FINAL REVIEW

AP MACROECONOMICS

Unit One: Intro to EconomicsGraphs: PPC, Circular FlowBig Concepts: Comparative and Absolute

Advantage, Circular Flow of Economic Activity

Circular Flow of Economic Activity

FundamentalsFundamental problem in economics is

scarcityOpportunity cost-next best alternative.

Adam Smith-Invisible hand, self-interest, justifies a market

Macro-Whole economyMicro-Part of the economy (firms and

households)

3 EconomiesMarketTraditionalCommandMIXED-Mix of market and government, its

what we have

Growth, or AS/LRASSources of Growth

Quantity and quality of human and natural resources increase

Amount of capital goods or stock increaseTechnology increases productivity

Unit Two: Supply and DemandGraphs: Supply and DemandBig Concepts: Price Ceilings and Floors

FundamentalsLaw of Demand-As price rises, quantity

demanded falls (D is downward sloping)Law of Supply-As price rises quantity

supplied rises (S is upward sloping)Quantity Demanded-Points on a demand

line.Quantity Supplied-Points on a supply line.

Ceilings and FloorsPrice Ceiling-Below equilibrium, causes

more quantity to be demanded than is willing to be supplied (shortage).

Price Floor-Occurs above equilibrium, causes more to be supplied than is demanded (surplus).

Unit Three: GDP, Unemployment and InflationGraphs: AD/AS, Phillips CurveBig Concepts:

CPI, GDP Deflator and Inflation CalculationsTypes of Unemployment GPD CalculationWho is hurt and helped by inflation?

Business CycleRecession-Decreased GrowthExpansion-Increased Growth

GDP 1Nominal GDP has not been adjusted for

inflationReal GDP is output that HAS been

adjusted for inflationGDP-Gross (Total) Domestic (In America)

Product (Stuff Produced). GDP is the total amount of stuff produced in America in a given year.

GDP2Things that count in GDP:

Additions to business inventories Rent and other services like a financial consultant. Final output at final prices

Things that don’t count in GDP: Household work Intermediate Goods Illegal activity Stuff from last year’s inventories Secondhand goods Stocks and Bonds

GDP (and AD) ComponentsConsumption-consumer purchasesI-Investment by businesses, strongly

influenced by interest rates.G-Government spending, fiscal policyNX-Net exports, exports-imports.

Depreciation increases NX as exports increase and imports decrease.

Appreciation decreases NX as exports decrease and imports increase.

Unemployment 1Four Types

Frictional-I’m between jobs (or dates)Structural-My skills don’t match the existing

jobs (or girls)Cyclical-Caused by a recession, this is all

unemployment below full-employment. Expansionary policy targets this.

Seasonal-Freebie.

Unemployment 2Labor force-people over 16, not in the

army, who are able and willing to work.Part time workers count as EMPLOYED.

NRU-Natural Rate of Unemployment=LRPCStructuralFrictional-Can be changed via changes in unemployment compensation.

Inflation 1Inflation-a rise in the price level over timeConsumer Price Index (CPI)-measures price level

over time using a market basket of goods.GDP Deflator-uses output of economy as market

basket.Another way to find inflation: solve for it given

nominal interest rates-real interest rates=inflation.

Demand-pull Inflation-Demand for goods causes prices to rise.

Cost-push-Decreases in Supply causes prices to rise.

Inflation 2Calculate rate of

inflation:

Quantities in Market Basket

Price in Base Year

Price in Current Year

Shoes 3 $15 $20

Foot-Long Subs

5 $5 $6

Guns 1 $30 $40

Inflation Rate=30% from base year to current

GDP Deflator=100 in base and 130 in current

Real GDP=Nominal GDP/Inflator

Inflation: Who is hurt and helped?Helped:

People with fixed rate loansHurt:

People on a fixed incomeLenders of fixed-rate loansSavers in fixed-rate accounts

AD/AS 1Potential Output-Output when an economy

is at its full employment (LRAS) point.If the price level changes it DOES NOT

CHANGE AD or AS!LRAS is vertical because price level

changes will not effect available resources or productivity in the long-run.

Inflationary Gap-Equilibrium occurs AFTER full-employment (overheating)

Recessionary Gap-Equilibrium occurs BEFORE full-employment (recession)

Supply ShocksPositive Supply Shocks

Increase ASNegative Supply Shocks

ContractionaryDecrease ASCause Stagflation

AD is downward sloping because…1. Wealth Effect- as price level goes down

people feel richer and buy more.2. Interest Rate Effect-Lower price levels

(inflation) means there is a lower interest rate, so output would go up.

3. International Effect-A decrease in the price level causes our stuff to feel cheaper, which causes exports and output to rise.

Unit Four: Fiscal PolicyGraphs: Loanable FundsBig Concepts: Balanced Budget Multiplier

and MPC Math, Fiscal Policy

MOST IMPORTANT SLIDE EVERFiscal Policy Taxes Government

Spending

Expansionary Cut Taxes Increase Government Spending

Contractionary Raise Taxes Cut Government Spending

When do you use fiscal policy?Expansionary Policy -> When you have

cyclical unemployment and are in a recession

Contractionary Policy -> When you have inflation and want price stability

Criticisms of Fiscal PolicyLag Time-Government is slow (IE,

everything we learned in AP Gov)Crowding Out-Increased deficit spending

can raise interest rates and crowd out private investment, offsetting the goal of increased AD

StabilizersThe federal government is set up with automatic

stabilizers that use expansionary policy in a recession, and contractionary in inflationary phases.

Discretionary Spending-Congress has to approve spending.

In a recession: Tax receipts go down so taxes are in effect, CUT. More people are unemployed so unemployment

compensation would go UPThe opposite of this would happen in an

inflationary phase.This process avoids a lot of the difficulties in

using fiscal policy as it is automatic.

TermsDeficit-When expenditures (spending)

exceeds revenue (taxes).Deficits are funded through the selling of

bonds in open-market operations.Surplus-Revenues exceed expenditures.Debt-Total amount of accumulated

deficits.

Classical EconomistsGiven flexible prices and wage, a classical

economist would deal with a recession by doing nothing.

They believe this would cause wages to drop ( as employers cut costs) and thus increasing AS back to full-employment.

Keynesian EconomistsArgue that wages and prices aren’t

flexible, and that decreased wages would cause AD to decrease even more.

He argues that the government must take action and increase AD through government spending and tax cuts (fiscal policy).

MPC and Balanced BudgetMPC is Marginal Propensity to ConsumeMPS is Marginal Propensity to SaveMPC + MPS = 1Government Spending or Expenditure

Multiplier is 1/MPS.Tax Multiplier is 1/MPS x MPC.Balanced Budget Concept-Government

Spending has a greater effect on AD than tax cuts.

Unit Five: Monetary PolicyGraphs: Money MarketBig Concepts: Reserve Requirement and

Money Expansion Math,

FundamentalsInvestment-purchase of real assets (factories,

machines).INVESTMENT IS THE BEST. Increase I

increases AD in the short run and increases LRAS!

Monetary policy influences AD/AS by effecting interest rates.

Higher interest rates decrease AD.Lower interest rates increase AD.Theory of rational expectations-Increasing the

MS on its own doesn’t increase AD because if the inflation is expected, then buying habits won’t change.

SECOND MOST IMPORTANT SLIDE EVERMonetary Policy Expansionary Contractionary

Open Market Operations

Buy Bonds Sell Bonds

Discount Rate Lower Raise

Reserve Requirement

Lower Raise

TermsFederal Reserve-central bank, conducts Monetary

PolicyDiscount Rate-Short-term interest rate on loans

from the Federal Reserve to Banks.Federal Funds Rate-Short-term interest rate on

loans from one bank to another.Prime Rate-Prime lending rate a bank will give to

people with the best credit.Fractional Reserve Banking-When you deposit

money, banks only keep a fraction and lend out the rest, allowing the money supply to be expanded.

MoneyFiat Money-money only backed by

government say so.3 Functions of Money

Store of Value-Can last for extended periods of time.

Unit of Account-can vary in prices.Medium of Exchange-can be traded for real

goods.

The Money Supply

M1-Checkable Deposits (Checking Accounts) Cash and Coins IN CIRCULATION

M2M1Savings AccountsShort Term CD’s (Money Market Accounts)

Quantity Theory of InflationMV=PQ

M is Money SupplyV is velocity of moneyP=Price LevelQ=Quantity of Real Goods SoldPQ=Nominal GDP

Assume V is constant, thus MS changes will change Nominal GDP.

Q is also unrelated to changes in MS, so price level is most directly effected by changes in MS.

Unit Six: International Trade

Graphs: Foreign Exchange Market

Big Concepts: Balance of Payments, Comparative and Absolute Advantage

TermsBalance of Trade: Exports-ImportsBalance of Payments: Current Account –

Capital/Financial AccountCurrent: All real goods and services

traded between countries.Capital/Financial: All loans

(inflows/outflows) that will have to be paid back at some point.

Complex DetailsInflationary Expections-If a questions says

this phrase, its referring to producers changing supply based on inflation.Lower than expected inflation-cut input costs

thus increasing AS