1. Aggregate Demand and Aggregate Supply

2.  Shows the amount of Real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level  The relationship between the price level and the level of Real GDP is inverse  See graph 

3. PL GDP R AD Aggregate Demand Curve

4.  Real-Balances Effect  When the price-level is high households and businesses cannot afford to purchase as much output.  When the price-level is low households and businesses can afford to purchase more output.  Interest-Rate Effect  A higher price-level increases the interest rate which tends to discourage investment  A lower price-level decreases the interest rate which tends to encourage investment  Foreign Purchases Effect  A higher price-level increases the demand for relatively cheaper imports  A lower price-level increases the foreign demand for relatively cheaper U.S. exports

5.  There are two parts to a shift in AD:  A change in C, I G, G and/or X N  A multiplier effect that produces a greater change than the original change in the 4 components  Increases in AD = AD   Decreases in AD = AD 

6. PL GDP R ADAD 1 Increase in Aggregate Demand

7. PL GDP R AD 1 AD Decrease in Aggregate Demand

8.  Consumption (C)  Gross Private Investment (I G )  Government Spending (G)  Net Exports (X N ) = Exports - Imports (X – M)

9.  Household spending is affected by:  Consumer wealth  More wealth = more spending (AD shifts  )  Less wealth = less spending (AD shifts  )  Consumer expectations  Positive expectations = more spending (AD shifts  )  Negative expectations = less spending (AD shifts  )  Household indebtedness  Less debt = more spending (AD shifts  )  More debt = less spending (AD shifts  )  Taxes  Less taxes = more spending (AD shifts  )  More taxes = less spending (AD shifts  )

10.  Investment Spending is sensitive to:  The Real Interest Rate  Lower Real Interest Rate = More Investment (AD  )  Higher Real Interest Rate = Less Investment (AD  )  Expected Returns  Higher Expected Returns = More Investment (AD  )  Lower Expected Returns = Less Investment (AD  )  Expected Returns are influenced by  Expectations of future profitability  Technology  Degree of Excess Capacity (Existing Stock of Capital)  Business Taxes  Hyperlink to InvestmentDemand.pps Hyperlink to InvestmentDemand.pps Hyperlink to InvestmentDemand.pps

11.  More Government Spending (AD  )  Less Government Spending (AD  )

12.  Net Exports are sensitive to:  Exchange Rates (International value of $)  Strong $ = More Imports and Fewer Exports = (AD  )  Weak $ = Fewer Imports and More Exports = (AD  )  Relative Income  Strong Foreign Economies = More Exports = (AD  )  Weak Foreign Economies = Less Exports = (AD  )

13.  AD reflects an inverse relationship between PL and GDP R  Δ in PL creates real-balance, interest-rate, and foreign purchase effects that explain AD’s downward slope  Δ in C, I G, G, and/or X N cause Δ in GDP R because they Δ AD.  Increase in AD = AD   Decrease in AD = AD 

14.  The level of Real GDP (GDP R ) that firms will produce at each Price Level (PL)

15.  Long-Run  Period of time where input prices are completely flexible and adjust to changes in the price-level  In the long-run, the level of Real GDP supplied is independent of the price- level  Short-Run  Period of time where input prices are sticky and do not adjust to changes in the price-level  In the short-run, the level of Real GDP supplied is directly related to the price level

16.  The Long-Run Aggregate Supply or LRAS marks the level of full employment in the economy (analogous to PPC)  Because input prices are completely flexible in the long-run, changes in price-level do not change firms’ real profits and therefore do not change firms’ level of output. This means that the LRAS is vertical at the economy’s level of full employment

17. PL GDP R LRAS YfYf

18.  Because input prices are sticky in the short-run, the SRAS is upward sloping.This reflects the fact that in the short-run, increases in the price-level increase firm’s profits and create incentives to increase output. As the price-level falls, firm’s profits drop and this creates an incentive to reduce output.

19. PL GDP R SRAS

20.  An increase in SRAS is seen as a shift to the right. SRAS   A decrease in SRAS is seen as a shift to the left. SRAS   The key to understanding shifts in SRAS is per unit cost of production Per-unit production cost = total input cost / total output

21. PL GDP R SRASSRAS 1

22. PL GDP R SRASSRAS 1

23.  Input Prices  Productivity  Legal-Institutional Environment

24.  Domestic Resource Prices  Wages (75% of all business costs)  Cost of capital  Raw Materials (commodity prices)  Foreign Resource Prices  Strong $ = lower foreign resource prices  Weak $ = higher foreign resource prices  Market Power  Monopolies and cartels that control resources control the price of those resources  Increases in Resource Prices = SRAS   Decreases in Resource Prices = SRAS 

25.  Productivity = total output / total inputs  More productivity = lower unit production cost = SRAS   Lower productivity = higher unit production cost = SRAS 

26.  Taxes and Subsidies  Taxes ($ to gov’t) on business increase per unit production cost = SRAS   Subsidies ($ from gov’t) to business reduce per unit production cost = SRAS   Government Regulation  Government regulation creates a cost of compliance = SRAS   Deregulation reduces compliance costs = SRAS 

27.  The equilibrium of AS & AD determines current output (GDP R ) and the price level (PL) GDP R PL AD SRASLRAS YFYF P

28.  Full Employment equilibrium exists where AD intersects SRAS & LRAS at the same point. GDP R PL AD SRASLRAS YFYF P

29.  A recessionary gap exists when equilibrium occurs below full employment output. GDP R PL AD SRAS LRAS YFYF P Y

30.  An inflationary gap exists when equilibrium occurs beyond full employment output. GDP R PL AD SRASLRAS YFYF P Y

31.  Δ Consumption (C)  C↑.: AD .: GDP R ↑ & PL↑.: u%↓ & π %↑  C↓.: AD .: GDP R ↓ & PL↓.: u%↑ & π %↓  Δ Gross Private Investment (I G )  I G ↑.: AD .: GDP R ↑ & PL↑.: u%↓ & π %↑  I G ↓.: AD .: GDP R ↓ & PL↓.: u%↑ & π %↓  Δ Government Spending (G)  G↑.: AD .: GDP R ↑ & PL↑.: u%↓ & π %↑  G↓.: AD .: GDP R ↓ & PL↓.: u%↑ & π %↓  Δ Net Exports (X N )  X N ↑.: AD .: GDP R ↑ & PL↑.: u%↓ & π %↑  X N ↓.: AD .: GDP R ↓ & PL↓.: u%↑ & π %↓

32. C↑, I G ↑, G↑ and/or X N ↑.: AD .: GDP R ↑ & PL↑.: u%↓ & π%↑ GDP R PL AD SRAS LRAS YFYF P Y AD 1 P1P1   

33. C↓, I G ↓, G↓ and/or X N ↓.: AD .: GDP R ↓ & PL↓.: u%↑ & π%↓ GDP R PL AD SRAS LRAS YFYF P Y AD 1 P1P1   

34.  Δ Input Prices  Input Prices↓.: SRAS .: GDP R ↑ & PL↓.: u%↓ & π %↓  Input Prices↑.: SRAS .: GDP R ↓ & PL ↑.: u%↑ & π %↑  Δ Productivity  Productivity↑.: SRAS .: GDP R ↑ & PL↓.: u%↓ & π %↓  Productivity↓.: SRAS .: GDP R ↓ & PL ↑.: u%↑ & π %↑  Δ Legal-Institutional Environment  Deregulation.: SRAS .: GDP R ↑ & PL↓.: u%↓ & π %↓  Regulation.: SRAS .: GDP R ↓ & PL ↑.: u%↑ & π %↑

35. Input Prices↓, Productivity↑, and/or Deregulation.: SRAS .: GDP R ↑ & PL↓.: u%↓ & π%↓ GDP R PL AD SRAS LRAS YFYF P Y SRAS 1 P1P1   

36. Input Prices↑, Productivity↓, and/or Regulation.: SRAS .: GDP R ↓ & PL↑.: u%↑ & π%↑ GDP R PL AD SRAS LRAS YFYF P Y1Y1 SRAS 1 P1P1   

37.  Δ C, Δ I G, Δ G, and/or Δ X N = Δ AD  AD .: GDP R ↑ & PL↑.: u%↓ & π %↑  AD .: GDP R ↓ & PL↓.: u%↑ & π %↓  Δ Input Prices, Δ Productivity, and/or Δ Regulation = Δ SRAS  SRAS .: GDP R ↑ & PL↓.: u%↓ & π %↓  SRAS .: GDP R ↓ & PL ↑.: u%↑ & π %↑  The AS/AD Model is the most important graph in AP Macroeconomics.  KNOW IT!!!