AD/AS Model & Multipliers Review Day #2: Tuesday May 2nd Unit-3 Macro Review AD/AS Model & Multipliers

Aggregate Demand AD = C + I + G + NX All components shift AD 3 reasons AD slopes downward =>

AD/AS Model Short run AS curve is upward sloping Prices/wages are sticky (slow to adjust) Long Run AS curve is vertical Prices/wages are flexible At full employment output level (on PPF) Actual price level = Expected price level

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 -------------------- -------------- P1 Y1 Y* E1 ----------- ---------- P1 Y1 Y* E1 Unemployment high, output low Below PPF, Actual Px level < Expected Unemployment very low, output high Above PPF, Actual Px level > Expected

Will shift BOTH curves (LRAS & SRAS, & PPF) Shifts in LRAS & SRAS If PPF goes right => LRAS shifts right Expected Price Level Input Prices Labor Capital Natural resources Technology Gov’t Incentives Shift SRAS ONLY (not LRAS) Will shift BOTH curves (LRAS & SRAS, & PPF)

MPC, MPS & Multipliers 3 Multipliers: Disposable Income (DI) = Gross Income – Net Taxes DI = Consumption + Savings (assuming no Gov’t taxes or transfers) MPC + MPS = 1 3 Multipliers: Spending Multiplier = 1/MPS Tax Multiplier = -MPC/MPS always 1 less than spending Balanced Budget Multiplier = 1 always 1 Example: MPC = .80 MPS = .20 Spending => 1/.20 = 5 Tax => .80/.20 = 4 Balanced => 5 - 4 = 1