Unit 3: Aggregate Demand and Supply and Fiscal Policy

Question 1

Describe the relationship between price level and real GDP

Answer 1

inverse

Question 2

Aggregate Demand

Answer 2

The demand for everything by everyone by everyone in the US

Question 3

Why is AD downwards sloping?

Answer 3

Wealth Effect
Interest Rate Effect
Foreign trade Effect

Question 4

Wealth Effect

Answer 4

high $ –> lower purchasing power and decrease expenditures and vice versa

Question 5

Interest rate Effect

Answer 5

Higher interest rates discourage consumer spending and business investment

Question 6

Foreign trade effect

Answer 6

When US price level rises, foreign buyers purchase fewer US goods and Americans buy more foreign goods

Question 7

Shifters of AD

Answer 7

Change in Consumer Spending
Change in Investment Spending
Change in Government Spending
Change in Net Exports (X-M)

Question 8

Aggregate supply

Answer 8

The supply for everything by all firms

Question 9

AS shifters

Answer 9

Resource Prices
Actions of the Government
Productivity

Question 10

Classical Theory

Answer 10

change in AD will not change output

AS is vertical

Question 11

Keynesian Theory

Answer 11

When there is high unemployment an inc in AD does not lead to higher prices until you get close to employment
AS is HORIZONTAL

Question 12

Three ranges of aggregate supply

Answer 12

Keynesian Range - horizontal
Intermediate Range - upward sloping
Classical Range - vertical at physical capacity

Question 13

autonomous consumption

Answer 13

consumers spend a certain amount no matter what

Question 14

disposable income

Answer 14

income after taxes

Question 15

discretionary

Answer 15

govt passes a bill to shift aggregate demand

Question 16

fiscal policy

Answer 16

actions by congress to stabilize economy

Question 17

nondiscretionary

Answer 17

no bill involved, congress does nothing

permanent spending or taxation laws

Question 18

contractionary

Answer 18

slow down economy
move left
closes inflationary gap
dec govt spending/inc taxes

Question 19

expansionary

Answer 19

speed up economy
inc govt spending/dec taxes
RIGHT

Question 20

multiplier effect

Answer 20

initial change in spending will set off a spending chain that is magnified in the economy

Question 21

spending multiplier formula

Answer 21

1/MPS OR 1/1-MPC

Question 22

Total change in GDP

Answer 22

multiplier*init change in spending

Question 23

Tax multiplier

Answer 23

spending multiplier-1 OR

MPC* (1/MPS)

Question 24

5 problems with Fiscal Policy (DPPCN)

Answer 24

Deficit Spending
Problems of Timing
Politically Motivated Policies
Crowding Out Effect
Net Export Effect

Question 25

Deficit Spending

Answer 25

Govt’s expenditures exceeds its revenue

Question 26

Problems of Timing

Answer 26

Recognition lag - Congress must react to economic indicators before its too late Administrative Lag - Congress takes time to pass legislation Operational lag - spending/planning takes time to organize and execute (changing taxing is quicker)

Question 27

Politically Motivated Policies

Answer 27

Politicians may use economically inappropriate policies to get reelected

Question 28

Crowding Out Effect

Answer 28

Govt spending might cause unintended effects that weaken the impact of the policy

Question 29

Net Export Effect

Answer 29

International trade reduces the effectiveness of fiscal policies