The fraction of an additional dollar of disposable income that a household spends on consumption.

The fraction of an additional dollar of disposable income that a household saves; MPC and MPS always sum to 1.

An initial rise or fall in spending that is not itself caused by a change in real GDP, and which sets off the multiplier process.

The ratio of the total change in real GDP to the initial autonomous change in spending that caused it.

The size of the multiplier depends on the MPC: a larger MPC means a larger multiplier and a bigger change in real GDP for any given change in spending.

An equation linking a household's consumer spending to its current disposable income.

The amount a household would spend even if its disposable income were zero.

The relationship between total consumer spending and total disposable income for the whole economy.

The investment spending that firms intend to undertake during a given period.

The value of the change in firms' inventories over a period, which counts as part of investment.

Unintended swings in inventories that occur when actual sales differ from what firms expected.

Planned investment spending plus unplanned inventory investment.

Shows the total quantity of goods and services demanded across the economy at each aggregate price level; it slopes downward.

A higher aggregate price level reduces the purchasing power of money holdings, lowering consumer spending, which helps make the AD curve slope down.

A higher aggregate price level raises money demand and interest rates, reducing investment and consumption, which also makes the AD curve slope down.

The AD curve shifts with changes in expectations, wealth, the existing stock of physical capital, and government fiscal and monetary policy.

The government's use of taxes, transfers, and purchases of goods and services to shift the aggregate demand curve.

The central bank's use of changes in the money supply and interest rates to shift aggregate demand.

Shows the total quantity of final output producers are willing to supply at each aggregate price level.

The dollar amount of a worker's wage, unadjusted for inflation.

Nominal wages that adjust slowly to economic conditions because of contracts and social norms.

Upward sloping: because wages and some prices are sticky, a higher price level temporarily raises output.

Vertical at potential output: once all prices, including wages, are flexible, output does not depend on the price level.

The level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible.

The framework that combines aggregate demand and aggregate supply to determine the economy's price level and output.

The point where the aggregate demand curve crosses the short-run aggregate supply curve, setting the short-run price level and output.

An event that shifts the aggregate demand curve, moving the price level and aggregate output in the same direction.

An event that shifts the short-run aggregate supply curve, moving the price level and aggregate output in opposite directions.

The combination of falling output and rising prices, produced by a negative supply shock, as in the 1970s oil crises.

The point where aggregate demand, short-run aggregate supply, and long-run aggregate supply all meet, with output at potential.

When actual aggregate output is below potential output.

When actual aggregate output is above potential output.

The percentage difference between actual aggregate output and potential output.

Over the long run, output gaps close on their own as sticky nominal wages eventually adjust, returning output to potential.

The use of fiscal or monetary policy to soften the swings of the business cycle.

Policymakers cannot cure both problems at once: boosting aggregate demand eases the output slump but worsens inflation, while cutting demand fights inflation but deepens the slump.

Because of lags in recognizing problems and enacting responses, poorly timed stabilization policy can actually make the economy less stable.

Government transfer programs, such as Social Security and Medicare, that protect families against economic hardship.

Increasing government purchases or transfers, or cutting taxes, to shift the aggregate demand curve to the right.

Reducing government purchases or transfers, or raising taxes, to shift the aggregate demand curve to the left.

Government purchases affect aggregate demand directly, while changes in taxes and transfers affect it indirectly by altering households' disposable income.

A change in government purchases has a stronger effect on the economy than an equal-sized change in taxes or transfers, because part of a tax or transfer change is absorbed by saving.

Taxes that do not depend on income; unlike other taxes, they do not reduce the size of the multiplier.

Tax and transfer rules that automatically dampen business-cycle swings, such as taxes falling and jobless benefits rising during a recession.

Deliberate changes in taxes or spending decided by policymakers, as opposed to automatic responses built into the system.

The collapse of spending deepened the 1930s slump, while the surge of government spending during World War II helped pull the economy out, illustrating the multiplier in action.

The American Recovery and Reinvestment Act of 2009 used expansionary fiscal policy, boosting spending and cutting taxes, to counter the Great Recession.