Aggregate Demand
What are the four components of aggregate demand?
Consumption, Investment, Government Spending, Net Exports (C + I + G + XN).
Name one factor that shifts SRAS but not LRAS.
Input costs (like wages, energy, raw materials).
What is the term for when actual GDP is below potential GDP?
Recessionary gap.
What is the formula for the spending multiplier?
1/MPS or 1/1-MPC
What is the main tool of fiscal policy?
Government spending and taxes.
If U.S. consumers increase spending on domestic goods, what happens to AD?
AD increases (shifts right).
What does the Long-Run Aggregate Supply (LRAS) curve represent on a graph?
The economy’s potential output/full employment level of GDP (where resources are fully utilized).
If AD increases, what happens to the GDP and the price level in the short run?
GDP increases, price level increases.
If MPC = 0.8, what is the multiplier?
5
What type of fiscal policy is used to close a recessionary gap?
Expansionary fiscal policy (increase G, decrease T).
Which AD shifter is affected when foreign incomes fall?
Net Exports (foreign sector).
If wages rise across the economy, what happens to SRAS?
SRAS decreases (shifts left).
What will happen to SRAS in the long run if there is an inflationary gap?
SRAS decreases (shifts left) as wages and input costs rise, returning the economy to full employment.
If government spending increases by $50 and the multiplier is 4, what happens to GDP?
GDP increases by $200 ($50 × 4).
What type of fiscal policy should the government use to fix high unemployment?
Expansionary fiscal policy (increase government spending or cut taxes).
True or False: A change in the price level shifts the AD curve.
False. A change in the price level is a movement along AD, not a shift.
If the government invests in new infrastructure that improves productivity, what happens to the LRAS curve?
LRAS increases (shifts right), because the economy’s potential output grows.
If AS decreases, what two things happen to price level and output?
Price level increases, output decreases (stagflation).
Give one example of an automatic stabilizer.
unemployment benefits, progressive income taxes, welfare programs.
Explain why a decrease in interest rates increases aggregate demand.
Lower interest rates make borrowing cheaper → increases investment & consumption → AD increases.
What happens to LRAS if there is an increase in human capital?
LRAS increases (shifts right).
Explain how the economy self-corrects from a recessionary gap without policy intervention.
Wages and input costs eventually fall, shifting SRAS right until full employment is restored.
If potential output is $5,000, and current is only $4,600, and the MPC = 0.75, how much new government spending is needed to close the gap using the spending multiplier?
$100.
What is the main goal of contractionary fiscal policy?
To reduce inflation by decreasing aggregate demand.