Macro Test #3 Notes
4 spending groups
1. Consumer (70%)
=f(income, interest rate, expectations, wealth, CC)
2. Investment (10%)
=f(interest rate, RGDP, expectations, BC)
3. Government (25%)
4. Net Export (5%)
=f(our RGDP, their RGDP, exchange rate)
Total spending = C + I + G + X n
a. Why is spending so important, especially in its relationship to RGDP?
Because when someone spends money, it is income to someone else. Our
spending depends on our income or RGDP so when we gain income we spend
more. So if the government spends money on building bridges and schools, that
spending is income to the workers who build the building/schools and the ones
who end up working there. And once they get more income, they start spending
(the multiplier effect).
b. Is there any limit to how long this added spending goes on?
Each additional dollar of income doesn’t always get spent because some of it gets
saved. The saving is the brake on the multiplier effect.
The Multiplier: 1 = 1
1 – mpc mps
The real mpc for the U.S: $ 0.99 (we only save 1¢) Our multiplier (on average): 2
c. How much of each new dollar of income do we spend on average?
If we spend 90 cents of each new dollar and we save 10 cents of each new dollar
then the extra spending from one dollar goes down each round of spending.
90% of 81¢ = 73¢ spent and 8¢ saved
90% of 73¢ = 66¢ spent and 7¢ saved
90% of 66¢ = 59¢ spent and 7¢ saved
90% of 59¢ = 53¢ spent and 6¢ saved
a. So what does the AS/AD model determine?
The relationship between Price and RGDP
b. What can we do with these numbers?
With P1: We can see what has happened to the price level since last year (up or
With Y1: We can compare it with last year (up or down) AND we can compare it
with Full Employment RGDP to see if we’re in a recession or inflation and where
c. We know that these numbers will change over time how? Overtime, the AS/AD curve will shift to the right because Full Employment level
is sloped upwards on the business cycle model
d. What does each curve show?
AS curve shows the levels of output that firms are willing to produce at different
prices. As the price level increases, firms are willing to produce more because
there is higher profit at higher prices to an incentive to offer more for sale.
The AS curve gets steeper as RGDP increases because at recession (low RGDP),
there is more resources (land, labor, capital, entrepreneurship) which means
people are unemployed and so it doesn’t cost as much to start a business.
However, it gets more and more expensive to hire more workers and produce
more because eventually the resources become scarce.
AD curve shows what spenders (C, I, G, X ) ane willing to buy at different prices.
When prices go down, spenders are willing to buy more.
e. Why is the AD curve downward sloping?
1. Real Balance Effect : When Price level goes down, our income goes farther so
our RGDP goes up because we spend more (purchasing power of dollar
2. Interest Rate Effec : A higher Price level increases the demand for money.
Given a fixed supply of money, an increase in money demanded will drive up
the price paid for its use. That price is the interest rate.
3. Foreign Exchange Rate Effect : The rise in the price level of another country
reduces the quantity of their goods demanded and so they buy our goods,
which increases our Net Export and also RGDP (more spending).
f. Why is the AS curve upward sloping?
Because the more profit the firms can potentially earn, the more they are willing
g. What shifts the AS Curve? Technology
Cost of Production
Legal Institutions (Gov’t regulation, taxes, and subsidies)
h. What shifts the AD Curve?
Any change in C, I, G, or X n
1. Fiscal Policy: Defined as government spending and taxes
An increase in government spending and a decrease in taxes would increase
total spending and shift the AD curve to the right thus increasing price and
A decrease in spending and an increase in taxes would cause a decrease in
total spending, a decrease in the price and a decrease in RGDP.
2. Expansionary Fiscal Policy (Recession Period): Defined as shifting the AD to the
right with a decrease in taxes (T) or an increase in Government spending (G) or both.
3. Contractionary Fiscal Policy (Inflation Period): Decrease in government spending
and increase in taxes. Result: AD curve shifts to the left which brings RGDP down.
4. The Multiplier Effect
Spending Multiplier Effect is derived…
ΔRGDP (or Y) = multiplier (or k) x ΔG
Ex: In 1932
ΔG = 335.1 (RGDP)
2 (multiplier) ΔG = 167 billion
Change in Taxes Formula
ΔY = k(mpc) ΔT