AD curve and change the price level and real output/GDP.
Aggregate Supply curve can be divided into 3 ranges: horizontal or Keynesian range, upward sloping or intermediate range, and the vertical or classical range.
Determinants of AS are changes in input prices, productivity, legal environment, inflation expectations, and quantity of available resources. These will shift the AS curve and change real GDP and the price level.
Changes in output can also be shown on the Keynesian Cross Model or Expenditures Model, however the price level remains constant.
Autonomous spending is the part of AD that is independent of the current rate of economic activity & induced spending depends on the current rate of economic activity.
The spending multiplier is a number that influences the relationship of changes in autonomous spending to changes in real GDP. Multiplier = 1/MPS or 1/1-MPC.
The tax multiplier is less than the spending multiplier when we use a Keynesian analysis. This can be shown mathematically as the tax multiplier is calculated as -MPC/MPS.
Keynesian economists believe that equilibrium levels of GDP can occur at less than or more than full-employment level of GDP. Classical economists believe that long-run equilibrium can occur only at full employment.
Fiscal Policy consists of government actions that may increase or decrease AD. The two actions are changes in government spending and taxes.
Expansionary Fiscal Policy's purpose is to increase AD. The government could increase government spending and/or decrease taxes.
Contractionary Fiscal Policy is used to decrease AD during a period of inflation. The government could increase taxes and/or decrease its spending.
Discretionary Fiscal Policy is when the government must take action or pass laws to change spending and taxation.
Automatic stabilizers change government spending or taxes without new laws or actions taken.
The balanced budget multiplier shows that equal increases or decreases in taxes and government spending increase or decrease equilibrium GDP by an amount equal to that increase or decrease.
Stagflation can be explained by a decrease in AS.
Unit 3 Student Wiki
Classical Economics: Believes in a self correcting economy. More savings means more investments. Prices and wages are flexible. In the long run, full employment is restored. (Bianca L.)
Keynesian Economics: The economy is not self regulating. More savings means less consuming. Prices and wages are "sticky" downward. In the long run, we are all dead. (Bianca L.)
Sticky Price Theory: In Keynesian economics, prices and wages are "sticky" downwards, meaning that businesses are slow to cut prices and wages. A cut in prices would result in a loss of revenue for businesses, and a cut in wages would decrease the morale of workers and therefore cause a decrease in productivity. (Jen S.)
Aggregate Demand: Total amount of spending on goods and services in the economy during a stated period of time. Consists of consumer spending, government spending, investment spending, and net exports. (Bianca L.)
Aggregate Supply: Total amount of goods and services available in the economy during a stated period of time. (Bianca L.)
Long-Run Equilibrium: This is represented by the intersection of the aggregate demand curve and the long run aggregate supply curve. At this point, the product and resource markets are in equilibrium simultaneously and the firms are utilizing all their resources at full employment. (Erin C.)
AD/AS and Recession: The real gross domestic product and price level is down along. Unemployment increased. (Bianca L.)
AD/AS and Inflation: Prices increase while money has less purchasing power. (Bianca L.)
AD/AS and Stagflation: Stagflation occurs when there is simultaneous high inflation and high unemployment. It is caused by a leftward shift of the short-run aggregate supply curve. (Bianca L.)
Supply Shock: unanticipated cost increase in raw materials such as oil; decrease in aggregate supply (cost-push inflation) (Jen S.)
Marginal Propensity to Consume: Change in consumption divided by change in disposible income. (Bianca L.)
Marginal Propensity to Save: Change in savings divided by change in disposible income. (Bianca L.)
Spending Multiplier: One divided by maginal propensity to save. (Bianca L.)
Tax Multiplier: Marginal propensity to consume divided by maginal propensity to save. (Bianca L.)
Tools of Fiscal Policy: Government spending and taxes (Dan M.).
Expansionary Fiscal Policy: Used to speed up the rate of GDP growth. Using a tax cut and/or an increase in government spending, this policy will stimulate aggregate demand and lower the unemployment rate. For instance, when increasing government spending (G), this will lead to an increase in aggregate demand which will lead to an increase in prices and real GDP and will lead to a decrease in unemployment. This policy is usually implemented during a recession and it can lead to higher federal budget deficits. (Erin C.)
Contractionary Fiscal Policy: This involves raising taxes or cutting government spending in an attempt to slow GDP growth. For instance, by raising taxes, this policy will lead to a decrease in disposable income (DI), leading to a decrease in consumer expenditures (C), which will lead to a decrease in aggregate demand, which will lead to a decrease in prices and a decrease in real GDP and an increase in unemployment. This policy is usually implemented during times of high inflation, when the government is attempting to lower inflationary pressures. (Erin C.)
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