2.  Gov. can affect AD through G or T  Directly: increase or decrease G, AD shifts  Indirectly: increase or decrease T and C and I will change, which will shift AD

3.  What’s the difference between actual and full employment?  Draw an economy with a recessionary gap.

4.  Expansionary Fiscal Policy  When AD is too low, the economy is not at full employment (or potential GDP)  Fiscal policy is expansionary to increase AD by increasing spending and/or reducing taxes  moves the economy toward full employment

5.  Expansionary policy increases employment, but  can raise price level  Result in budget deficits

6.  Draw an economy in with an inflationary gap.

7.  Contractionary Policies  If the level of AD is too high, it creates inflationary pressures.  Fiscal policy is contractionary  Reduce taxes and/or decrease spending  Moves economy to full employment

8.  Contractionary policies can reduce inflationary pressures, but  Can reduce output  Reduce employment level  Can also result in budget surpluses ( or smaller deficits)

9.  The multiplier effect  Tax multiplier  Always negative  MPC/ (1-MPC)  Same as MPC/MPS  Any change in taxes has a greater effect on C and/or I

10.  The multiplier effect  The spending multiplier  1/(1-MPC)  Same as 1/MPS  Any change in government spending has a greater effect than the amount of the spending

11.  Because of the multiplier effect the change in G or T to close a recessionary or inflationary gap (between the actual equilibrium level and the full employment level of output) will be smaller than the gap.  Change in G or T multiplied by the multiplier should equal the size of the gap.

12.  Discretionary Fiscal Policy  When the government chooses to change G or T, at the discretion of Congress and the president.

13.  Automatic Fiscal Policy  Policies that work to stabilize the economy through changes that happen automatically.  No one needs to make a decision about these; a system is already in place.  Progressive income tax, unemployment, income based-transfer payments,

14.  Any policy that changes a determinant of of SRAS will affect the macroeconomy through the supply side.  What are the determinants of SRAS?

15.  Determinants of SRAS ( things that will shift the SRAS):  Economy wide input prices (like wages and energy prices)  Productivity  Factors that affect LRAS:  Increase in available resources  Higher quality resources  Technological advances

16.  Draw 2 correctly labeled AS/AD graphs.  Show the effect of the following on eq. price and RGDP:  Graph 1 increase in AD  Graph 2 increase in AS  What are the differences in the results for graph 1 and 2?

17.  Goals of Monetary and Fiscal policy  Economic growth  Full employment  Price stability

18.  How might a shift in AS move the economy toward the main goals?  What might cause such a shift?

19. AD 1 LRAS SRAS AD Price Level RGDP PL PL 1 Y* Y1Y1 Suppose the Fed increases the MS: Interest rates decrease Investment and interest sensitive consumption increases Increase in AD Output increases PL increases

20. AD 1 LRAS SRAS AD Price Level RGDP PL PL 1 Y* Y1Y1 New short run equilibrium has output above the full employment level. As a result, nominal wages will rise (the demand for more workers to increase output allows workers to bargain for higher wages.

21. AD 1 LRAS SRAS AD Price Level RGDP PL PL 1 Y* Y1Y1 The higher wages lead to a leftward shift of the AS. New long run- equilibrium at full- employment level Higher price level In the long run, increase in MS has NOT changed RGDP, only increase in PL. SRAS 1 PL 2

22. SRAS 1 LRAS SRAS AD Price Level RGDP PL PL 1 Y* Y1Y1