AP Macroeconomics FINAL REVIEW

Unit One: Intro to Economics Graphs: PPC, Circular Flow Big Concepts: Comparative and Absolute Advantage, Circular Flow of Economic Activity

Circular Flow of Economic Activity

Fundamentals Fundamental problem in economics is scarcity Opportunity cost-next best alternative. Adam Smith-Invisible hand, self-interest, justifies a market Macro-Whole economy Micro-Part of the economy (firms and households)

3 Economies Market Traditional Command MIXED-Mix of market and government, its what we have

Growth, or AS/LRAS Sources of Growth Quantity and quality of human and natural resources increase Amount of capital goods or stock increase Technology increases productivity

Unit Two: Supply and Demand Graphs: Supply and Demand Big Concepts: Price Ceilings and Floors

Fundamentals Law 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 Floors Price 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 Inflation Graphs: AD/AS, Phillips Curve Big Concepts: CPI, GDP Deflator and Inflation Calculations Types of Unemployment GPD Calculation Who is hurt and helped by inflation?

Business Cycle Recession-Decreased Growth Expansion-Increased Growth

GDP 1 Nominal GDP has not been adjusted for inflation Real GDP is output that HAS been adjusted for inflation GDP-Gross (Total) Domestic (In America) Product (Stuff Produced). GDP is the total amount of stuff produced in America in a given year.

GDP2 Things that count in GDP: Things that don’t 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) Components Consumption-consumer purchases I-Investment by businesses, strongly influenced by interest rates. G-Government spending, fiscal policy NX-Net exports, exports-imports. Depreciation increases NX as exports increase and imports decrease. Appreciation decreases NX as exports decrease and imports increase.

Unemployment 1 Four 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 2 Labor 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=LRPC Structural Frictional-Can be changed via changes in unemployment compensation.

Inflation 1 Inflation-a rise in the price level over time Consumer 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 2 Calculate 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? People with fixed rate loans Hurt: People on a fixed income Lenders of fixed-rate loans Savers in fixed-rate accounts

AD/AS 1 Potential 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 Shocks Positive Supply Shocks Negative Supply Shocks Increase AS Negative Supply Shocks Contractionary Decrease AS Cause 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 Policy Graphs: Loanable Funds Big Concepts: Balanced Budget Multiplier and MPC Math, Fiscal Policy

MOST IMPORTANT SLIDE EVER Fiscal 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 Policy Lag 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

Stabilizers The 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 UP The 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.

Terms Deficit-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 Economists Given 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 Economists Argue 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 Budget MPC is Marginal Propensity to Consume MPS is Marginal Propensity to Save MPC + MPS = 1 Government 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 Policy Graphs: Money Market Big Concepts: Reserve Requirement and Money Expansion Math,

Fundamentals Investment-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 EVER Monetary Policy Expansionary Contractionary Open Market Operations Buy Bonds Sell Bonds Discount Rate Lower Raise Reserve Requirement

Terms Federal Reserve-central bank, conducts Monetary Policy Discount 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.

Money Fiat 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- M2 Checkable Deposits (Checking Accounts) Cash and Coins IN CIRCULATION M2 M1 Savings Accounts Short Term CD’s (Money Market Accounts)

Quantity Theory of Inflation MV=PQ M is Money Supply V is velocity of money P=Price Level Q=Quantity of Real Goods Sold PQ=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

Terms Balance of Trade: Exports-Imports Balance of Payments: Current Account – Capital/Financial Account Current: 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 Details Inflationary 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