Credit Sprint's Guide to Macroeconomics Unit 3: National Income & Price Determination

AP® weight 17–27%CLEP® weight 15–20%

Aggregate demand (AD) and short-run aggregate supply (SRAS) set the price level and real output. Long-run aggregate supply (LRAS) is vertical at full-employment output. Multipliers explain why a change in spending moves GDP by more than the initial amount.

What you need to know

AD shifts with changes in C, I, G or Xn. SRAS shifts with input prices, productivity and expectations.
AD slopes down because of the wealth, interest-rate and exchange-rate effects.
Recessionary gap: equilibrium output below full employment. Inflationary gap: above it.
Without policy, a recessionary gap closes as nominal wages fall and SRAS shifts right.
Spending multiplier = 1 ÷ MPS. Tax multiplier = −MPC ÷ MPS.
A balanced-budget change (G and T up by the same amount) raises GDP by that amount.
Automatic stabilizers (unemployment insurance, progressive taxes) work without new laws.

Formulas

MPC + MPS = 1

Spending multiplier = 1 ÷ (1 − MPC)

Tax multiplier = −MPC ÷ (1 − MPC)

Required ΔG = Output gap ÷ Spending multiplier

Exam traps

Watch forA change in the price level moves along AD; it does not shift it.

Watch forTax multipliers are always one smaller (in absolute value) than spending multipliers.

Watch forStagflation is an SRAS story, not an AD story.

Key terms

Aggregate demand: Total spending on domestic output at each price level: C + I + G + Xn.
SRAS: Short-run aggregate supply. Upward sloping because wages and some prices are sticky.
LRAS: Long-run aggregate supply. Vertical at full-employment output; shifts with resources and technology.
MPC: Marginal propensity to consume: the share of each extra dollar of income spent. MPC + MPS = 1.
MPS: Marginal propensity to save: the share of each extra dollar of income saved.
Spending multiplier: 1 ÷ (1 − MPC). How much GDP changes per $1 change in spending.
Tax multiplier: −MPC ÷ (1 − MPC). Always one smaller in absolute value than the spending multiplier.
Balanced-budget multiplier: Equal to 1. Raising G and T by the same amount raises GDP by that amount.
Recessionary gap: Equilibrium output below full-employment output; unemployment above the natural rate.
Inflationary gap: Equilibrium output above full-employment output; upward pressure on prices and wages.
Stagflation: Rising prices and falling output at the same time. Caused by a leftward SRAS shift.
Automatic stabilizers: Taxes and transfers that change on their own with the economy, like unemployment insurance.
Expansionary fiscal policy: Raising government spending or cutting taxes to shift AD right.

Practice questions

Five of the 45 Unit 3 questions in Credit Sprint. Every choice is explained in the app.

1. The MPC is 0.8. If government spending rises by $20 billion, the maximum increase in real GDP is:

$16 billion
$25 billion
$80 billion
$20 billion
$100 billion

Show answer

$100 billion. Multiplier = 1 ÷ 0.2 = 5, and 5 × $20B = $100B.

2. If the MPS is 0.25, the spending multiplier is:

1.33
3
4
0.75
0.25

Show answer

4. Multiplier = 1 ÷ MPS = 1 ÷ 0.25.

3. The price level is above its equilibrium level. What happens?

LRAS shifts left
There's a surplus of real output, and the price level falls
AD shifts right
There's a shortage of real output
The money supply shrinks

Show answer

There's a surplus of real output, and the price level falls. Firms can't sell everything they produce, so prices fall.

4. The recessionary gap is $300 billion and the MPC is 0.75. The minimum increase in government spending to close it is:

$75 billion
$300 billion
$100 billion
$225 billion
$150 billion

Show answer

$75 billion. Multiplier = 1 ÷ 0.25 = 4; $300B ÷ 4 = $75B.

5. Contractionary fiscal policy in the short run will:

Raise both output and prices
Change only LRAS
Raise output only
Lower real output and the price level
Raise real output and lower the price level

Show answer

Lower real output and the price level. AD shifts left.