National Income & Price: every key term you need (+ practice quiz)

More AP Macroeconomics guides

• Basic Economic Concepts
• Supply, Demand, Elasticity
• Financial Sector
• Long-Run Growth

GDP Components

GDP = C + I + G + Nx where C=consumption, I=investment, G=government, Nx=net exports. Income approach: wages + profits + interest + rent.

Consumption

Household spending on goods/services. Largest component of GDP (~70% US). Influenced by income, wealth, expectations, interest rates.

Investment

Business spending on capital (factories, equipment). Volatile; sensitive to interest rates and business confidence.

Government Spending

Federal, state, local purchases. Includes salaries, infrastructure, military. NOT transfers (Social Security) - don't count in GDP.

Net Exports

Exports - imports. Positive: trade surplus (export >import). Negative: trade deficit (import >export).

GDP vs GNI

GDP: produced within country. GNI (Gross National Income): produced by country's citizens. Usually similar; differ for countries with significant overseas income.

Price Level

Average prices of all goods/services. Measured by CPI (Consumer Price Index) or GDP deflator. Affects real GDP calculation.

CPI Basket

Fixed bundle of goods/services representing typical consumer. Compare costs: (cost this year/cost base year) × 100.

Inflation Rate

Percent change in price level year-over-year. Moderate inflation (2-3%) normal; high inflation (>5%) problematic.

Deflator

Adjusts nominal to real. Real GDP = (Nominal GDP / GDP deflator) × 100. Accounts for price changes over time.

Aggregate Demand (AD)

Total spending on economy; downward-sloping. Higher price level → lower real spending (wealth effect, interest rate effect).

Aggregate Supply (AS)

Total production; upward-sloping short-run, vertical long-run at potential output.

Unit 3 Summary

GDP measured by income or spending approach. Price level adjusted for inflation. AD-AS model explains output and price interaction.

Wealth Effect

A higher price level erodes the real value of money holdings, so households feel poorer and buy less. It helps explain the downward slope of AD.

Interest Rate Effect

A higher price level raises money demand, pushing nominal interest rates up and discouraging interest-sensitive investment and durable consumption.

Foreign Purchases Effect

A higher domestic price level makes home goods pricier relative to foreign goods, cutting exports and raising imports, so net exports and AD fall.

Sticky Wages and SRAS

Nominal wages adjust slowly, so a higher price level lowers real wages and raises profit per unit, inducing firms to produce more. This gives SRAS its upward slope.

LRAS

A vertical line at full-employment output. In the long run wages and prices fully adjust, so real output depends on resources and technology, not the price level.

Recessionary Gap

Short-run equilibrium output below LRAS. Unemployment exceeds the natural rate and downward price pressure exists.

Inflationary Gap

Short-run equilibrium output above LRAS. Unemployment is below the natural rate and the economy overheats, generating rising prices.

Self-Correction Mechanism

In a recessionary gap nominal wages eventually fall, shifting SRAS right until output returns to LRAS. The process is slow, which motivates active policy.

Negative Supply Shock

A jump in input costs such as oil shifts SRAS left, raising the price level while lowering real output. This is the textbook cause of stagflation.

Marginal Propensity to Consume

MPC is the fraction of an additional dollar of disposable income that is spent. MPC plus MPS equals 1 in a simple closed model.

Spending Multiplier

1 divided by (1 minus MPC), equivalently 1 divided by MPS. An MPC of 0.8 yields a multiplier of 5.

Tax Multiplier

Negative MPC divided by MPS. It is smaller in absolute value than the spending multiplier because part of a tax cut is saved.

Balanced Budget Multiplier

Raising spending and taxes by the same amount still raises GDP, with a net multiplier of 1, because spending injects fully while taxes leak partly into saving.

Automatic Stabilizers

Progressive taxes and transfer programs that expand deficits in recessions and shrink them in booms without new legislation, dampening the business cycle.

Discretionary Fiscal Policy

Deliberate changes to government spending or tax rates. Subject to recognition, administrative, and operational lags.

Contractionary Fiscal Policy

Cutting spending or raising taxes to close an inflationary gap. AD shifts left, lowering the price level and real output toward LRAS.

Short-Run Phillips Curve

Downward-sloping trade-off between inflation and unemployment. Movement along it corresponds to a shift in AD.

Long-Run Phillips Curve

Vertical at the natural rate of unemployment, mirroring vertical LRAS. There is no permanent inflation-unemployment trade-off.

Shifts of the SRPC

Changes in expected inflation or supply shocks shift the short-run Phillips curve; higher expected inflation shifts it up and right.

Demand-Pull vs Cost-Push Inflation

Demand-pull comes from AD shifting right along an upward SRAS. Cost-push comes from SRAS shifting left and is paired with falling output.

Real GDP per Capita Interpretation

Rising real GDP with faster population growth can still mean falling living standards, so per capita figures are the better welfare proxy.

Aggregate Expenditures and the 45-Degree Line

Equilibrium occurs where planned aggregate expenditure equals real output. Unplanned inventory changes push the economy back toward that point.

National Saving Identity

In a closed economy, private saving plus public saving equals investment. Government deficits reduce public saving and total funds for investment.