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

2. 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

3. 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

4. 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
increases the quantity of
goods and services demanded.

5. 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)

6. 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

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

8. 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

9. 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