Unit 8 Economics Study Hub

Core definitions

Aggregate Demand (AD)

Total demand for all final goods and services in the economy at different price levels. AD = C + I + G + NX. Slopes downward due to the wealth effect and interest-rate effect.

SRAS (Short-Run Aggregate Supply)

Amount firms are willing to produce at different price levels in the short run. Slopes upward. Shifts when input costs or productivity change.

LRAS (Long-Run Aggregate Supply)

Economy's potential / full-employment output. Vertical because in the long run, output depends on resources, capital, and technology — NOT on the price level.

Real GDP (RGDP)

Inflation-adjusted total output of the economy. Rises when AD or SRAS shifts right.

Price Level (PL)

The overall average level of prices across the economy. Rises when AD shifts right or SRAS shifts left.

Recessionary gap

Equilibrium RGDP is BELOW full-employment output (LRAS). Unemployment is above the natural rate. Calls for EXPANSIONARY policy.

Inflationary gap

Equilibrium RGDP is ABOVE full-employment output (LRAS). Calls for CONTRACTIONARY policy.

MPC (Marginal Propensity to Consume)

Fraction of an extra dollar of income that is SPENT. Example: MPC = 0.8 means 80¢ of every extra dollar is spent.

MPS (Marginal Propensity to Save)

Fraction of an extra dollar of income that is SAVED. MPS = 1 − MPC. Always: MPC + MPS = 1.

Fiscal policy

Government action using taxes (T), government spending (G), and transfer payments to shift AD and influence the economy.

Monetary policy

Central bank actions — buying/selling bonds, changing reserve requirements, discount rate — to change the money supply and interest rates, shifting AD.

Spending multiplier

The factor by which a change in autonomous spending (ΔG, ΔI) multiplies into a final change in GDP. = 1 / MPS.

Tax multiplier

The factor by which a tax change shifts GDP. = −MPC / MPS. Always one unit smaller in absolute value than the spending multiplier because part of the tax change is saved.

Transfer multiplier

Same absolute value as tax multiplier but POSITIVE. = MPC / MPS. Transfer increases raise GDP; decreases lower it.

Wealth effect

Higher price level erodes the real value (purchasing power) of money holdings → households feel poorer → spend less → one reason AD slopes down.

Interest-rate effect

Higher price level means people need more money for transactions → interest rates rise → investment and some consumption fall → second reason AD slopes down.

Interactive AD-AS graph

What each shift does

AD right PL rises, RGDP rises

AD left PL falls, RGDP falls

SRAS right PL falls, RGDP rises

SRAS left PL rises, RGDP falls (stagflation)

LRAS right Potential output increases

Long-run self-correction

Inflationary gap: Wages rise → SRAS shifts left → output returns to LRAS at higher PL

Recessionary gap: Wages fall → SRAS shifts right → output returns to LRAS at lower PL

Key rule: Cannot permanently keep output above LRAS — only creates ongoing inflation.

All formulas

Aggregate Demand

AD = C + I + G + NX

MPC / MPS identity

MPC + MPS = 1 → MPS = 1 − MPC

Multipliers

Spending multiplier = 1 / (1 − MPC) = 1 / MPS

Tax multiplier = −MPC / (1 − MPC) = −MPC / MPS

Transfer multiplier = MPC / (1 − MPC) = MPC / MPS

GDP change formulas

ΔGDP = ΔG × spending multiplier

ΔGDP = ΔT × tax multiplier (ΔT up → GDP down)

ΔGDP = ΔTransfers × transfer multiplier

Finding the needed policy change to close a gap

ΔG needed = gap ÷ spending multiplier

ΔT needed = gap ÷ |tax multiplier| (opposite direction)

ΔTransfers needed = gap ÷ transfer multiplier

Multiplier reference table

MPC	MPS	Spending mult	Tax mult	Transfer mult

Key multiplier rules

G vs Tax: For the same dollar amount, government spending has a LARGER effect because every dollar of G directly enters the economy, while part of a tax cut is saved (MPS fraction).

To match G: A tax cut must be LARGER than ΔG to achieve the same ΔGDP.

Tax vs Transfer: Same absolute value multiplier, opposite sign.

MPS falls: Multiplier = 1/MPS → multiplier RISES.

Finding MPC from data

From income/spending:
MPC = Δspending / Δincome

From multiplier value M:
1/(1−MPC) = M → MPC = 1 − 1/M

Example: $40M investment → $160M GDP
M = 160/40 = 4 → MPC = 1 − 1/4 = 0.75

Cause-and-effect chains

Fiscal Expansionary fiscal policy (recessionary gap)

G rises→AD right→RGDP ↑→PL ↑→unemployment ↓

Taxes fall→disposable income ↑→C rises→AD right→RGDP ↑, PL ↑

Transfers rise→disposable income ↑→C rises→AD right→RGDP ↑, PL ↑

Fiscal Contractionary fiscal policy (inflationary gap)

G falls→AD left→RGDP ↓→PL ↓

Taxes rise→disposable income ↓→C falls→AD left→RGDP ↓, PL ↓

Monetary Expansionary monetary policy

Buy bonds / lower reserve req / lower discount rate→money supply ↑→interest rates ↓→investment ↑→AD right→RGDP ↑, PL ↑

Monetary Contractionary monetary policy

Sell bonds / raise reserve req / raise discount rate→money supply ↓→interest rates ↑→investment ↓→AD left→RGDP ↓, PL ↓

SRAS Supply shocks

Oil prices ↑→production costs ↑→SRAS left→PL ↑→RGDP ↓→stagflation

Productivity ↑→unit costs ↓→SRAS right→PL ↓→RGDP ↑→LRAS right (LR)

LRAS Long-run self-correction (inflationary gap)

Output > LRAS→tight labor market→wages rise→costs rise→SRAS left→output returns to LRAS→PL higher

LRAS Corporate tax cut — full chain

Corp tax ↓→lower costs (SR)→SRAS right→PL ↓, RGDP ↑

Corp tax ↓→more investment (LR)→capital stock ↑→LRAS right→potential output ↑

AD and SRAS shifter quick reference

AD shifts RIGHT

Taxes fall · Consumer confidence rises · Wealth/stock market rises · Investment rises · Government spending rises · Exports rise · Interest rates fall

AD shifts LEFT

Taxes rise · Consumer confidence falls · Stock market crashes · Consumer debt high · Investment falls · Government spending falls · Exports fall · Interest rates rise

SRAS shifts RIGHT

Oil/input prices fall · Productivity rises · Business taxes fall · Deregulation

SRAS shifts LEFT

Oil/input prices rise · Wages rise · Business taxes rise · More costly regulation

Multiplier calculator

MPC = 0.8

Spending multiplier

Tax multiplier

Transfer multiplier

Policy impact — how much does GDP change?

Δ = $ billion

Gap closer — how much policy is needed?

Gap = $ billion

Find MPC from a scenario

Δincome = $ Δspending = $