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AP Macroeconomics / National Income and Price Determination

Lesson

Gaps, sticky wages, and fiscal shifts

Output can sit above or below potential until prices and policy adjust.

Learning goals

  • Identify recessionary and inflationary gaps on an AD-AS graph.
  • Show how government spending or taxes can shift AD.

Explanation

Long-run aggregate supply sits at potential output, the level consistent with normal resource use. If short-run equilibrium is left of LRAS, the economy has a recessionary gap. If it is right, it has an inflationary gap. Sticky wages can delay the return to potential.

Fiscal policy uses government purchases and taxes. More purchases or lower taxes can shift AD right. The multiplier idea is that an initial spending change can ripple through income. Crowding out is the warning that higher public borrowing can raise interest rates and trim private investment.

Key terms

  • Potential output. The real GDP an economy can sustain with normal resource use, shown by LRAS.
  • Crowding out. A decrease in private investment that can follow higher government borrowing and higher interest rates.

Common mistakes

  • Assuming fiscal policy always lands exactly on potential.
  • Forgetting that a tax cut works through disposable income, not by moving LRAS by itself.

Practice

Original Marlow Works items. Check the answer explanation after you try.

1 of 1National Income and Price Determination · medium · short answer

Using AD–AS reasoning, what happens to aggregate demand and the short-run price level if government purchases increase while short-run aggregate supply is unchanged?

Original Marlow Works item — not a College Board question.

Take your time—this is practice, not a test.

Answer explanation

The economy is at potential and government purchases rise. What is the short-run AD-AS result?

Answer. AD shifts right, real output rises above potential, and the price level rises.

At full employment, extra spending mainly bids up prices and overheats output in the short run.

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Related resources

External links with reuse status. Marlow Works is independent and does not copy restricted exam or textbook material.

  • Official / link only

    AP Macroeconomics course page

    Official six-unit framework for national income and policy models.

    College Board · All rights reserved · accessed 2026-10-01

    Open source

  • Official / link only

    FRED economic data

    Federal Reserve economic data. Terms vary by series; do not scrape or ingest.

    Federal Reserve Bank of St. Louis · Varies by series · accessed 2026-10-01

    Open source