National Income and Price Determination

• Understanding the interaction between aggregate supply (AS) and aggregate demand (AD) is the key to national income and price determination.
• Macroeconomic equilibrium arises where AD and AS curves intersect, defining the price level and real GDP.
• Shifts in either AD or AS cause macroeconomic variable fluctuations, influencing inflation, unemployment, and economic growth.

Aggregate Demand

• Aggregate Demand (AD) is the total demand for goods/services in an economy at different price levels.
• The AD curve slopes downward, showing an inverse relationship between price level and real GDP.
• AD comprises consumption (C), investment (I), government spending (G), and net exports (NX), where AD = C + I + G + NX.
• Consumption depends on disposable income, consumer confidence, interest rates, and wealth.
• Investment is influenced by interest rates, business expectations, technological changes, and capacity utilization.
• Government spending reflects fiscal policy, while net exports depend on exchange rates and relative income levels.
• AD curve shifts result from changes in consumer, investment, and government spending, as well as net exports.
• Higher government spending or lower taxes shift the AD curve to the right.

Multiplier Effect

• The Multiplier effect describes the amplified impact of changes in autonomous spending on aggregate demand.
• Spending multiplier = 1 / (1 - MPC), where MPC is marginal propensity to consume.
• Tax multiplier = -MPC / (1 - MPC).
• Higher MPC leads to a larger multiplier, as more income is spent instead of saved.
• The multiplier effect is reduced by leakages like savings, taxes, and imports.

Aggregate Supply

• Aggregate Supply (AS) indicates the total goods/services firms can supply at various price levels.
• The short-run aggregate supply (SRAS) curve slopes upward, meaning a direct relationship between price level and real GDP.
• Input prices, technology, and expectations impact SRAS.
• The long-run aggregate supply (LRAS) curve is vertical at potential output, representing the full employment GDP level.
• Resource availability, technology, and institutions determine LRAS.
• SRAS shifts are caused by changes in input prices (wages, materials), productivity, or supply shocks.
• LRAS shifts are caused by changes in technology, resources, or institutions.
• The LRAS shows the economy's potential output, with all resources fully utilized.

Equilibrium

• Short-run macroeconomic equilibrium occurs at the AD and SRAS curves intersection.
• The economy produces output consistent with aggregate demand and short-run aggregate supply at this point.
• Long-run macroeconomic equilibrium occurs where the AD curve intersects both the SRAS and LRAS curves.
• Reflecting production at potential output and no price level change pressure at this point.
• AD or AS shifts can disrupt long-run equilibrium, leading to inflationary or recessionary gaps.

Changes in Equilibrium

• Higher aggregate demand increases the price level and real GDP in the short run, potentially causing inflation.
• Lower aggregate demand decreases the price level and real GDP in the short run, potentially causing a recession.
• Increased short-run aggregate supply decreases the price level and increases real GDP, enhancing economic growth.
• Decreased short-run aggregate supply increases the price level and decreases real GDP, potentially causing stagflation.
• The economy self-corrects to its potential output level in the long run.
• Fiscal or monetary policies can stabilize the economy and lessen AD or AS shocks.

Fiscal Policy

• Fiscal policy uses government spending and taxation to influence the economy.
• Expansionary fiscal policy increases government spending or lowers taxes to boost aggregate demand.
• Contractionary fiscal policy decreases government spending or raises taxes to reduce aggregate demand.
• Fiscal policy addresses recessionary or inflationary gaps, promoting full employment and price stability.
• Its effectiveness depends on the multiplier effect, crowding-out effects, and time lags.

Automatic Stabilizers

• Automatic stabilizers moderate economic fluctuations without policy changes.
• Unemployment insurance, progressive income taxes, and welfare programs are examples.
• During recessions, unemployment insurance rises, supporting unemployed workers and stabilizing aggregate demand.
• Progressive income taxes fall during recessions, boosting household disposable income.
• These stabilizers reverse during expansions, reducing inflationary pressures.

The Phillips Curve

• The Phillips curve shows the short-run inverse relationship between inflation and unemployment.
• Lower unemployment often increases inflation, and vice versa.
• The short-run Phillips curve (SRPC) slopes downward.
• Inflationary expectations or supply shocks can shift the SRPC.
• The long-run Phillips curve (LRPC) is vertical at the natural unemployment rate, indicating full employment.
• The natural rate of unemployment is the total of frictional and structural unemployment.
• There's no long-run trade-off between inflation and unemployment, as the economy operates at its natural unemployment rate regardless of inflation.

Fiscal and Monetary Policy

• Governments use fiscal policy to impact the economy through spending and taxation adjustments.
• Central banks use monetary policy to influence the economy via interest rates and money supply changes.
• Combining fiscal and monetary policies achieves goals like full employment, price stability, and economic growth.
• Supply-side policies improve long-run aggregate supply by enhancing productivity, cutting regulations, and boosting human capital investment.

Inflation

• Inflation is a lasting rise in the general price level of goods/services over time.
• Demand-pull inflation occurs when aggregate demand exceeds aggregate supply, pushing prices up.
• Cost-push inflation occurs when higher input costs raise prices.
• Inflation cuts purchasing power, reduces savings value, and distorts investment.
• Central banks control inflation using monetary policy, such as adjusting interest rates or the money supply.
• The quantity theory of money states that money supply changes directly affect the price level, where MV = PQ (M is money supply, V is velocity of money, P is price level, Q is quantity of goods/services).

Understand how aggregate supply (AS) and aggregate demand (AD) interact to determine macroeconomic equilibrium. Macroeconomic equilibrium signifies the point where the AD and AS curves intersect, establishing the overall price level and real GDP. Changes in AD or AS can impact inflation and economic growth.