Transcript Concepts and Key Models in AP Macroeconomics

Concepts and Key Models in
AP Macroeconomics
Sally Meek
[email protected]
AP Economics Tests
Microeconomics and Macroeconomics
Test Date - Macro, Thursday, May 14, 2015 (afternoon)
Micro, Friday May 15, 2015 (morning)
Two components to test – Multiple choice questions and free
response questions
Test Specifications
2
Multiple Choice
60 questions to be answered in 70 minutes (5 answer choices per question)
One point is given for each correct answer. The grade on this part of the test
makes up 2/3 of the AP score.
Suggestions:
 Skip questions that are completely unfamiliar
 Answer easy questions first
 Intent of question will probably be included in stem, therefore, try to
formulate an answer before you read the distractors
Test Specifications
3
Free Response (Not Essay!)
3 Questions; 1 long question and two short questions. 10 minute reading period and 50
minutes to complete answers in answer booklet.
The free response portion of the test makes up 1/3 of the AP score.
Question 1 comprises half of the free response score and questions two and three
comprise the other half.
Suggestions:
 Reading period is important – use it wisely, formulating analysis and practicing
graphs
 Testing conceptual knowledge, and step by step analysis, therefore, the linkages
and consistency in your answer are crucial
 The models generally are the proof for your answers.
 Never simply make assertions!
Test Specifications
4
Resources –
 5 Steps to a 5: AP Macroeconomics/ Microeconomics by Eric
Dodge, published by McGraw Hill
 The Princeton Review Cracking the AP Economics Macro and
Micro AP Exam by David Anderson, published by Random House
Website Resources
 www.apcentral.collegeboard.com – this website includes the past
free response questions and answers from 1999 through 2014
Test Specifications
5
Models in
AP Macroeconomics
 Production
Possibilities Frontier
(opportunity cost, economic growth, trade)
 Circular
Flow Model
(National Income Accounting)
 Market
Supply and Demand
(foreign exchange markets, money market,
loanable funds market)
Macroeconomics
Key Graphs
•Aggregate Supply and Demand,
Including LRAS
(monetary policy, fiscal policy, market self
regulation)
•Investment demand
•Money Market
(monetary policy)
Macroeconomics
Key Graphs
 Loanable
funds market
(fiscal policy)
 Phillips
Curve – short run and long run
Macroeconomics
Key Graphs
Increasing opportunity costs
resources are NOT perfectly substitutable
Good X
Good X
Good Y
Constant opportunity costs
perfectly substitutable resources
Good Y
Production Possibility Frontier
Capital
goods
Price
Level
Consumer goods
LRAS
Yf
Real GDP
Potential Output at Full Employment
Radios
3
Radios
Country M
12
Wheat
2
Country C
4
Wheat
Using PPFs and comparative
advantage
Input
Time to produce 1
Radios
Wheat
Output
Amount produced in 1 hour
Radios
Wheat
M
20 min
5 min
3
12
C
30 mi
15 min
2
4
Determining Comparative
Advantage
13
Input
Time to produce 1
Radios
M
C
20 min
5
30 min
15
Wheat
5 min
20
15 min
30
input = under
Output
Amount produced in 1 hour
Radios
Wheat
12
3
3
12
4
2
2
4
output = over
Determining Comparative
Advantage
14
Input
Time to produce 1
Radios
Wheat
Output
Amount produced in 1 hour
Radios
Wheat
M
4w
1/4 r
4w
1/4 r
C
2w
1/2 r
2w
1/2 r
Opportunity Costs for the
production of each product
Determining Comparative Advantage
15
Assume they trade
1 r for 3 w
Radio 4
s
3
Radios
Country M
2
12
Wheat
Country C
4
6
Wheat
Using PPFs and CPFs
Product Market
Consumption expenditures
Goods and services
Net taxes
Net taxes
Government
Households
Public goods and services
Firms
Public goods and services
Land, labor, capital. entrepreneurial ability
Rent, wages, interest, profits
Resource Market
Circular Flow Model
 GDP: total value of all new and final goods and services
produced within a country’s borders in a given period
Expenditure Approach
Income Approach
Personal Consumption
Expenditures by households
+
Gross Private Domestic
investment by firms
+
Government Purchases
+
Net exports (exports minus imports
Rent
+
Wages
+
Interest
+
Profits
National Income
+
Statistical adjustments:
depreciation, indirect business
taxes and GNP to GDP adjustment
National Income Accounting
18
 Actual
Investment = spending by firms on
capital, all construction (includes
residential) and changes in inventories
 Planned
investment or Gross Private
Domestic Investment (Ig) = Net Private
Domestic Investment + Depreciation (also
called consumption of fixed capital or
capital consumption allowance)
Definitions of Domestic Private
Investment
19
 If
Ig = depreciation, a static economy (no
change in the ability to produce goods and
services)
 If
Ig is greater than depreciation, In is
positive, therefore economics growth
 If
Ig is less than depreciation, a declining
economy
Ig = In = depreciation
20
P
S
P1
D
Q1
Q
Perfectly Competitive Market
 Caused
by a changes in the product price,
graphed by moving along existing curve
 Demand:
P increases and QD decreases
and vice versa
 Supply:
P increases and QS increases and
vice versa
Changes in quantity supplied
and demanded
22
Changes in Demand or Changes in Supply:
Graphed by shifting the curve
(creating a new curve)
Demand
Supply
Changes in:
Changes in:
•Taste and preference
•Income
•Marketsize (# of buyers)
•Consumer expectations
•Price of related goods
complements or substitutes
•Resource prices
•Technology
•Number of sellers
•Producer expectations
•Taxes and subsidies
•Price of alternative goods
Non-price determinants for Perfectly
Competitive Product Markets
 Money
Market
 Loanable
Funds Market
 Currency
Market
Perfectly Competitive Markets
in Macro
24
The supplier of one currency is the consumer
of the other currency.
The sellers of Dollars IS the buyer of Yen
and the seller of Yen IS the buyer of Dollars
S$
Yen/$
$/Yen
SYen
D$1
SYen1
D$
DYen
USD
Yen
Currency Markets
Supply and Demand
 Changes
in any of the following:
Relative real interest rates
Relative price levels
Relative national income
Taste for imports
Speculation
Determinants of Exchange Rates
LRAS
PL
SRAS
PL1
AD=C+Ig+G+Xn
Yf
RGDP
Aggregate Supply and Demand
PL
LRAS
Yf
 Determinants:
changes in technology,
productivity, and the
quantity or quality of
land, labor, capital
RGDP
Long-run Aggregate Supply
LRAS 1
LRAS 2
Yf 1
Yf 2
PL
Economic
Growth
RGDP
Using LRAS to illustrate
Economic Growth
(a LONG RUN concept)
Using PPF to illustrate Economic
Growth
an increase in potential output at Yf
30
PL
SRAS
Determinants (all long run
determinants + plus
short-run only determinants
changes in input costs
and inflation expectations
RGDP
Short-run Aggregate Supply
31
PL
SRAS
Assumption:
“sticky input prices”
RGDP
Short-run Aggregate Supply
32
PL
AD = C+Ig+G +Xn
RGDP
Aggregate Demand
33
RIR
(As
compared
to the
expected
rate of
return)
•As RIR changes the quantity of
Investment demanded changes
•Other determinants shift the ID curve:
• costs of capital
•business taxes
ID
•Technology
•expectations
Q
Investment Demand
 LRAS
–changes in technology, productivity,
and the quantity or quality of land, labor,
capital
 SRAS
– changes in technology, productivity,
and the quantity or quality of land, labor,
capital
AND changes in input costs and
inflation expectations
 AD
– changes in personal consumption
spending, gross private domestic investment,
government purchases and net exports
Determinants
 Disposable
Income = Consumption +
Savings
Income creates consumption which creates more income: this is the
basis for the multiplier effect
Change in output/change in spending = multiplier
spending or income multiplier = 1/1-MPC or1/MPS
tax multiplier = - MPC/MPS (smaller because of a leakage to savings)
balanced budget multiplier = 1
ba
Spending and Tax Multipliers
36
MS
NIR
•MS – affected by actions of the
Federal Reserve
i1
MD
Q1
Q
•MD –
•Transaction demand
determined by GDP
•Asset demand
determined by NIR
Money Market
Money Creation
Asset
required reserves
excess reserves
Liabilities & Net Worth
demand deposits
owner’s equity
loans
government securities
ssible change in MS = change in er X
38
Assume a 10% rr and a cash deposit of $1000
Asset
required reserves
excess reserves
$100
$900
Liabilities & Net Worth
$1000
demand deposits
$0
owner’s equity
loans
government securities
$900 X 10 = $9000
39
Assume a 10% rr and the Fed buys $1000 in
bonds from the public
Asset
required reserves
excess reserves
$100
$900
Liabilities & Net Worth
$1000
demand deposits
$0
owner’s equity
loans
government securities
$900 X 10 = $9000 created in the banking
system + $1000 created by Fed = $10,000
40
Assume a 10% rr and the Fed buys a $1000 bond
from a bank
Asset
required reserves
excess reserves
Liabilities & Net Worth
demand deposits
$1,000
owner’s equity
loans
government
securities
-$1000
$1,000 X 10 = $10,000
41
RIR
S LF
r1
D LF
Q1
Q
•Supply of Loanable
Funds:
personal savings and
financial capital from
abroad
•Demand for Loanable
Funds:
firms demand for funds
for
capital and interest
sensitive consumption
Loanable Funds Market
Inflation
rate
LRPC
4%
2%
SRPC (assumes 4 % expected inflation at each UR)
SRPC (assumes 2% expected inflation at each UR)
Natural rate
of
unemployment
Unemployment
rate
Phillips Curve – LR and SR
 Short-run
instability associated with the
business cycle
Contraction
or recession
 Demand
Expansion or
recovery
Pull Inflation - during expansion
 Cyclical
Unemployment - during
recession
rt-run instability and the business cy
44
 Inflation
- a sustained increase in the
general level of prices
 Demand
pull - all sectors spending
outstrips production (AD increases)
 Cost push - input costs increase and
push up prices (SRAS decreases)
 Measured
deflator
with CPI, PPI and GDP
Inflation
45
Index number
price of market basket in a selected period
X
100
price of market basket in base
Nominal and Real Numbers
Nominal numbers include current prices
Real numbers adjust for price level changes
46
 Nominal
GDP = current prices X current
output
 Real GDP = base year prices X current
output
 or
GDP/price index
(in hundredths)
= Real GDP
 Nominal
interest rates = real interest rates
+ expected inflation
47
Natural rate of unemployment
 the
rate of unemployment consistent with
full employment level of output
 the rate of unemployment with zero
cyclical unemployment or with frictional
and structural unemployment only
Natural rate of Unemployment
48
 Official
unemployment rate (U3
unemployment rate)
unemployed
labor force (employed + unemployed)
Calculating Unemployment
49
Comparing Fiscal and Monetary
Policies
50
LRAS
PL
SRAS
PL1
AD=C+Ig+G+Xn
Y1
Fiscal
Decrease taxes to increase disposable
income and consumption spending,
And/or increase government spending
Creates a deficit budget
Yf
RGDP
Monetary
OMO -Buy bonds decreasing fed funds rate,
decrease rr, decrease discount rate
This increases money supply in
Money market
Assume recession
51
Fiscal
Monetary
LRAS
SRAS
PL
MS
MS1
NIR
RIR
PL1
AD2
AD=C+Ig+G+Xn
Y1
Yf
RGDP
ID
MD
Money market
Q
Investment
demand
Q
Fiscal
Monetary
SLF
RIR
PL
DLF1
SRAS
PL1
AD1
DLF
AD=C+Ig+G+Xn
Loanable Funds Market
Q
Y1
Yf
RGDP
Fiscal
Monetary
Xn Effects
Yen/$
$/Yen
S$
$/Yen
Yen/$
SYen
SYen1
SYen
S$
SYen1
D$1
D$
USD
Yen
RIR increases, demand for $
increases, $ appreciates,
exports decrease and
imports increase, Xn decreases
(or S$ decreases,
with DYen decrease)
DYen
D$
DYen
D$1
USD
Yen
NIR and RIR decreases, demand
for $ decreases, $ depreciates,
exports increase, imports decrease,
Xn increases (or S$ increases with
DYen increase)
LRAS
PL
SRAS
PL1
AD=C+Ig+G+Xn
Yf
Fiscal
Increase taxes to decrease disposable
income and consumption spending,
And/or decrease government spending
Creates a surplus budget
Y1
RGDP
Monetary
OMO -Sell bonds increases fed funds rate,
increase rr, increase discount rate
This decreases money supply in
Money market
Assume demand pull inflation
Fiscal
PL
Monetary
SRAS
MS1 MS
NIR
PL1
RIR
AD=C+Ig+G+Xn
AD2
Yf
Y1
RGDP
ID
MD
Money market
Q
Investment
demand
Q
Fiscal
Monetary
SLF
RIR
PL
SRAS
PL1
DLF
AD=C+Ig+G+Xn
DLF1
AD1
Loanable Funds Market
Q
Yf
Y1
RGDP
Fiscal
Monetary
Xn Effects
Yen/$
SYen1
$/Yen
S$
$/Yen
Yen/$
SYen
SYen1
S$
SYen
D$1
D$
D$
DYen
D$1
USD
Yen
RIR decreases, demand for $
decreases, $ depreciates,
exports increase and
imports decrease, Xn increases
USD
Yen
NIR and RIR increases, demand
for $ increases, $ appreciates,
exports decrease, imports increase,
Xn decreases
Two Major Accounts
Current Account
Exports +
Imports Net Income
Net Transfers
Balance on Current Account
Financial Account
Foreign owned US assets +
(portfolio and real assets)
Us owned assets abroad
(portfolio and real assets)
Balance on Financial Account
Balance of Payments
59
Current Account + Financial Account
MUST equal zero
If Current Account is in deficit then
Financial Account will be an offsetting surplus
If Current Account is in surplus then
Financial Account will be an offsetting deficit
Balance of payments
60
Comparing Fiscal and Monetary
Policies
61
Fiscal
Monetary
Congress and The President
The Federal Reserve
Board of Governors and
FOMC
Key Tool – The Federal Budget
(Expenditures and Taxes)
Key Tool – The Money Supply
(open market operations,
reserve requirement, discount
and fed funds rate)
To fight inflation –
To fight inflation –
Raise taxes to decrease
consumption spending,
And decrease government
Spending
Creates a surplus budget
Sell bonds, increase rr
Increase fed funds/discount rate
Decreasing money supply in
Money market
62
Fiscal
Decreases AD,
PL and RDO decrease
Monetary
Decreasing MS increases i
Surplus budget–
decreases demand for
loanable funds, decreasing i
i decreases Ig increases
i increases, Ig decreases,
AD decreases, PL and RDO
decreases
i decreases, demand for $
decreases, $ depreciates,
exports increase and
imports decrease, Xn increases
i increases, demand for $
increases, $ appreciates,
exports decrease and
imports increase, Xn decreases
63
Fiscal
To fight unemployment
Recession –
Decrease taxes to increase
Consumption spending,
And increase government
Spending
Creates a deficit budget
Monetary
To fight unemployment &
Recession –
Buy bonds, decrease rr,
Decrease discount rate/
fed funds rate
Increasing money supply in
Money market
64
Fiscal
Monetary
Increases AD,
PL and RDO increase
Increasing MS decreases i
Deficit budget – increases
demand for loanable
funds increasing i
i decreases, Ig increases,
i increases Ig decreases
(Crowding out effect)
AD increases, PL and RDO
Increase
i increases, demand for $
increases, $ appreciates,
exports decrease and
imports increase, Xn decreases
i decreases, demand for $
decreases, $ depreciates,
exports increase, imports
decrease,
Xn increases
65
Classical Understanding of the
Macroeconomy
66
LRAS
PL
SRAS
PL1
AD=C+Ig+G+Xn
Yf
RGDP
Flexible wages, other input
prices and flexible inflation
expectations produce an
output level at full-emploment
Classical
LRAS
SRAS2
PL
SRAS1
PL1
AD=C+Ig+G+Xn
Yf
Y1
RGDP
If a short-run equilibrium occurs as
AD increases, as input prices and
inflation expectations become flexible
in the long run, wages increase and
SRAS decreases
Classical
LRAS
PL
SRAS1
SRAS2
PL1
AD=C+Ig+G+Xn
Y1
Yf
RGDP
If a short-run equilibrium occurs as AD declines,
as input prices and inflation expectations become
flexible in the long run, wages decrease.
This increases SRAS.
Classical
69
LRAS
PL
SRAS1
SRAS2
PL1
AD=C+Ig+G+Xn
Y1
Yf
RGDP
If a short-run equilibrium occurs when
SRAS decreases, as input prices and
inflation expectations become flexible in
the long run, wages decrease and SRAS increases.
Classical
70