1. Unit 4: National Income & Price Determination
Modules 16-21
Read “From Boom to Bust”, pg. 158
& FYI pg. 162
(See Module 2 for more about the business cycle)

2. Module 16 Key Terms & Review
Autonomous change in aggregate spending
Disposable income
Planned investment spending
Inventory investment
Unplanned inventory investment 1. 2. 3. 4. 5.

3. Spending Multiplier
Autonomous (initial) changes in C, I, G, or Xn cause a ripple effect that changes GDP by a much larger factor
How much larger?

4. Spending Multiplier cont.

5. Consumption Function

6. Consumer Spending (C)
C = Autonomous consumer spending + (MPC x current disposable income)
“For American households, the best estimate of the average household’s autonomous consumer spending is $17,484 and the best estimate of the MPC is ”

7. Shifts in the Consumption Function

8. What can cause the consumption function to shift?
Read pgs

9. Investment spending (I)

10. Investment cont.
Planned investment spending is determined by

11. Interest rates

12. Inventory (pgs )
Inventory investment – value of the change in total inventories held in the economy during a given period

13. Module 17 Key Terms & Review
Wealth effect
Interest rate effect
Fiscal policy
Monetary policy 1. 2. 3. 4. 5.

14. Aggregate Demand

15. Why is AD downward-sloping?
AD represents C + I + G + Xn
G is constant (government decisions are not affected by the price level)
Similar to the Law of Demand? No.
You buy less Oreos when their price rises because you can switch to buying Moreos (a generic brand of Oreos produced on Mayberry Island)

16. AD cont. Downward-sloping due to the Wealth effect
Interest rate effect

17. Shifts in Aggregate Demand

18. Factors that shift AD (17.1 pg. 176)
Changes in expectations
Changes in wealth
Size of the existing stock of physical capital
Government policies (fiscal policy)
Use of G and/or taxes to stabilize the economy
Federal Reserve policies (monetary policy)
Use of changes in interest rates to stabilize the economy

19. Module 18 Key Terms & Review
Nominal wage
Sticky wages
Commodity 1. 2. 3. 4. 5.

20. Aggregate Supply

21. Why is AS upward-sloping?
Largest production cost for most suppliers is wages
Profit = price per unit – production cost per unit
Higher PL 
Lower PL 

22. Shifts in AS

23. Factors that shift AS
Factors that affect profit per unit

24. In the long run…
Wages, as well as the cost of all inputs, are flexible
Price level has no effect on AS

25. Long Run Aggregate Supply

26. Shifts in LRAS
LRAS = PPC

27. SRAS  LRAS
SRAS2
LRAS
Price
level
SRAS1
Real GDP

28. SRAS  LRAS
LRAS
SRAS1
Price level
SRAS2
Real GDP

29. Module 19 Key Terms & Review
Demand shock
Stagflation
Recessionary gap
Inflationary gap
Output gap 1. 2. 3. 4. 5.
Unemployment!
Inflation!

30. The AD-AS Model

31. Shifts in AD

32. Shifts in AS

33. Long-run Macroeconomic Equilibrium

34. Negative Demand Shock

35. Positive Demand Shock

36. Module 20 Key Terms & Review
Stabilization policy
Social insurance
Bush-era tax cuts - CBS news
Colbert Report: trickle-down economics 1. 2. 3. 4. 5.

37. Stabilization Policy
“In the long run we are all dead.” – John Maynard Keynes
Advocated use of fiscal policy to smooth out the business cycle
Negative demand shock:

38. Negative Supply Shocks
Fiscal policy is not effective in increasing AS (return to original Yf)
Solution:
What problem does this fix?
What problem does this cause?

39. Fiscal Policy Remember that pesky Circular Flow Diagram???
Read pgs to learn about the the different categories of taxes and spending

40. Fiscal Policy cont.
GDP = C + I + G + Xn

41. Types of Fiscal Policy Recessionary gap  expansionary fiscal policy
Taxes:
Government spending:
Transfer payments:
Inflationary gap  contractionary fiscal policy
Read about Lags in Fiscal Policy, pgs

42. Module 21 Key Terms & Review
Lump-sum taxes
Automatic stabilizers
Discretionary fiscal policy 1. 2. 3. 4. 5.

43. Fiscal Policy & the Multiplier Effect
Autonomous (initial) change in government spending is magnified by the multiplier effect
Changes to transfer payments & taxes have a lesser effect
Tax multiplier =

44. Balanced Budget Multiplier
Government collects taxes to cover its spending
Add spending & tax multipliers together to get net impact on the economy

45. Example
Increase in G by $50 requires and increase in taxes of $50. If the MPC is 0.8 
Spending multiplier =
Impact on the economy:
Tax multiplier =
Overall impact:

46. Who should the government target?
Unemployed / poor have a higher MPC than the rich 

47. Taxes & the Multiplier
Most taxes are positively correlated with RGDP 
Acts as an automatic stabilizer for the economy

48. Automatic stabilizers
Progressive taxes
Transfer payments:
Changes in government spending & taxes = discretionary fiscal policy
Requires deliberate action by the legislative & executive branches

49. Unit 4 Review (pgs )
11.
12.
13.
14.
15.
16.
17.
18.
19.
20. 1. 2. 3. 4. 5. 6. 7. 8. 9.
10.
21.
22.
23.
24.
25.

50. Inflation & the AD-AS Model
SRAS2
LRAS
Demand-pull
AD increases  workers demand higher wages 
SRAS decreases
Long-run equilibrium: same output, higher price level
Economy can only operate beyond full employment in the short-run
Price level
SRAS1
AD2
AD1
Real GDP

51. Inflation cont. Cost-push 2 choices SRAS2 LRAS Price level
AS decreases > price level increases while output decreases > recession
2 choices
Increase AD, could cause inflation
Let the recession run its course
Decreased demand for inputs will eventually lower their cost  AS will increase
Price level
SRAS1
AD2 ??
AD1
Real GDP

52. Recession & the AD-AS Model
Decrease in AD causes lower output & price level
Lower price level may eventually lead to lower wages  increase in AS
End result: same output, lower price level
Reality: Will wages actually fall?
LRAS
Price level
SRAS1
SRAS2
AD1
AD2
Real GDP

53. When the magic happens…
Permanent, long-run economic growth
Rightward shift of LRAS = outward shift of PPC
New, higher level of output without inflation
LRAS
LRAS1
Price level
SRAS1
SRAS2
AD2
AD1
Real GDP