UnofficialAP MacroeconomicsUnit 3 of 6

AP Macroeconomics Unit 3: National Income and Price Determination

Aggregate demand, aggregate supply and multipliers.

Unit overview

This unit builds the aggregate demand and aggregate supply model. Aggregate demand slopes downward because of the wealth, interest rate and exchange rate effects. Short-run aggregate supply slopes upward because some input prices are sticky, while long-run aggregate supply is vertical at full-employment output.

Shifts in aggregate demand or short-run aggregate supply cause recessionary or inflationary gaps. The spending multiplier, $\frac{1}{MPS}$ , explains why a change in spending has a larger total effect on GDP, and the tax multiplier is $\frac{-MPC}{MPS}$ . Fiscal policy changes government spending or taxes to close output gaps, and in the long run wages and prices adjust so the economy returns to its long-run aggregate supply curve.

Key topics

Aggregate demand: Why it slopes down and what shifts it.
Short- and long-run aggregate supply: Sticky wages, supply shocks and full-employment output.
Multipliers: Spending multiplier $1/MPS$ and tax multiplier $-MPC/MPS$ .
Fiscal policy: Expansionary and contractionary policy and automatic stabilisers.

Worked example

The marginal propensity to consume is 0.8. Government spending rises by $10 billion. Find the maximum change in real GDP.

$MPS = 1 - 0.8 = 0.2$ , so the multiplier is $1/0.2 = 5$ .
Change in GDP $= 5 \times 10 = 50$ billion dollars.

Answer: $50$ billion dollars

Common mistakes

Shifting long-run aggregate supply in response to demand changes.
Using the spending multiplier for a tax change; the tax multiplier is smaller by one.
Labelling the axes of the AD-AS graph with price and quantity instead of price level and real GDP.

Exam tips

On the graph, mark the new equilibrium and label the change in price level and real output.
Always state the direction of the gap before recommending a fiscal policy.

See the AP Macroeconomics exam format and every unit on the course page.