1. 3.1 – 3.4 Review

2. What is Aggregate Demand?
Aggregate- “added all together.”
When we use aggregates
we combine all prices and all quantities.
Aggregate Demand is all the goods and services (real GDP) that buyers are willing and able to purchase at different price levels.
The Demand for everything by everyone in the US.
There is an inverse relationship between
price level and Real GDP.
If the price level:
Increases (Inflation), then real GDP demanded falls.
Decreases (deflation), the real GDP demanded increases.

3. Shifters of Aggregate Demand
GDP = C + I + G + Xn

4. What is Aggregate Supply? The supply for everything by all firms.
Aggregate Supply is the amount of goods and services (real GDP) that firms will produce in an economy at different price levels.
The supply for everything by all firms.
Aggregate Supply differentiates between short run and long-run and has two different curves.
Short-run Aggregate Supply
Nominal Wages and Resource Prices will not increase as price levels increase.
Long-run Aggregate Supply
Nominal Wages and Resource Prices will increase as price levels increase.

5. Shifters of Aggregate Demand Shifters of Aggregate Supply
AD = C + I + G + Xn
Change in Consumer Spending
Change in Investment Spending
Change in Government Spending
Change in Net EXport Spending
Shifters of Aggregate Supply
AS = R + A + P
Change in Resource Prices
Change in Actions of the Government
Change in Productivity

6. Example: Assume the government increases spending
Example: Assume the government increases spending. What happens to PL and Output?
LRAS
Price Level AS
PL and Q will Increase
PL1
PLe
AD1 AD QY Q1
GDPR 6

7. Inflationary Gap Output is high and unemployment is less than NRU LRAS
Price Level AS
Actual GDP above potential GDP
PL1
AD1 QY Q1
GDPR 7

8. Example: Assume consumer spending falls. What happens to PL and Output?
LRAS
Price Level AS
PL and Q will decrease
PLe
PL1 AD
AD1 Q1 QY
GDPR 8

9. Recessionary Gap Output low and unemployment is more than NRU LRAS
Price Level AS
Actual GDP below potential GDP
PL1
AD1 Q1 QY
GDPR 9

10. Stagnate Economy + Inflation Still considered recessionary gap
Example: If there is a negative “supply shock” of oil. What happens to PL and Output?
LRAS
Price Level
AS1 AS
Stagflation
Stagnate Economy + Inflation
PL1
PLe
Still considered recessionary gap AD Q1 QY
GDPR 10

11. In the long-run, wages and costs increase
If consumer spending increases, what will happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
AS1
Real GDP
Price
Level AS
PL2
PL1
Real GDP
PLe AD
AD1 QY Q1
GDPR
Time 11

12. In the long-run, wages and costs increase
If consumer spending increases, what will happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
AS1
Real GDP
Price
Level
PLe
Real GDP
AD1 QY
GDPR
Time 12

13. In the long-run, wages & costs eventually decrease
If consumer spending decreases, what will happen in the short-run and in the long-run?
In the long-run, wages & costs eventually decrease
LRAS
Real GDP
Price
Level AS
AS2
PLe
PL1
Real GDP
PL2
AD2 AD Q1 QY
GDPR
Time 13

14. Debates Over Aggregate Supply
Keynesian Theory
A decrease in AD will lead to a persistent recession because prices of resources (wages) are NOT flexible.
Increase in AD during a recession puts no pressure on prices AS
Price level
“Sticky Wages” prevents wages from falling.
The government should deficit spend to close the gap AD
AD1 Q1 Qf
Real domestic output, GDP 14

15. AD/AS and the Phillips Curve
Show what happens on both graphs if AD increase
LRPC
Price Level
LRAS
Inflation AS
PLe
AD1 AD
SRPC QY
GDPR UY
Unemployment 15

16. AD/AS and the Phillips Curve
Correctly draw the LRPC and SRPC with the recessionary gap. What happens when AD falls?
Price Level
LRAS
LRPC
Inflation AS
PLe AD
SRPC
AD1 QY
GDPR UY
Unemployment 16

17. AD/AS and the Phillips Curve
Correctly draw the LRPC and SRPC at full employment. What happens when AS falls?
Price Level
LRAS
LRPC
Inflation
AS1 AS
PLe
SRPC1 AD
SRPC QY
GDPR UY
Unemployment 17

18. AD/AS and the Phillips Curve
Correctly draw the LRPC and SRPC with a recessionary gap. What happens when AS goes up?
Price Level
LRAS
LRPC
Inflation AS
AS1
PLe
SRPC AD
SRPC1 QY
GDPR UY
Unemployment 18

19. SRAS
LRPC
LRAS
Price Level
Inflation
SRPC QY
GDPR UY
Unemployment

20. SRAS
LRPC
LRAS
Price Level
Inflation
PLe
AD2 AD
SRPC
AD3 QY
GDPR UY
Unemployment

21. AS1
SRAS
LRPC
LRAS
Price Level
Inflation
AS2
PLe
SRPC1 AD
SRPC2
SRPC QY
GDPR UY
Unemployment

22. Long-Run impacts of an AD Increase
LRPC
LRAS
Price Level
Inflation
PLe
SRPC1
AD2 AD
SRPC QY
GDPR UY
Unemployment

23. How is Spending “Multiplied”?
Assume the MPC is .5 for everyone
Assume the Super Bowl comes to town and there is an increase of $100 in Ashley’s restaurant.
Ashley now has $100 more income.
She saves $50 and spends $50 at Karl’s Salon
Karl now has $50 more income
He saves $25 and spends $25 at Dan’s fruit stand
Dan now has $25 more income.
This continues until every penny is spent or saved
= Multiplier x
Total change in GDP
Initial Change
in Spending

24. Calculating the Spending Multiplier
If the MPC is .5 how much is the multiplier?
Spending
Multiplier OR
If the multiplier is 4, how much will an initial increase of $5 in Government spending increase the GDP?
How much will a decrease of $3 in spending decrease GDP?
MPC = .5 the multiplier is 2
= Multiplier x
Total change in GDP
Initial Change
in Spending 24

25. Calculating the Tax Multiplier
If the MPC is .75 how much is the tax multiplier?
MPC
MPS
Simple Tax
Multiplier
MPC x OR
If the spending multiplier is 4, then the tax multiplier is only 3
But remember that an increase in taxes decreases GDP so the tax multiplier is negative.
MPC = .5 the multiplier is 2
= Tax Multiplier x
Total change in GDP
Initial Change
in Taxes

26. Draw and Practice
Congress uses discretionary fiscal policy to the manipulate the following economy (MPC = .8)
LRAS
What type of gap?
Contractionary or Expansionary needed?
What are two options to fix the gap?
How much initial government spending is needed to close gap? AS
Price level P1
AD1
AD2
+$40 Billion
$ $1000FE
Real GDP (billions) 26