1. AD/AS Model & Multipliers
Review Day #1: Monday May 2nd
Unit-3 Macro Review
AD/AS Model & Multipliers

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

3. Aggregate Demand AD = C + I + G + NX Components shift AD
3 reasons AD slopes downward =>

4. 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

5. 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

6. 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)

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

8. Practice Questions 1 E 14 B 2 C 15 3 16 4 17 A 5 D 18 6 19 7 20 8 21 922 10 23 11 24 12 25 13

9. Consumption Function Slope of consumption function = MPC = ∆C / ∆ DI
Slope of savings function = MPS = ∆S / ∆ DI
Autonomous Consumption: ↓
C = (DI)
Except for taxes & transfers,
Savings & Consumption
Functions shift in opposite
directions