Question 1

What is aggregate demand?

Accepted Answer

The total demand for goods and services within a particular market

(same as real GDP; C + I + G + Xn)

Question 2

What does the AD Curve measure?

Accepted Answer

The relationship between the price level and the quantity of goods and services demanded

Question 3

What is the relationship between the price level and the AD Curve?

Accepted Answer

As the price level increases, the aggregate quantity of goods and services demanded decreases

Question 4

What is the real wealth effect?

Accepted Answer

The decrease in consumption and investment spending due to a decline in real wealth

Higher price level = less spending

Question 5

What is the interest rate effect?

Accepted Answer

The decrease in consumption and investment spending due to an increase in interest rates at higher price levels

Higher price level = less investment due to higher interest rates

Question 6

What is the exchange rate effect (foreign trade effect)?

Accepted Answer

Lower price levels make an economy's goods more attractive to foreign buyers, increasing exports

Higher price level = less exports

Question 7

What are the three reasons that AD is downward sloping?

Accepted Answer

Real wealth effect

Interest rate effect

Exchange rate effect

Question 8

What causes a shift of the AD curve?

Accepted Answer

Any change in the components of aggregate demand (consumption, investment, government spending, or net exports) that is not due to changes in the price level

Question 9

What is the multiplier effect?

Accepted Answer

The multiplier effect is the idea that an initial change in spending will set off a spending chain that is magnified in the economy.

Question 10

What is marginal propensity to consume (MPC)?

Accepted Answer

How much people consume rather than save when they gain disposable income

(earning an extra $100 and spending $20 -> MPC=0.2)

Question 11

What is marginal propensity to save (MPS)?

Accepted Answer

How much people save rather than consume when they gain disposable income

(earning an extra $100 and spending $20 -> MPS=0.8)

Question 12

What is the relationship between MPC and MPS?

Accepted Answer

MPC and MPS are inversely related, meaning that an increase in MPC will lead to a decrease in MPS and vice versa

MPC + MPS = 1

Question 13

How do you calculate MPC?

Accepted Answer

By dividing the change in consumption by the change in disposable income.

MPC = Change in Consumption / Change in Disposable Income

Question 14

What does a high MPC indicate?

Accepted Answer

A high MPC indicates a high level of consumer spending.

Question 15

What is the spending multiplier?

Accepted Answer

The ratio of how much the GDP changes to how much spending changes

(with a spending multiplier of 5, an extra $100 of spending will increase the GDP by $500)

Question 16

How do you calculate the spending multiplier?

Accepted Answer

Question 17

What is the tax multiplier?

Accepted Answer

The factor by which a change in taxes will alter GDP

(with a tax multiplier of -5, a $100 cut in taxes will increase GDP by $500)

Question 18

What is the formula for the Tax Multiplier?

Accepted Answer

Question 19

Why are tax multipliers smaller than spending multipliers?

Accepted Answer

Spending multipliers have an immediate impact on the economy, but tax multipliers first have to go through someone's income before having an impact on the economy

Question 20

How do income taxes influence consumer spending?

Accepted Answer

Increased taxes reduce consumer spending

Reduced taxes increase consumer spending

Question 21

What is aggregate supply?

Accepted Answer

The amount of goods and services (real GDP) that firms will produce in an economy at different price levels

(the supply for everything by all firms)

Question 22

What does the short-run aggregate supply curve describe?

Accepted Answer

The relationship between the price level and the quantity of goods and services supplied in an economy

Question 23

Why is the SRAS curve upward sloping?

Accepted Answer

Wages/prices are sticky in the short run, so an increasing price level means that resources are easier to obtain

Question 24

Why is there a short-run tradeoff between inflation and unemployment?

Accepted Answer

Increased price level (inflation) increases output, meaning that employment must rise to match that output

Because employment rises, unemployment falls

Question 25

What is long-run aggregate supply (LRAS)?

Accepted Answer

A curve that shows the relationship between the price level and real GDP if all prices and wages were fully flexible

(price can change, but output cannot, so the curve is a straight vertical line)

Question 26

What is a consequence of flexible long-run prices/wages?

Accepted Answer

There is no long-run tradeoff between inflation and unemployment

(in contrast to the short-run tradeoff)

Question 27

What is maximum sustainable capacity?

Accepted Answer

The total output an economic system will produce over a set period of time if all resources are fully employed

Question 28

Why is the LRAS vertical at the full-employment level of output?

Accepted Answer

In the long run, prices and wages are flexible, so output isn't affected by price-level

(LRAS only changes with resources and productivity, just like PPC)

Question 29

What can shift the LRAS?

Accepted Answer

Change in resource quantity/quality

Change in technology

(same as the PPC)

Question 30

What are the two types of equilibrium when referring to the aggregate economy?

Accepted Answer

Short-run aggregate equilibrium (quantity of aggregate demanded is equal to the quantity of aggregate supply)

Long-run equilibrium (the current output is also equal to potential output)

Question 31

What is a recessionary gap?

Accepted Answer

When output is low, and unemployment is greater than NRU

("busts")

Question 32

What is an inflationary gap?

Accepted Answer

When output is high, and unemployment is less than NRU.

("booms")

Question 33

What are the three places that an economy can be at?

Accepted Answer

Full employment: Unemployment is at the NRU (frictional + structural)

Recessionary gap (negative output gap): Output low and unemployment is greater than NRU

Inflationary gap (positive output gap): Output is high and unemployment is less than NRU

Question 34

When does long-run equilibrium occur?

Accepted Answer

When the AD and SRAS curves intersect on the LRAS

(full employment)

Question 35

When does short-run equilibrium occur?

Accepted Answer

When the aggregate quantity of output demanded and the aggregate quantity of output supplied are equal

Question 36

What are positive and negative shocks?

Accepted Answer

Sudden increases/decreases in demand or supply

(negative supply shock = sudden decrease in supply)

Question 37

How do positive/negative shocks affect AD?

Accepted Answer

They cause output, employment, and the price level to rise/fall in the short run

Question 38

How do positive/negative shocks affect SRAS?

Accepted Answer

Positive: output and employment rise, price level falls

Negative: output and employment fall, price level rises

Question 39

What are the two main types of inflation?

Accepted Answer

Cost-push: changes in AS (higher costs push up prices)

Demand-pull: changes in AD (higher demand pulls up prices)

Question 40

What happens to flexible wages/prices in the long-run with no government interventions after a shock to AD or AS?

Accepted Answer

Flexible wages and prices will adjust to restore full employment, and unemployment will revert to its natural rate

(in the long-run, wages/prices self-adjust),

Question 41

What do shifts to the LRAS curve represent?

Accepted Answer

Changes in the full-employment level of output and economic growth

(rightward shifts mean economic growth, e.g., due to new technology or resources)

Question 42

If consumer spending increases, what will happen in the short- and long-run if there is no government policy action?

Accepted Answer

Price level will increase, but LRAS will not shift unless there is a change in resources/productivity

Question 43

If consumer spending decreases, what will happen in the short- and long-run if there is no government policy action?

Accepted Answer

Price level will decrease, but LRAS will not shift unless there is a change in resources/productivity

Question 44

If investment increases, what happens in the long-run?

Accepted Answer

LRAS shifts to the right

(consumer and govt. spending typically don't cause LRAS to shift, only business investment)

Question 45

What is fiscal policy?

Accepted Answer

Actions by Congress to stabilize the economy

(government spending or taxation changes)

Question 46

What is discretionary vs. non-discretionary fiscal policy?

Accepted Answer

Discretionary fiscal policy: Congress creates a new bill that is designed to change AD through government spending or taxation (stimulus checks during Covid)

Non-discretionary fiscal policy: permanent spending or taxation laws already on the books that help regulate the economy (social security, welfare, and unemployment compensations)

Question 47

What is contractionary vs. expansionary fiscal policy?

Accepted Answer

Contractionary: Laws that reduce inflation, decrease GDP (Close an Inflationary Gap)

Expansionary: Laws that reduce unemployment and increase GDP (Close a Recessionary Gap)

Question 48

How much government spending is required to close a $20 B recessionary gap if the MPC=0.8?

Accepted Answer

MPC=0.8, so MPS=0.2 and spending multiplier = 5

$20 B / 5 = $4 B to close the gap

Question 49

How much in tax cuts is required to close a $20 B recessionary gap if the MPC=0.8?

Accepted Answer

MPC=0.8, so MPS=0.2 and tax multiplier = -MPC/MPS = -4

$20 B / -4 = -$5 B in tax is required to close to gap ($5 B cut)

Question 50

What are automatic stabilizers (non-discretionary fiscal policy)?

Accepted Answer

Economic mechanisms that automatically increase or decrease government spending or taxation to stabilize the economy during economic ups and downs without requiring active policy changes

(support the economy during recessions and help prevent the economy from being overheated during expansionary periods; social security, progressive income tax, etc.)

Question 51

Why is the progressive income tax an automatic stabilizer?

Accepted Answer

When GDP is down, the tax burden on consumers is low, promoting consumption and increasing AD

When GDP is up, more tax burden on consumers, discouraging consumption and decreasing AD

Question 52

Why is the system of unemployment benefits an automatic stabilizer?

Accepted Answer

When GDP is down, unemployment is higher and more benefits will be paid out, increasing AD

When GDP is up, unemployment is low and fewer benefits will be paid out, decreasing AD

Unit 3 - National Income & Price Determination, AP Macroeconomics Flashcards