Macro Ch.21

If the multiplier is 5, then the MPC is

0.8

If the stock market crashes, then

aggregate demand decreases, which the Fed could offset by increasing the money supply.

Tax cuts

and increases in government expenditures shift aggregate demand right.

Automatic stabilizers

are changes in taxes or government spending that increase aggregate demand without requiring policy makers to act when the economy goes into recession.

People hold money primarily because it

can directly be used to buy goods and services.

The change in aggregate demand that results from fiscal expansion changing the interest rate is called the

crowding-out effect.

The marginal propensity to consume (MPC) is defined as the fraction of

extra income that a household consumes rather than saves.

Permanent tax cuts shift the AD curve

farther to the right than do temporary tax cuts.

In recent years, the Federal Reserve has conducted policy by setting a target for the

federal funds rate.

Fiscal policy refers to the idea that aggregate demand is affected by changes in

government spending and taxes.

Supply-side economists focus more than other economists on

how fiscal policy affects aggregate supply.

If the government cuts the tax rate, workers get to keep

more of each additional dollar they earn, so work effort increases, and aggregate supply shifts right.

Government purchases are said to have a

multiplier effect on aggregate demand.

Other things the same, automatic stabilizers tend to

raise expenditures during recessions and lower expenditures during expansions.

Assume the multiplier is 5 and that the crowding-out effect is $20 billion. An increase in government purchases of $10 billion will shift the aggregate-demand curve to the

right by $30 billion.

Assume the MPC is 0.75. Assume there is a multiplier effect and that the total crowding-out effect is $6 billion. An increase in government purchases of $10 billion will shift aggregate demand to the

right by $34 billion.

If the interest rate is below the Fed's target, the Fed would

sell bonds to decrease the money supply.

According to liquidity preference theory, an increase in money demand for some reason other than a change in the price level causes

the interest rate to rise, so aggregate demand shifts left.

Aggregate Demand curve slopes downward for three reasons:

• the wealth effect • the interest-rate effect (the most important of these effects for the U.S. economy) • the exchange-rate effect