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AP Macroeconomics · Unit 3 of 6

National Income & Price Determination

17–27% of the exam9 lessons · 126 min47 terms
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What this unit covers

The topics below follow the published Macro course framework for Unit 3. This unit is worth 17–27% of the exam, so budget your time against that rather than against how long the unit takes to teach.

AD-ASMultipliersFiscal policyEquilibrium

Lessons in this unit

Formulas in Unit 3

The components of aggregate demand
AD ≡ C + I + G + Xn
A rise in any component shifts AD right; a fall shifts AD left. This mirrors the GDP expenditure identity, now viewed as a demand relationship at each price level.
The multipliers
Spending multiplier = 1 / (1 − MPC) = 1 / MPS · Tax multiplier = −MPC / (1 − MPC)
MPC + MPS = 1. Total ΔGDP = (multiplier) × (initial change). The tax multiplier is always smaller in absolute value than the spending multiplier.
Spending needed to close a gap
Required ΔG = Output gap / Spending multiplier
Using taxes instead: Required ΔT = − Output gap / Tax multiplier. Because the tax multiplier is smaller, the required tax change is larger than the required spending change.
Slope versus shift
PRICE LEVEL changes → movement ALONG AD · C, I, G or Xn changes for any other reason → SHIFT of AD
The single most useful discriminator in the unit. If the cause is the price level, you move along; if it is anything else, you shift.
What shifts what
SRAS shifts: input prices, nominal wages, supply shocks, productivity, inflation expectations · LRAS shifts: labor force, capital stock, technology, institutions
Anything that changes real productive capacity shifts BOTH. Anything that only changes costs shifts SRAS alone.
Self-correction outcomes
recessionary gap → wages fall → SRAS right → output ↑ to potential, price level ↓ · inflationary gap → wages rise → SRAS left → output ↓ to potential, price level ↑
Output always ends at potential. What differs between the two cases is the direction the price level moves.
Reading the direction of a shock
AD shift → output and price level move the SAME way · SRAS shift → output and price level move OPPOSITE ways
Given what happened to output and prices, this identifies which curve moved. The single most useful diagnostic in Unit 3.
The cyclical budget
recession → tax revenue ↓ and transfers ↑ → deficit widens automatically
A deficit that grows in a recession may reflect no policy change at all. This is why the *structural* balance — what the budget would be at potential output — is the meaningful measure of fiscal stance.
The chain most questions follow
shock → which curve, which direction → real GDP and price level → unemployment (opposite to GDP) → interest rate (same direction as GDP, via money demand)
Unemployment moves opposite to real GDP. The nominal interest rate moves with real GDP, because higher income raises money demand.

Every term in Unit 3

All 47 terms we publish for National Income & Price Determination, with definitions. Reading them through is the fastest way to find the ones you cannot define — then drill those in cram mode until you can produce them without the prompt.

Spending multiplier
1 / MPS, equivalently 1 / (1 − MPC). Applies to any autonomous change in spending — C, I, G or Xn.
Tax multiplier
−MPC / MPS, equivalently −MPC × spending multiplier. Negative, and always one smaller in magnitude than the spending multiplier, because the first round of a tax cut is partly saved.
Why AD slopes downward
Three effects, none of them the microeconomic substitution effect: the wealth effect, the interest-rate effect, and the exchange-rate (net exports) effect.
Automatic stabilizers
Features of the budget that dampen the cycle without new legislation: progressive income taxes (collections fall in a recession) and transfer payments such as unemployment insurance and food assistance (outlays rise). They shrink the multiplier and reduce the size of both recessions and booms.
Aggregate demand (AD)
Total quantity of real output demanded at each price level by households, firms, government and foreigners. It is C + I + G + (X − M) drawn against the price level.
Wealth effect
A lower price level raises the real value of money holdings, so households feel richer and consume more. One of the three reasons AD slopes down.
Interest-rate effect
A lower price level reduces money demand, which lowers the nominal interest rate, which raises investment and interest-sensitive consumption.
Exchange-rate effect
A lower domestic price level makes exports cheaper abroad and imports dearer at home, raising net exports and so raising quantity of real GDP demanded.
Shifters of AD
Anything changing C, I, G or Xn: consumer and business confidence, wealth, taxes, government spending, real interest rates, foreign income, exchange rates. Not the price level — that is a movement along.
Short-run aggregate supply (SRAS)
Upward-sloping because input prices — especially nominal wages — are sticky in the short run, so a higher output price raises profit margins and output.
Shifters of SRAS
Input prices, nominal wages, productivity, business taxes and subsidies, supply shocks, and inflation expectations. A change in resource prices moves SRAS, not AD.
Long-run aggregate supply (LRAS)
Vertical at full-employment output. In the long run all prices and wages adjust, so output depends only on resources, technology and institutions — not on the price level.
What shifts LRAS
Only things that change productive capacity: labor force, capital stock, human capital, technology, institutions. The same list that shifts the PPC outward.
Short-run equilibrium
Where AD crosses SRAS. It determines the price level and real output, and can sit above, below or at full-employment output.
Long-run equilibrium
Where AD, SRAS and LRAS all intersect. Output equals potential, unemployment equals its natural rate, and there is no self-correcting pressure.
Self-correction from a recessionary gap
High unemployment eventually lowers nominal wages, SRAS shifts right, output returns to potential at a lower price level. Slow, and the delay is the case for policy.
Self-correction from an inflationary gap
Tight labor markets raise nominal wages, SRAS shifts left, output returns to potential at a higher price level. Inflation is the cost of doing nothing.
Stagflation
Falling real output alongside a rising price level, caused by a leftward SRAS shift. It is the case where demand-side policy cannot fix both problems at once.
Marginal propensity to consume (MPC)
Fraction of an additional dollar of disposable income that is spent: ΔC / ΔYd. Always between 0 and 1.
Marginal propensity to save (MPS)
Fraction of an additional dollar of disposable income that is saved: ΔS / ΔYd. MPC + MPS = 1.
Balanced budget multiplier
Exactly 1. An equal rise in government spending and taxes still raises GDP by the amount of the change, since G has the larger multiplier.
Using a multiplier on the exam
Total change in real GDP = multiplier × initial change in spending. To close a gap of a given size, divide the gap by the multiplier to find the spending change needed.
Why the multiplier is smaller in practice
Leakages: saving, taxes and imports all remove money from the domestic spending stream at each round. More leakage means a smaller multiplier.
Fiscal policy
Changes in government spending and taxation, decided by Congress and the President, used to shift AD. Distinguish it from monetary policy in every answer.
Expansionary fiscal policy
Increase government spending or cut taxes. AD shifts right, raising real output and the price level, and lowering unemployment.
Contractionary fiscal policy
Decrease government spending or raise taxes. AD shifts left, lowering the price level and real output, and raising unemployment.
Discretionary vs automatic fiscal policy
Discretionary requires a new act of Congress and suffers recognition, decision and implementation lags. Automatic stabilizers act immediately but cannot be scaled to the gap.
Lags in fiscal policy
Recognition (data arrive late), decision (legislation is slow), and implementation (spending takes time to reach the economy). The reason poorly timed stimulus can amplify the cycle.
Budget deficit vs national debt
A deficit is a single year's shortfall of revenue against spending; the debt is the accumulated total of past deficits. A falling deficit still adds to the debt.
Aggregate expenditure vs aggregate demand
Aggregate expenditure plots planned spending against real GDP at a fixed price level; AD plots real output demanded against the price level. Different axes, different questions.
Why AD slopes down is NOT substitution
AD is everything, so there is nothing outside it to substitute toward. The slope comes from the wealth, interest-rate and net-export effects.
The wealth effect behind AD
A lower price level raises the real value of money holdings, so people feel richer and buy more. Distinct from a change in actual wealth, which SHIFTS AD.
The interest-rate effect behind AD
A lower price level reduces money demand, lowering the interest rate and raising investment. This is a movement ALONG AD, not a shift.
Slope versus shift, in one test
If the PRICE LEVEL caused it, you move along AD. If anything else changed C, I, G or Xn, the curve shifts. The most useful discriminator in Unit 3.
Why SRAS slopes up
Nominal wages and many input prices are sticky, so a higher output price widens margins and makes producing more attractive. Remove the stickiness and the curve is vertical.
Why LRAS is vertical
With full wage and price adjustment, doubling all prices and wages leaves real incentives unchanged. Output depends only on real resources and technology.
Shocks that move both supply curves
Technology and productivity shift SRAS and LRAS right. An oil price change shifts SRAS only, since capacity is unaffected. Read for costs versus capacity.
Why self-correction is slow downward
Wages are sticky downward: contracts, minimum wages and resistance to pay cuts mean firms lay workers off instead. Inflationary gaps close far faster.
Policy versus self-correction, same output
Both reach potential. Policy shifts AD right and ends at a HIGHER price level; self-correction shifts SRAS right and ends at a LOWER one.
The same-way / opposite-way test
An AD shift moves output and the price level the SAME way. An SRAS shift moves them OPPOSITE ways. Given both directions, this identifies the curve.
Why stagflation defeats demand policy
Shifting AD moves output and prices together, so any AD action fixes one problem and worsens the other. Only a rightward SRAS shift improves both.
Demand-pull vs cost-push inflation
Demand-pull: AD right, so prices rise WITH output. Cost-push: SRAS left, so prices rise WHILE output falls. Only the first has a clean policy remedy.
Why a deficit widens with no policy change
Falling incomes shrink the tax base while rising unemployment expands transfer eligibility. This is why the headline deficit cannot reveal the fiscal stance.
Structural vs cyclical budget balance
Cyclical: caused by where the economy is. Structural: what the balance would be at potential output. Only the structural part describes policy.
The three fiscal policy lags
Recognition (identifying the problem), decision (passing the law) and implementation (spending the money). Monetary policy largely avoids the second.
The AD–AS rubric checklist
Axes labeled, all three curves drawn and labeled, LRAS vertical, equilibrium marked with dotted lines, the shift arrowed and relabeled, direction stated in WORDS.
The chain after an AD shift
Output up ⇒ unemployment down ⇒ money demand up ⇒ nominal rate up ⇒ investment down. Later parts of a question are answered from this chain.

What examiners penalize here

Practice Macro

Our practice bank is drawn from across the whole course rather than filtered to one unit, which is closer to how the exam asks anyway — it will not tell you which unit a question is testing.

84 practice questionsEvery one with a written explanationFRQ trainerWritten answers scored against the rubricMacro study guideAll units, weights and score data in one placeAll 6 Macro unitsThe full course

Questions about this unit

How much of the AP Macroeconomics exam is Unit 3?

Unit 3, National Income & Price Determination, is worth 17–27% of the Macro multiple-choice section according to the published course framework. Across all 6 units that makes it one of the heaviest units on the exam, and worth front-loading.

What topics are covered in Macro Unit 3?

National Income & Price Determination covers AD-AS, Multipliers, Fiscal policy and Equilibrium. We publish 47 terms with definitions for this unit, all of them on this page.

How should I study Macro Unit 3?

Read the 9 lessons below first — about 125 minutes — then drill the 47 terms in cram mode until you can produce each definition from memory rather than just recognize it. Recognition is what makes a unit feel finished when it is not. Finish with practice questions and read the explanation for every one you get right by elimination as well as the ones you miss.

All 6 units of AP Macroeconomics

  1. Unit 1 · Basic Economic Concepts
  2. Unit 2 · Economic Indicators & Business Cycle
  3. Unit 3 · National Income & Price Determination
  4. Unit 4 · Financial Sector
  5. Unit 5 · Long-Run Consequences of Policy
  6. Unit 6 · Open Economy

Unit names, topics and exam weights follow the published College Board course framework for AP Macroeconomics. AP® is a trademark registered by the College Board, which does not endorse this site.