AD/AS Model & Multipliers

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Presentation transcript:

AD/AS Model & Multipliers Unit-3 Macro Review AD/AS Model & Multipliers

GDP = C + I + G + (X-M) Calculating GDP: What does not Count? Business Investment, Consumer/Business Construction, & Change in Inventories. (new houses count as investment!) GDP = C + I + G + (X-M) What does not Count? Used goods International products Financial transactions Non-market transactions Gov’t Transfers (i.e. welfare, social security) What Counts? Only NEW & FINAL goods Domestic Products GDP does not measure: mix of goods, quality of products, quality of life, leisure time

AD/AS Model Short run AS curve is upward sloping Prices/wages are sticky Long Run AS curve is vertical Prices/wages are flexible At full employment output level AD = C + I + G + NX A change in component shifts AD curve

AD Downward Slope AD Price Level Real GDP 3-Factors make it downward sloping Price Level AD P Y 1. A decrease in the price level . . . Y2 P2 Real GDP 2. . . . increases the quantity of goods and services demanded.

Will shift BOTH curves (LRAS & SRAS) Shifts in AS Shifts occur when you have a change in: Expected Price Level Input Prices Labor Capital Natural resources Technology Gov’t Incentives Shift SRAS but not LRAS Will shift BOTH curves (LRAS & SRAS)

Inflationary Gap Recessionary Gap Economy above full output Economy below full output LRAS1 Price Level Real GDP SRAS1 LRAS1 Price Level Real GDP SRAS1 AD1 AD1 Unemployment high, output low Below PPF, Actual Px level < Expected Unemployment very low, output high Above PPF, Actual Px level > Expected

Disposable Income & MPS/MPC Disposable Income (DI) = Gross Income – Net Taxes DI = Consumption + Savings (assuming no Gov’t taxes or transfers) MPC + MPS = 1

3 Multipliers & Fiscal Policy 1) Gov’t Spending or Investment Multiplier = 1/MPS 1/.20 = 5 2) Tax Multiplier: -MPC/MPS -.80/.20 = -4 LRAS1 Price Level Real GDP SRAS1 MPC = .80 MPS = .20 AD1 Tax Multiplier is always 1 smaller Expansionary Fiscal Policy: ⁭ Gov’t Spending 1 billion MPS = .25 AD shifts right by 4 billion (multiplier = 4) 3) Balanced Budget Multiplier is always = 1

Goal of an Economy: Shift LRAS Right PPF Graph Price Level LRAS1 LRAS2 Technology allowed USA to maintain high GDP & low inflation in 1980’s & 1990’s Y1 Real GDP Y2