AP Macroeconomics Unit 3 Cheatsheet: National Income and Price Determination

Definition: Relationship between price level and quantity of goods/services demanded (C + I + G + NX).

Why negative slope?

• Real wealth effect: Higher price level → lower purchasing power → less consumption
• Interest rate effect: Higher price level → higher interest rates → less investment
• Exchange rate effect: Higher price level → higher interest rates → stronger currency → fewer net exports

AD Shifts (not price-level changes):

• Change in C, I, G, or NX (autonomous)
• Consumer/business confidence
• Tax changes
• Foreign income

Definition: Relationship between price level and quantity supplied in the short run.

Upward-sloping because: Sticky wages and prices. When price level rises, real wages fall → firms hire more → output increases.

SRAS Shifts (cost changes):

• Input prices (wages, oil)
• Inflationary expectations
• Productivity changes
• Supply shocks

Short-run inflation-unemployment trade-off: An increase in AD raises output and the price level (i.e., higher inflation), lowering unemployment below its natural rate — this inverse inflation-rate/unemployment-rate relationship is the short-run Phillips Curve, the mirror image of movement along SRAS.

How the economy returns to full employment:

After negative AD shock (recession): Unemployment rises → wages fall → SRAS shifts right → output and employment recover → price level falls.

After positive AD shock (overheating): Unemployment falls below natural rate → wages rise → SRAS shifts left → output falls back to full employment → price level rises.

Key: In long run, flexible wages/prices restore full employment. No long-run inflation-unemployment trade-off.

LRAS shifts: Indicate changes in full-employment output and economic growth (capital, labor, technology, institutions).