Transcript AP Macro Review

AP Macro Review
Aggregate Demand
• Consumption, investment, govt. purchases and net exports
(exports – imports)
• More income, more wealth = more spending
• Investment – purchases of new capital by businesses; interest
rate rises – less investment; interest rate falls – more
investment
• $ appreciates – U.S. goods more expensive; exports fall
• $ depreciates – U.S. goods less expensive; exports rise
• AD increases – shifts to right; P rises, GDP rises,
unemployment falls
• AD decreases – shifts left; P falls, GDP falls, unemployment
rises
MPC and MPS
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MPC = ∆ consumption resulting from a ∆ in income
MPS = ∆ savings resulting from a ∆ in income
MPC = 1 – MPS
If MPC = .80 then a $100 increase in income will cause us
to spend $80
Multiplier = 1/MPS
∆ in GDP = multiplier x ∆ in spending
If multiplier is 5, consumption rises by $100, GDP rises by
$500.
If MPC = .8, multiplier is 5; income rises by $100,
consumption rises by $80, GDP rises by $400
Multiplier works for any increase in spending, whether to
consumption, investment, govt. purchases or net exports
i
Money Market
Vertical S curve –
S set by FED;
Includes S and D
for all $ in the
economy
i3
i1
i2
Sm3 Sm1
Sm2
Dm
Q
Loanable Funds Market
i
S
Government
deficit affects
demand;
Savings affects
supply
i1
D
Q1
Q
Loanable funds market
• Increase in budget deficit increases D for
loanable funds; interest rate increases
• Decrease in budget deficit decreases D for
loanable funds; interest rate falls
• Increase in savings increases S for
loanable funds; interest rate falls
• Decrease in savings decreases S for
loanable funds; interest rate rises
ASlr
P
AS
Expansionary
Fiscal Policy
or Easy
Money Policy
P2
P1
AD2
AD1
GDP1
Qf
GDP
Fiscal vs. Monetary policy
Expansionary Fiscal
• Implemented by govt.
• Cut taxes
• Increase govt. purchases
• Increases budget deficit
• Increases D for loanable
funds
• Increases interest rate
• $ appreciates
Easy money policy
• Implemented by FED
• Buy bonds
• Decrease required
reserve ratio
• Decrease discount rate
• Increases S of $ in
money mkt.
• Interest rate falls
• $ depreciates
ASlr
P
AS
P1
AD1
P2
Contractionary
Fiscal Policy
or Tight
Money Policy
AD2
Qf GDP1
GDP
Fiscal vs. Monetary policy
Contractionary Fiscal
• Implemented by govt.
• Increase taxes
• Decrease govt.
purchases
• Decreases budget deficit
• Decreases D for loanable
funds
• Decreases interest rate
• $ depreciates
Tight money policy
• Implemented by FED
• sell bonds
• increase required reserve
ratio
• increase discount rate
• decreases S of $ in
money mkt.
• Interest rate rises
• $ appreciates
Demand-Pull Inflation
P
ASLR ASSR2 ASSR1
P3
P2
AD2
P1
AD1
Qf
Q2
GDP
Demand pull inflation if govt
does not respond to the inflation
• In the long run, prices and wages are flexible.
• Increase in price level causes wages to rise.
• Increase in wages shifts AS in short run to left –
more expensive to produce
• As economy approaches long run equilibrium,
GDP returns to full employment GDP and
unemployment returns to the natural rate of
unemployment
Recession
ASLR AS AS
SR1
SR2
P
P1
P2
AD1
P3
AD2
Q2
Qf
GDP
Recession if govt does not
respond w/ fiscal or monetary
policy
• In the long run, prices and wages are flexible.
• Wages fall when unemployment increases.
• decrease in wages shifts AS in short run to right
– cheaper to produce
• As economy approaches long run equilibrium,
GDP returns to full employment GDP and
unemployment returns to the natural rate of
unemployment
P
Inflation
rate
AS2
Phillips Curve
AS1
P2
P1
SRPC2
AD
GDP2
GDP1
P goes up
Unemployment rises
GDP
SRPC1
Unemployment rate
Phillips Curve
• Short run – tradeoff between
unemployment and inflation; as 1 goes up
the other falls
• If AS shifts, short run PC shifts in opposite
direction
• If AD shifts, movement along the PC.
• Long run – no tradeoff between
unemployment and inflation
• LRPC is a vertical line
Capital
goods
Effect on AS
P
ASLR1 ASLR2
PPF1
PPF2
Consumer
goods
Qf1 Qf2 GDP
Economic Growth
• Rightward shift of PPF curve = rightward
shift of long run AS
• Caused by increase in technology, # or
quality of natural or human resources,
increase in capital stock
• Economic growth influenced by interest
rates – if interest rates rise, I (investment)
falls, capital stock declines, less economic
growth
P
Effect on AS
ASLR1
ASLR2
Qf1
Qf2
Inflation
GDP
LRPC2 LRPC1
NRU2 NRU1 Unem
U.S. Exports – English buying American wheat
P in
pounds
P in
dollars
D2
S1
S
S2
P2
P1
P1
P2
D
D1
Q1 Q2
Mkt. for Dollars
Q
Q1 Q2
Mkt. for Pounds
Exchange rates
• If 1 currency appreciates, the one it’s being
compared to depreciates.
• Interest rates and value of the currency move in
same direction.
• If D for $ increases (b/c people want U.S. wheat
or higher interest rates in U.S.), $ appreciates.
• The English must supply more pounds to get the
dollars they demand so the pound depreciates.
U.S. Imports – Americans buying English tea
P in
pounds
P in
dollars
S1
S
S2
P2
P1
D2
P1
P2
D1
D
Q1 Q2
Mkt. for Dollars
Q
Q1 Q2
Mkt. for Pounds