Transcript AP Macro Review

Mr. Roper

You need:
◦ Pencils
◦ Pen (blue or black only)
◦ Personal ID

You can not have:
◦ Phones
◦ Calculators
What is in the AP Curriculum?
 A.
Scarcity, choice, and opportunity costs
 B. Production possibilities curve
 C. Comparative advantage, specialization,
and exchange
 D. Demand, supply, and market equilibrium
 E. Macroeconomic issues: business cycle,
unemployment, inflation, growth

Scarcity
◦ All resources that are both desirable and in limited supply
are considered scarce
◦ Resources can be placed into four categories
1.
2.
3.
4.
Land
Labor
Capital (Physical AND Human)
Entrepreneurship

Choice

Opportunity cost
◦ Because of scarcity, we have to make choices
◦ When ever a choice is made, alternatives are forgone
◦ Most desirable alternative forgone when a choice is made



Shows various ways an economy can
allocate scarce resources between
the production of two things
Each axis represents a good or
service that could be produced
The line/curve itself represents
different combinations that utilize all
available resources.
◦ Called the “Frontier”

Economic growth is shown by an
outward shift of the frontier. Can be
caused by:
◦ More resources
◦ Better technology

Comparative Advantage
◦ Focusing on the good or service that can be made at the lowest
opportunity cost
◦ When calculating remember:
 Input problem? IOU
(Input = Other goes Under)
 Output problem? OOO
(Output = Other goes Over)

Specialization

Exchange
◦ Basis for global trade
◦ Countries focus on producing whatever good they can make the
most efficiently and trade with other nations
◦ As long as both parties benefit, there is a net gain from trade.
◦ Trade between countries allows them to consume outside their
production possibilities curves.

Demand
◦ Represents consumers
◦ Negative Slope
◦ Determinants (things that
shift it)





Consumer Tastes
Price of related goods
Population
Consumer Income
Future Prices

Supply
◦ Represents producers
◦ Positive slope
◦ Determinants




Technology
Input costs
# of suppliers
Future prices

Business Cycle
◦ Four Phases:
1.
2.
3.
4.

Expansion/recovery – growing GDP
Peak
Recession/contraction – shrinking GDP
Trough
Unemployment
◦ Measured by the Unemployment Rate

(# of unemployed)/(total labor force) = Unemployment rate
◦ Three types:
1.
2.
3.

Cyclical – caused by recession/economic downturn
Structural – skills do not match available jobs
Frictional – chose to leave job to find another/looking for first job
Inflation
◦ Measured by the Consumer Price Index (CPI)

[(Price in current year)/($ in base year)] x 100 = CPI

Values > 100 indicate inflation since base year
 A.
National income accounts
 B.
Inflation measurement and adjustment
 C.
Unemployment
1.Circular flow
2.Gross domestic product
3.Components of gross domestic product
4.Real versus nominal gross domestic product
1.Price indices
2.Nominal and real values
3.Costs of inflation
1.Definition and measurement
2.Types of unemployment
3.Natural rate of unemployment

Simple Circular Flow
◦ Shows interaction between producers (firms) and
consumers (households)

Expanded Circular Flow
◦ More realistic picture of money moving through an
economy
◦ REMEMBER: Money going into each square MUST
EQUAL money going out

GDP is the total dollar value of all final goods in
services produced in a country in a given year
◦ Final goods – goods in the final form they are sold
◦ Produced within a country – only domestically produced
goods count toward GDP

Not counted
◦ Intermediate goods – used to make final goods
◦ Used goods – already have been counted
◦ Transfers – money changing hands (stock, bonds, social
security, etc…)
◦ Foreign Produced – count toward other nations GDP
◦ Underground Economy – illegal goods and “under the
table” payments

Expenditure Approach – measures total spending
◦ C+I+G+NX = GDP





Income Approach – measures total income
◦ Sum of all income sources





C = consumer spending. Largest component.
I = investment (business spending, inventories)
G = government spending
NX = net exports (imports – exports)
Wages for labor
Rents from land
Interest from capital
Profits from entrepreneurship
Remember: Aggregate spending = Aggregate income

Nominal GDP – Value of current production
using current prices

Real GDP – Value of current production, but
using prices from a fixed point in time
◦ Also called “constant dollar GDP”
◦ Accounts for inflation
◦ More accurate

“Deflating” Nominal GDP
◦ Real GDP = 100 x (nominal GDP)/(Price Index)

Main measure of inflation is the CPI
◦ Calculated by the Bureau of Labor Statistics
◦ Establishes the rate of inflation by comparing prices
of a “market basket” of goods to a base year

Calculating a price index
◦ Price Index = 100 x [Current year $/Base year $]


“Nominal” = Not adjusted for inflation
“Real” = Adjusted for inflation

Nominal GDP: GDP
measured in terms
of current Price
Level at the time of
measurement.
(Unadjusted for
inflation)

Real GDP: GDP
adjusted for
inflation; GDP in a
year divided by a
GDP deflator (Price
Index) for that year
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
NOMINAL INCOME:
number of dollars
received by an
individual or group
for its resources
during some period
of time

REAL INCOME:
amount of goods
and services which
can be purchased
with nominal
income during
some period of
time; nominal
income adjusted for
inflation
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
NOMINAL I%:
interest rate
expressed in terms
of annual amounts
currently charged
for interest; not
adjusted for
inflation

REAL I%: interest
rate expressed in
dollars of constant
value (adjusted for
Inflation) and equal
to the NOMINAL I%
minus the
EXPECTED RATE OF
INFLATION
21
ANTICIPATED INFLATION
11%
=
+
6%
Expected Inflation
5%
Nominal
Interest
Rate
Real
Interest
Rate
22


NOMINAL WAGES:
amount of money
received by a
worker per unit of
time (hour, day,
etc.);
Money Wage

REAL WAGES:
amount of goods
and services a
worker can
purchase with their
NOMINAL WAGE;
purchasing power
of the nominal
wage.
◦ (Real = Nominal –
Inflation rate)
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


If nominal rates INCREASE and Price Level
INCREASE, the CHANGE in Real is
“indeterminable.”
If nominal Wage rates do NOT change and
Price Level fall. REAL WAGES increase.
NOMINAL RATES “PIGGY-BACK” REAL RATES &
NOT VICE VERSA.
24

Unexpected Inflation Hurts:
◦ Businesses that have to change prices
 menu costs
◦ People of Fixed incomes
 pension receivers & minimum wage earners
◦ People saving money at fixed interest
◦ People loaning money at fixed interest

Unexpected Inflation Helps
◦ People borrowing money at fixed interest

Measurements:
◦ Labor Force – Sum of all individuals over 16 that are
employed or unemployed
 Remember: Unemployed MUST BE searching for work
 Not searching for work = “discouraged worker”
◦ Unemployment Rate – Unemployed/Labor Force
1.
2.
3.
4.
Frictional – Someone new enters labor
market OR chooses to switch jobs
Seasonal – periodic/predictable job loss
Structural – Jobs lost because skills are no
longer in demand
Cyclical – Jobs lost as a result of an
economic downturn

Full Employment:
◦ NO CYCLICAL UNEMPLOYEMENT
◦ Traditionally 5-6%
◦ Natural Rate of Unemployment
 Unemployment rate associated with full employment
 A.
Aggregate demand
 B.
Aggregate supply
 C.
Macroeconomic equilibrium
1.Determinants of aggregate demand
2.Multiplier and crowding-out effects
1.Short-run and long-run analyses
2.Sticky versus flexible wages and prices
3.Determinants of aggregate supply
1.Real output and price level
2.Short and long run
3.Actual versus full-employment output
4. Business cycle and economic fluctuations

AD Always slopes down
◦ Wealth effect – As prices rise purchasing
power of wealth falls

AD Shifts when…
◦ There is a change in consumer spending
◦ There is a change in government
spending
◦ There is a change in investment
spending
 This includes changes in taxes and
transfers
◦ There is a change in net exports

Consumption and Savings
◦ MPC = △Consumption/ △Disposable Income
◦ MPS = △Savings/ △Disposable Income
◦ MPC + MPS = 1
Commonly Used Multipliers…

Spending Multiplier
◦ 1/MPS or 1/(1-MPC)

Tax Multiplier
If MPC is
The Spending
Multiplier is..
.90
10
.80
5
.75
4
.50
◦ MPC/MPS
◦ ALWAYS smaller then spending multiplier
2
 Taxes have a smaller impact than government spending!

Short Run AS
◦ Input costs and wages are
“sticky” in the short run and
do not change quickly
◦ This lag between changes in
output price and input prices
create a positive slope

Long Run AS
◦ All inputs prices are flexible in
the long run regardless of
price level

Short run shifts

Long Run Shifts
◦ △ input prices
◦ △ taxes on producers
◦ △ regulations
◦ △ Quantity and Quality of
resources
◦ △ Technology
◦ △ Human capital (education and
training of labor force)
◦ Policy initiatives
 Government programs designed
to encourage investment

Macroeconomic equilibrium occurs when real
output demanded is equal to real output
supplied
Short Run Equilibrium
Long Run Equilibrium OR
“economy at full employment”

Expansion

Peak

Recession/Contraction

Trough
◦ Real GDP grows
◦ Unemployment falls
◦ Real GDP stops growing
◦ Unemployment hits lowest
point
◦ Real GDP falls
◦ Unemployment increases
◦ Real GDP Stops falling
◦ Unemployment hits highest
point.

A. Money, banking, and financial markets
1.
2.
3.
4.
5.
6.
Definition of financial assets: money, stocks, bonds
Time value of money (present and future value)
Measures of money supply
Banks and creation of money
Money demand
Money market and the equilibrium nominal interest rate

B. Loanable funds market

C. Central bank and control of the money supply
1. Supply of and demand for loanable funds
2. Equilibrium real interest rate
3. Crowding out
1. Tools of central bank policy
2. Quantity theory of money
3. Real versus nominal interest rates

Money
◦ Money must serve three functions
 Medium of Exchange
 Store of Value
 Standard of Value (Unit of Account)
◦ Different Types:
 Commodity – gold, silver, diamonds…
 Fiat – Money that has value because a government says it
does. “Legal Tender”


Stocks – Share of ownership in a corporation.
Can be bought and sold as an investment. Price
based on S and D.
Bonds – Loan that is to be repaid to bondholder
over a set period of time with interest.

M1 – Liquid Money

M2 – “Near money” + M1
◦ Includes all physical money, such as coins and currency, as
well as demand deposits, checking accounts
◦ Includes savings deposits, money market mutual funds and
other time deposits, which are less liquid and not as suitable
as exchange mediums but can be quickly converted into cash
or checking deposits.
◦ M1 is included as part of the M2 Supply.



Banks “create” money
by issuing their excess
reserves as loans.
These funds find their
way back into the
banking system and
are
The formula 1/RR
determines the
“money multiplier”
which can allow us to
calculate the total
money that could be
“created” by a deposit.

Your demand for money is how much of your
wealth you wish to hold as money at any
moment in time


Shows how the demand for money affects
nominal interest rates.
Changes in the Money Supply by the central
bank also influence nominal interest rates.
1. Supply of and demand for loanable funds

2. Equilibrium real interest rate

Found at the intersection of Slf and Dlf

3. Crowding out
◦ Government deficits increase the demand for
loanable funds because the government bust
borrow money to continue operations
 This drives up interest rates, and lowers business and
personal investment in the economy.
1. Tools of central bank policy
Open Market Operations
 Buying and selling bonds to influence the amount of money in
circulation.
 Buy Bonds = Bigger Bucks - MS and AD increase, IR decreases
 Sell Bonds = Smaller Bucks - MS and AD decrease, IR increases
Discount Rate
 Interest rate a central bank charges member banks for loans
 Higher discount rate = Lower MS, AD decreases, IR increases
 Lower discount rate = Higher MS, AD increases, IR decreases
Reserve Requirement
 The amount of money banks are required to hold in reserves.
Influenced the money multiplier
 Lower RR = higher MS, AD increases, IR decreases
 Higher RR = Lower MS, AD decreases, IR increases


2. Quantity theory of money
Velocity of money is defined simply as the rate at
which money changes hands.
◦ If velocity is high, money is changing hands quickly, and a
relatively small money supply can fund a relatively large
amount of purchases.
◦ if velocity is low, then money is changing hands slowly, and
it takes a much larger money supply to fund the same
number of purchases.

The relationship between velocity, the money supply,
the price level, and output is represented by the
equation M * V = P * Y
◦
◦
◦
◦
M is the money supply
V is the velocity
P is the price level
Y is the quantity of output.
 A.
Fiscal and monetary policies
1.Demand-side effects
2.Supply-side effects
3.Policy mix
4.Government deficits and debt
 B.
The Phillips curve
1.Short-run and long-run Phillips curves
2. Demand-pull versus cost-push inflation
3.Role of expectations

An Expansionary Fiscal Policy as previously
diagrammed will lead to higher interest
rates.
◦ At higher interest rates, businesses will take out
fewer loans and there will be a decrease in
INVESTMENT (I)
◦ At the same time there will be a decrease in
CONSUMER SPENDING (C) as they will take out
fewer loans as well.

This CROWDING OUT EFFECT will reduce
the gain made by the expansionary fiscal
policy.

Classical: Believes that the government
SHOULD NOT interfere in the economy. And
believes in self-correction of economic
problems.

Keynesian: Believes that GOVERNMENT SHOULD
interfere in the economy (taxes, government
spending). Most “mainstream” economists are
Keynesians
 Rational Expectations: Believes that monetary and
fiscal policy have certain effects on the economy and
take action to make these policies ineffective.


Shows the relationship between the rate of
inflation (y axis) and the unemployment rate
(x axis)
The long-run Phillips curve is vertical at the
Natural Rate of unemployment (no cyclical)

Demand Pull inflation:
◦ Caused by a rightward shift
of the AD curve.
◦ Caused by
 Too much money in
circulation due to fiscal or
monetary policy

Cost Push Inflation
(Stagflation):
◦ Caused by a leftward shift
of the AS Curve.
◦ Caused by
 Rising input costs
 Rising labor costs
 Rising taxes on businesses
 A.
Definition of economic growth
 B. Determinants of economic growth
1.Investment in human capital
2.Investment in physical capital
3.Research and development, and technological
progress
 C.
Growth policy

Defined as an increase in “Real GDP per
capita”
◦ Per capita is used in order to isolate the effect of
changes in population
◦ Sustained growth in real GDP per capita occurs
ONLY WHEN the amount produced by the average
worker increases steadily
 Productivity = output per worker
1.
Investment in Human Capital
◦ Education and knowledge improve a nations workforce, making it more productive
2.
Investment in Physical Capital
◦ Equipment used to produce a good or service
3.
Technology
◦ Technical means for the production of a good or
service

Policies that promote economic growth
◦ Promote investments in technology, education, and
capital investment
 A.
Balance of payments accounts
1.Balance of trade
2.Current account
3.Financial account (formerly known as capital account)
 B.
Foreign exchange market
1.Demand for and supply of foreign exchange
2.Exchange rate determination
3.Currency appreciation and depreciation
 C.
Imports, exports, and financial capital flows
 D. Relationships between international and
domestic financial and goods markets

The sum of all transactions between U.S. residents and
residents of all foreign nations
◦ Current Account: a country’s exports and imports of goods and services.
◦ Capital/Financial Account: Shows the country’s investment (financial as
well as capital-plants and factories) abroad and Foreign investment in the
country


Credits: A credit are those transactions for which the country
receives income (exports, foreign purchase of assets)
Debits: Those transactions that the country must pay for:
imports and purchasing of assets abroad.



The Current Account and Financial/Capital
Account must be equal.
Official Reserves Account: The Central Banks of
all nations hold foreign currency to make up any
deficit in the combined capital and current
accounts.
If the U.S. has more credits than debits it finances
this difference by dipping into its reserve
account.
The value of a foreign nation’s currency in relation to
your own currency is called the exchange rate.



An increase in the value of a currency is
called appreciation.
A decrease in the value of a currency is called
depreciation.
Multinational firms convert currencies on the
foreign exchange market, a network of about
2,000 banks and other financial institutions.
61

Fixed Exchange-Rate
Systems
◦ A currency system in
which governments try
to keep the values of
their currencies
constant against one
another is called a fixed
exchange-rate system.

Flexible ExchangeRate Systems
◦ Flexible exchange-rate
systems allow the
exchange rate to be
determined by supply
and demand.
62

Let’s say a U.S. citizen travels to Japan. This transaction will
provide a supply of the U.S. dollar and result in a demand
for yen. It will become cheaper for the Japanese to buy the
dollar and more expensive for Americans to buy the Yen.
The Yen is Appreciating and the dollar is Depreciating.
Yen Price of
dollar
(Y/$)
Dollar Price
of Yen
($/Y)
P2
S$1
S$2
P1
SY1
P1
DY2
P2
DY1
D$1
Q1
Q2
Quantity of U.S. Dollars
Q1
Q2
Quantity of Yen
You must be able to
draw/label/manipulate these
graphs
Causes of Economic Growth
1. Increased investment in
physical capital
 Equipment and
machinery
2. Increased investment in
human capital
 Education and
training
3. New Technology
4. Increase in
quality/quantity of
resources