Section 4

Key Terms Marginal Propensity to Consume Interest rate effect of a change in the aggregate price level Supply Shock Stagflation Marginal Propensity to Save Recessionary Gap Autonomous Change in Aggregate Spending Fiscal Policy Inflationary Gap Monetary Policy Output Gap Spending Multiplier Aggregate Supply Curve Self-Correcting Consumption Function Nominal Wage Stabilization Policy Autonomous Consumer Spending Sticky Wages Social Assistance Short-Run Aggregate Supply Curve Expansionary Fiscal Policy Aggregate Consumption Function Contractionary Fiscal Policy Long-Run Aggregate Supply Curve Planned Investment Spending Tax Multiplier Inventory Investment Potential Output Balanced Budget Multiplier Unplanned Investment Spending AD-AS Model Lump-sum Taxes Short-Run Macroeconomic Equilibrium Automatic Stabilizers Actual Investment Spending Discretionary Fiscal Policy Aggregate Demand Curve Long-Run Macroeconomic Equilibrium Wealth Effect of a change in the aggregate price level Demand Shock

Key Formulas MPC = Δ consumption/ Δ disposable income MPC + MPS = 1 Spending Multiplier = 1/1-MPC Tax Multiplier = -MPC/1-MPC Balanced Budget Multiplier = 1

Key Formulas Consumption Function = A + MPC* YD Output Gap = actual aggregate output – potential output x 100 potential output

Key Graphs Consumption Function

Key Graphs AD-AS Model

Key Concepts Shifts in Aggregate Demand Changes in Expectations Changes in Wealth Size of Existing Stock of Physical Capital Government Policies Fiscal Policy Monetary Policy

Key Concepts Shifts in Aggregate Supply Changes in Commodity Prices Changes in Nominal Wages Changes in Productivity Changes in Expectations about Inflation

Key Concepts Long-Run Aggregate Supply Represents potential output. A shift of the LRAS to the right represents economic growth. If the economy is operating to the left (below) of the LRAS curve -> recessionary gap. If the economy is operating to the right (above) of the LRAS curve -> inflationary gap. The economy self-corrects in the LR -> know how to trace out and explain self-correcting steps. -> know how to identify appropriate fiscal policy to close these gaps.

AP Exam Tips Be able to calculate MPC, MPS and the multiplier. An increase in unplanned inventory is preceded by a decrease in consumer spending. A decrease in unplanned inventory is preceded by an increase in consumer spending. Aggregate demand is the demand for all goods and services in the market rather than the demand for one good or service. Make sure all AD-AS graphs are labeled completely and properly. Know the wealth and interest rate effects that explain why AD is downward sloping. Because wages are sticky, they fall very slowly even when the unemployment rate is high. This is important to know when you look at how the economy self-corrects with no government involvement. A decrease is left, an increase is right when looking at shifts of AD/SRAS/LRAS. Know all the factors that can shift AD and SRAS. When asked to graph the effect of a change, graph the first thing that happens in the short-run, unless the question tells you to look at the long-run. Know how to draw and identify a recessionary and inflationary gap. Know the ways governments can use fiscal policy to shift aggregate demand – transfers, taxes, and government spending.