Unit 3

Unit Overview:
Aggregate Demand- shows the amount of Real GDP that the private, public, and foreign sector collectively devise to purchase each possible price level.
The relationship between the price level and Real GDP is inverse.
3 Reasons AD is downward sloping:
1. Real Balance Effect- when price level is high, households and businesses cannot afford to purchase as much output.
2. Interest Rate Effect- a higher price level increases the interest rate which tends to discourage investment.
3. Foreign Purchase Effect- a higher price level increases the demand for relatively cheaper imports.
Shifts in AD:
-change in multiplier effect
-change in C Ig G or Xn
Increases shift to the right
Decreases shift to the left
Aggregate Supply: is the level of Real GDP that firms will produce at each price level.
Longrun vs. Shortrun:
Longrun- period of time where inout prices are completely flexible and adjust to changes in price level.
Shortrun- period of time where input prices are sticky and do not adjust to changes in the price level.
LRAS- marks the level of full employment in the economy..
because input prices are completely flexible in the long run, changes in price level do not change firms, real profits, therefore don't change firms level output.
SRAS- because input prices are sticky in the short run, SRAS is upward sloping.
Determinants of SRAS:
-Input Prices
-productivity
-legal-institutional environment
Shifts: increase-right decrease-left
Investment Demand:
-the shape of the ID curve is downward sloping.
Why?
because when interest rates are high, fewer investments are profitable; when they are low, more investments are profitable.
3 Schools of Economics:
-Classical (Says Law…supply creates its own demand.)
-Keynesian (Demand creates own supply.)
-Monetary (gov't. can best control the health of the economy.)
Fiscal Policy: changes in the expenditure on tax revenues of the federal government.
-2 tools of fiscal policy:
-taxes- gov't. can increase or decrease taxes
spending- gov't. can increase or decrease spending.
Balanced Budget- Revenues=expenditures
Budget Deficit- revenues<expenditures
Budget Surplus-Revenues>expenditures
Discretionary Policy-
Expansionary: think…deficit! (recession)
Contractionary: think…surplus (inflation)
Non-Discretionary: no action
Automatic: unemployment compensation and marginal tax rate.
Discretionary- increasing or decreasing voernment spending and/or taxes in order to return the economy to full employment.