AP Macro: Economic Models and Graphs Study Guide
Price Level
AP Macro: Economic Models and Graphs Study Guide
Economic Conditions
Recession LRAS SRAS
Price Level
Serious Inflation LRAS SRAS
PL1
PL1
AD
AD
Y1 YF
Real GDP
Full Employment with Mild Inflation
Price Level
LRAS SRAS
PL1
Price Level
PL2
PL1
YF Y1 Real GDP
Stagflation SRAS2 LRAS SRAS1
SRAS Cost-Push Inflation
AD
AD
YF
Real GDP
Y2 YF
Real GDP
Interest Rate
Sm1 Sm2
Effects of Expansionary Monetary Policy
Interest Rate
Price Level
LRAS SRAS
i1 i2
i1 i2
PL2 PL1
AD2
Dm
ID
AD1
Q1 Q2 Q of Money
Q1 Q2 Q of Investment $
Y1 YF
RGDP
MS i
i I (and C)
AD PL GDP
(Sm)
unemployment
Expansionary Monetary Policy actions by FED:
Short Run vs Long Run Effects
reserve requirement
Short Run: i I AD (shift right) PL and
discount rate
output and unemployment; net export effect: Xn
Buy U.S. government bonds/securities (Open
Long Run eco growth: I LRAS (shift right ?
Market Operation)
same as shift right of PPC curve)
Interest Rate
Sm2 Sm1
Effects of Contractionary Monetary Policy
Interest Rate
Price Level
LRAS SRAS
i2 i1
i2 i1
PL1 PL2
AD1
Dm
ID
AD2
Q2 Q1 Q of Money
Q2 Q1 Q of Investment $
YF Y1
R GDP
MS i
i I (and C)
AD PL GDP
unemployment
Contractionary (Restrictive) Monetary Policy
Short Run vs Long Run Effects
actions by FED:
Short Run: I AD (shift left) PL output
reserve requirement
unemployment; Net export effect: Xn
discount rate
Sell U.S. bonds/securities (Open Market Operation) Long Run Eco. growth: I LRAS (shift left ?
same as shift left of PPC curve)
Effects of Expansionary Fiscal Policy: G T (creates deficit; government must borrow $ to spend)
Interest Rate
Sm Interest
Rate
Price Level
LRAS SRAS
i2 i1
i2 i1
PL2 PL1
AD2
Dm2
AD3
Dm1
ID
AD1
Q1
Q of Money
Q2 Q1 Q of Investment $
Y1 YF
RGDP
Dm i
i I (and C) (Crowding out effect)
Crowding out weakens the impact of expansionary fiscal policy
Expansionary Fiscal Policy actions:
Short Run vs Long Run Effects of Expansionary
Fiscal Policy
Increase in G directly increases AD as G is a
Short Run: increases AD (shift right): PL and
component of AE. Decrease in T increases Yd (disposable income) and more spending (C) occurs. Overall impact is increase in AD (increase in output, employment and PL). Side Effect: Deficit spending increases the demand
output; unemployment. Deficit Dmi I due to crowding out effect and Xn due to net export effect (I D foreign demand for bonds appreciation of $ Xn)
for money and pushes up interest rates. Higher interest rates crowd out some business investment and interest rate sensitive spending by consumers. To the extent that crowding out occurs, the expansionary
Long Run Economic Growth: decrease I decreases LRAS (shift left ? same as shift left of PPC curve) (depends on the amount of crowding out that occurs)
impact of the fiscal policy will be weakened.
Effects of Contractionary Fiscal Policy: G T (moves budget toward surplus; less borrowing)
Interest Rate
Sm Interest
Rate
Price Level
LRAS SRAS
i1 i2
i1 i2
PL1 PL2
Dm1
Dm2
ID
AD1 2
Q1
Q of Money
Q1 Q2 Q of Investment $
YF Y1 RGDP
Dm i
i I (and C)
(lessening of Crowding out effect)
overall impact: AD
Impact of Monetary and Fiscal Policies on Interest Rates and Business Investment Spending
Policy
Money Market
Interest Rates Investment (I)
Expansionary Monetary Policy Expansionary Fiscal Policy
Contractionary Monetary Policy Contractionary Fiscal Policy
Increase supply of money Increase demand for money Decrease supply of money Decrease demand for money
decrease increase increase decrease
increase decrease decrease increase
Effect of an increase in G or decrease in T
Effect of a decrease in G or increase in T
Initially at Full Employment
Initially at Full Employment
Price Level
LRAS SRAS
Price Level
LRAS SRAS
PL2
PL1
PL1
PL2 AD2
AD1
AD1
AD2
YF Y2 Real GDP
Y2 YF
Real GDP
Effect of a supply-side shock:
Initially at Full Employment
Price Level
PL2
SRAS2 LRAS SRAS1
PL1
AD
Effect of an increase in G and T of same amount: *
Initially at Full Employment
Price Level
LRAS SRAS
PL2 PL1
AD2 AD1
Y2 YF Real GDP
YF Y2 Real GDP
Balanced budget increase in G and T is expansionary. * If G and T were decreased by the same amount, the effect would be contractionary ( AD
Short Run vs Long Run Adjustments
Short Run --- not enough time for wages to adjust to price level changes. Changes in PL, output and unemployment occur. Long Run --- enough time for wages to adjust; key effect is on PL.
PL
LRAS
SRAS1 SRAS2
AD PL and output
and unemployment in SR
PL1
a
PL2
b
AD1
PL3
c
AD2
Y2 YF Real GDP
Over time lower PL and surplus of labor put downward pressure on wages.
Wages lower business costs and SRAS. LR: Lower PL. (a c)
If PRICES AND WAGES ARE FLEXIBLE --- NOT STICKY!
Short Run vs Long Run Adjustments
If PRICES AND WAGES ARE FLEXIBLE --- NOT STICKY!
SRAS2
PL
LRAS SRAS1
AD PL and output
PL3
c
and unemployment in SR
PL2
b
Over time higher PL and
PL1
a
AD2
shortage of labor put
upward pressure on wages.
AD1
YF Y2 Real GDP
Wages raise business costs and SRAS. LR: Higher PL.
1
Nonprice Level Determinants of Aggregate Supply and Aggregate Demand
C + I + G + Xn = AE AD GDP (Direct relationship between any component of AE and AD and GDP)
Factors that Shift AD Curve
personal taxes ( Yd) corporate income taxes ( profit exp.) government spending (exp. Fiscal) G and T by same amount . G offsets the C. Effect = 1 x G. profit expectations of businesses wealth or consumer indebtedness exports / imports $ depreciates money supply interest rates
Net export effect deficit spending DLF and/or Dm interest rates (i)
in personal taxes ( Yd) corporate income taxes (profit exp.) government spending (contr. Fiscal ) G and T by same amount . G offsets the C. Effect = 1 x G. profit expectations of businesses wealth or consumer indebtedness exports / imports $ appreciates money supply interest rates
Net export effect deficit spending DLF and/or Dm interest rates (i)
Factors that Shift the SRAS
C AD resource availability I AD WAGES (or any other resource cost) G AD New technology
AD PRODUCTIVITY
I AD government regulation C AD government subsidies Xn AD business taxes (sales/excises) Xn AD costs of production I C AD Xn I AD
C AD Supply-side shock ( energy prices) I AD resource availability G AD WAGES (or any other resource cost) G AD technology
I C Xn Xn I C Xn I
AD AD AD AD
AD
AD
PRODUCTIVITY government regulation government subsidies business taxes (sales/excises) costs of production
inflationary expectations wages
SRAS SRAS SRAS SRAS
SRAS SRAS SRAS SRAS
SRAS SRAS SRAS SRAS
SRAS SRAS SRAS SRAS SRAS
SRAS
INCREASE = SHIFT RIGHT DECREASE = SHIFT LEFT (APPLIES TO BOTH CURVES)
Reasons for the inverse relationship between the price level and the quantity of real output purchased (negative slope of the AD curve):
? Interest rate effect: PL Dm i quantity of I and C (real output purchased) (opposite true if PL) ? Wealth/Real balances effect: PL purchasing power of wealth/real balances quantity of C ? Foreign Purchases effect: PL exports (seem more expensive) and imports (seem cheaper) Xn
Reason for the positively sloped AS curve (direct relationship between the PL and the quantity of real output produced): higher PL needed to encourage higher production. Demand-pull inflation: AD PL (too much money chasing too few goods) Cost-push inflation: SRAS PL (stagflation)
If AD no in PL but increases in output and employment, the economy is operating in the horizontal (Keynesian) portion of its AS curve. High unemployment allows businesses to hire more workers without putting pressure on wages or prices. If AD PL but no in output and employment, economy is operating in the vertical (classical) range of its AS curve. Increased demand puts pressure on prices only as economy is operating at its maximum of output and employment.
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