Essential Graphs in Macroeconomics (for Mock Preparation)
Graphs are required of students when requested on the AP Economics Exams. Here is a short list of
required graphs for macro that can assist students in understanding theoretical material. Students must
be able to analyze these graphs as well as construct them.
I. The Production Possibility Curve (PPC) or the Production Possibility Frontier (PPF)
(a)
INVESTMENT
GOODS
A
C
PPC
B Possibilities
Curve
CONSUMPTION
GOODS
Point A. Efficiency = full employment of existing economic resources
Point B. Inefficiency = underemployment of existing economic resources
Point C. Unattainable with the existing quantity and quality of economic resources and the level of
technology
(b) Movement from the Recession to the Full-employment = movement from the point inside the PPC
to the point on the PPC
INVESTMENT
GOODS
A
PPC
B
Possibil
ities
Curve
CONSUMPTION
GOODS
(c) The long-run Economic Growth = increase in the Production Possibilities due to the increase in the
Quantity and/or Quality of Economic Resources and/or in the Level of Technology = rightward shift of
the PPC = movement from point A to point C
INVESTMENT
GOODS
INVESTMENT
GOODS
INVESTMENT
GOODS
C
A
PPC1
PPC2
Possibilities
Curve
Possibilities
Curve CONSUMPTION
GOODS (C)
CONSUMPTION
GOODS
CONSUMPTION
GOODS
II. The Circular Flow Model
(a) The Simple (two-sector) Model: household and business, resource and product markets
(Circular Flows in a Simple Private Closed Economy)
Revenues
Spending on goods & services
Goods & Services
Goods Market
Goods & Services
Households
Firms
Economic Resources
Incomes
Economic Resources
Resource Market
Factor Payments
(b) The Simple (two-sector) Model with the Financial Market
(Circular Flows in a Simple Private Closed Economy with Financial Market)
Revenues
Consumption Spending (C)
Goods & Services
Goods Market
Goods & Services
Investment Spending (I)
Households
Saving (S)
Financial Market
Loanable Funds (F)
Economic Resources
Incomes
Firms
Economic Resources
Resource Market
Factor Payments
(c) The Model with the Government Sector (three-sector model or closed-economy macro model)
(Circular Flows in a Mixed Closed Economy)
Revenues
Goods Market
Consumption
Spending (C)
Government
Purchases (G)
Taxes (Tx)
расходы
(С)
Investment
Spending (I)
Taxes (Tx)
Government
Subsidies (Sb)
Loan to the
Government
Transfers (Tr)
Households
Saving (S)
Loanable Funds (F)
Financial Market
Incomes
Firms
Resource Market
Factor Payments
(d) The Open-Economy (four-sector) Macro Model
(Circular Flows in an Open Economy)
Exports (Ex)
Foreign Sector
Imports (Im)
Consumption
Spending (C)
Taxes (С)
(Tx)
расходы
Revenues
Goods Market
Government
Purchases (G)
Investment
Spending (I)
Taxes (Tx)
Government
Households
Transfers (Tr)
Saving (S)
Subsidies (Sb)
Loan to the
Government
Financial Market
Firms
Loanable Funds (F)
Capital Inflow
(when Im > Ex)
Resource Market
Incomes
Factor Payments
III. The Business Cycle
Points A and C – peak, point B – trough, time period of movement from A to B – recession
or contraction, time period of movement from B to C – recovery or expansion.
REAL
GDP
C
TREND
A
BUSINESS CYCLE
B
TIME (years)
IV. The Keynesian Cross Model
(a) The Consumption Line, where С – autonomous consumption spending and mpc – marginal
propensity to consume.
CONSUMPTION
SPENDING (C)
С
C  С  mpcYD
mpc
DISPOSABLE
INCOME (YD)
(b) The Shifts and the Slope of the Consumption Line
CONSUMPTION
SPENDING (C)
Increase in autonomous
consumption spending
CONSUMPTION
SPENDING (C)
С 2  mpcYD
Increase in marginal
propensity to consume
С  mpc 2 YD
С  mpc1YD
С1  mpcYD
С2
С1
mpc
С
DISPOSABLE
INCOME (YD)
mpc2
mpc1
DISPOSABLE
INCOME (YD)
(c) The Saving Line, where  С is autonomous saving, and mps – marginal propensity to save.
SAVING (S)
S  С  mpsYD
DISPOSABLE
INCOME (YD)
mps
С
(d) The Shifts and the Slope of the Saving Line
SAVING (S)
SAVING (S)
Increase in autonomous
saving
Increase in marginal
propensity to save
S2  С  mps2YD
S2  С2  mpsYD
S1  С1  mpsYD
 С2
 С1
DISPOSABLE
INCOME (YD)
mps
S1  С  mps1YD
С
DISPOSABLE
INCOME (YD)
mps1
(e) The Investment Line
INVESTMENT
SPENDING (I)
REAL
INTEREST
RATE (r)
In the (I – Y) space
In the (r – I) space
I(Y)
I(r)
INVESTMENT
SPENDING (I)
REAL
OUTPUT (Y)
(f) The Equilibrium in the Two-sector Model, where YE – equilibrium level of income/output,
AEP – planned aggregate expenditures, and IP – planned investment spending
AGGREGATE
EXPENDITURES (AE)
AE = Y
SAVING (S),
INVESTMENT (I)
AEP = C + IP
E
S  С  mpsYD
E
YE
YE
REAL OUTPUT (Y)
IP
REAL OUTPUT (Y)
(g) The Multiplier Effect of the increase in autonomous planned investment spending, where A is
autonomous spending.
AGGREGATE
EXPENDITURES (AE)
AE = Y
AEP(I2)
B
AEP(I1)
A2  С  I 2
A
A1  С  I1
Y1
REAL OUTPUT (Y)
Y2
(h) The “Paradox of Thrift”
SAVING (S),
INVESTMENT (I)
SAVING (S),
INVESTMENT (I)
Increase in autonomous saving
Increase in the marginal propensity to save
S2
B
Y2
S1
A
IP
B
A
Y2
Y1
Y1 REAL OUTPUT (Y)
S2
S1
IP
REAL OUTPUT (Y)
(i) The Equilibrium in the Three-sector Model (closed economy) and in the Four-sector Model (open
economy)
AGGREGATE
EXPENDITURES (AE)
AGGREGATE
EXPENDITURES (AE)
Closed Economy
Open Economy
AE = Y
AE = Y
AEP = C+ IP+G
AEP = C+ IP+G+NX
E
E
mpc-mpm
mpc
YE
REAL OUTPUT (Y)
YE
REAL OUTPUT (Y)
(g) Output gaps and expenditure gaps, where YE – equilibrium (short-run) output, and YF – fullemployment (long-run) or potential output.
AGGREGATE
EXPENDITURES (AE)
AGGREGATE
EXPENDITURES (AE)
Recessionary Gap
Inflationary Gap
AE = Y
AE = Y
AEP
AEP
E
E
YE < Y F
REAL OUTPUT (Y)
REAL OUTPUT (Y)
YF > Y E
(h) Aggregate Demand Curve
PRICE
LEVEL (P)
P2
B
A
P1
AD
Y2
Y1
REAL
OUTPUT (Y)
(i) Shifting Aggregate Demand
PRICE
LEVEL (P)
Increase in AD
PRICE
LEVEL (P)
Aggregate Demand
Decrease in AD
Aggregate Demand
AD1
AD2
AD2
AD1
REAL
OUTPUT (Y)
REAL
OUTPUT (Y)
V. The Fiscal Policy
(a) Changes in Government Purchases: increase in G = expansionary fiscal policy,
decrease in G = contractionary fiscal policy
AGGREGATE
EXPENDITURES (AE)
AGGREGATE
EXPENDITURES (AE)
Increase in G
AE = Y
Decrease in G
AE = Y
AEP( G2 )
A
AEP( G1 )
B
A
AEP( G1 )
AEP( G2 )
B
G
G
Y1
Y2
Y2
REAL OUTPUT (Y)
REAL OUTPUT (Y)
Y1
(b) Changes in the Lump-sum Taxes: decrease in T x = expansionary fiscal policy,
increase in T x = contractionary fiscal policy
AGGREGATE
EXPENDITURES (AE)
Decrease in T x
AE = Y
AGGREGATE
EXPENDITURES (AE)
AEP( T x2 )
Increase in T x
AE = Y
A
AEP( T x1 )
B
A
AEP( T x1 )
AEP( T x2 )
B
ΔC = mpc×Δ T x
ΔC = mpc×Δ T x
Y1
Y2
Y2
REAL OUTPUT (Y)
(c) The Balanced Budget Policy: G  T x
AGGREGATE
EXPENDITURES (AE)
AE = Y
B
AEP( G1 , T x1 )
С
ΔC = mpc×Δ T x
AEP( G2 , T x 1 )
AEP ( G2 , T x2 )
A
G
Y1 Y2
Y1'
ΔY = G  T x
REAL OUTPUT (Y)
Y1
REAL OUTPUT (Y)
(d) Changes in the Proportional Tax Rate: decrease in t = expansionary fiscal policy,
increase in t = contractionary fiscal policy.
AGGREGATE
EXPENDITURES (AE)
AGGREGATE
EXPENDITURES (AE)
Decrease in t
AE = Y
Increase in t
AE = Y
AEP(t1)
A
AEP(t2)
AEP(t2)
AEP(t1)
B
B
A
Y1
Y2
Y1 REAL OUTPUT (Y)
Y2
REAL OUTPUT (Y)
(e) Changes in Transfer Payments: increase in T r = expansionary fiscal policy,
decrease in T r = contractionary fiscal policy
AGGREGATE
EXPENDITURES (AE)
AGGREGATE
EXPENDITURES (AE)
Increase in T r
AE = Y
A
Decrease in T r
AE = Y
AEP( T r1 )
A
AEP( T r2 )
AEP( T r2 )
AEP( T r1 )
B
B
ΔC = mpc×Δ T r
ΔC = mpc×Δ T r
Y1
Y2
Y2
REAL OUTPUT (Y)
Y1
(f) The Impact of Automatic Stabilizers on the Business Cycle
REAL
GDP
BUSINESS CYCLE (with the
presence of built-in stabilizers)
TREND
BUSINESS CYCLE (with the
absence of built-in stabilizers)
TIME (years)
REAL OUTPUT (Y)
(g) The Laffer Curve
TAX REVENUES (Tx)
B
Txmax
A
Tx
topt t
TAX RATE
(t)
VI. The Loanable Funds Market
(a) Equilibrium in the loanable funds market (where rE - real rate of interest, FE – equilibrium quantity
of loanable funds, FD – demand for loanable funds, and FS – supply of loanable funds)
REAL INTEREST
RATE (r)
FS
E
rE
FD
FE
QUANTITY OF
LOANABLE FUNDS (F)
(b) Shifts in the demand for loanable funds
REAL INTEREST
RATE (r)
Increase in G, Tr or in I
FS
REAL INTEREST
RATE (r)
Decrease in G, Tr or in I
S
F S2
F
B
r2
A
r1
r1
A
FD2
FD1
QUANTITY OF
LOANABLE FUNDS (F)
r2
B
FD2
FD1
QUANTITY OF
LOANABLE FUNDS (F)
(c) Shifts in the supply of loanable funds in the closed economy
Decrease in Tx or in SPRIVATE
Increase in Tx or in SPRIVATE
REAL INTEREST
RATE (r)
REAL INTEREST
RATE (r)
FS1
S
F
FS2
S
F
FS21
2
B
r2
A
r1
r1
r2
A
B
FD
FD
QUANTITY OF
LOANABLE FUNDS (F)
QUANTITY OF
LOANABLE FUNDS (F)
(g) Crowding-out effect of the expansionary fiscal policy (the case of increase in government
purchases)
REAL INTEREST
RATE (r)
AGGREGATE
EXPENDITURES (AE)
REAL INTEREST
RATE (r)
AE = Y
FS
AEP( G2 , I1 )
AEP ( G2 , I 2 )
AEP( G1 , I1 ) r2
A'
B
B
r2
B
I
r1
A
A
r1
A
I(r)
FD2
G
FD1
Y1 Y2
Y1'
REAL
OUTPUT (Y)
QUANTITY OF
LOANABLE FUNDS (F)
VII. The Money Market
a) Equilibrium in the money market (where iE – equilibrium nominal rate of interest,
ME – equilibrium quantity of money, MD – demand for money, MS – supply of money)
NOMINAL
INTEREST
RATE (i)
iE
MS
E
MD
ME
QUANTITY OF
MONEY (M)
I2
I1 INVESTMENT
SPENDING (I)
(b) Shifts of the demand for money
Increase in the demand
for money
MS
NOMINAL
NOMINAL
INTEREST
INTEREST
RATE
RATE(i)
(i)
i2
B
iE1
A
Decrease in the demand
for money
NOMINAL
NOMINAL
INTEREST
INTEREST
RATE(i)(i)
RATE
MDD12
M
MSS
M
iE1
AA
i2
B
MD1
MD1
MEe
MD2
QUANTITY OF
MONEY (M)
MEe
QUANTITY OF
MONEY (M)
(c) Crowding-out effect of the expansionary fiscal policy (the case of increase in government
purchases): alternative explanation
AGGREGATE
EXPENDITURES (AE)
INTEREST
RATE (i)
AE = Y
MS
AEP(G2,I1)
AEP (G2,I2)
A'
AEP(G1,I1)
B
B
r2
B
i2
A
r1
i1
ΔI
INTEREST
RATE (i)
A
A
I(r)
MD2
ΔG
MD1
Y1 Y2
REAL
OUTPUT (Y)
Y’1
QUANTITY OF
MONEY (M)
I2 INVESTMENT
I1
SPENDING (I)
(d) Shifts of the supply of money
NOMINAL
INTEREST
RATE (i)
NOMINAL
INTEREST
RATE (i)
MS1 MS2
i2
i1
A
MS2 MS1
B
i1
A
B
i2
MD
M1
M2
QUANTITY OF
MONEY (M)
MD
M2
M1
QUANTITY OF
MONEY (M)
VIII. Monetary Policy
(a) Money transmission mechanism under monetary expansion
NOMINAL
INTEREST
RATE (i)
INTEREST
RATE (i)
MS1
i1
LRAS
MS2
SRAS
A
i1
A
B
i2
PRICE
LEVEL (P)
P2
B
i2
B
A
P1
MD
M1
M2
AD1
I
I1
QUANTITY OF
MONEY (M)
I2
AD2
Y1
INVESTMENT (I)
YF
REAL
OUTPUT (Y)
(b) Money transmission mechanism under monetary contraction
NOMINAL
INTEREST
RATE (i)
INTEREST
RATE (i)
MS2
i2
SRAS
B
i2
A
P1
A
i1
P2
MD
M2
LRAS
MS1
B
i1
PRICE
LEVEL (P)
M1
A
B
AD1
I
I2
QUANTITY OF
MONEY (M)
I1
INVESTMENT (I)
AD2
Y2
YF
(c) The Shape of the Money Demand Curve
NOMINAL
INTEREST
RATE (i)
In the Keynesian Model
NOMINAL
INTEREST
RATE (i)
MD
QUANTITY OF
MONEY (M)
In the Monetarist Model
MD
QUANTITY OF
MONEY (M)
REAL
OUTPUT (Y)
(d) The Shape of the Investment Demand Curve
In the Keynesian Model
INTEREST
RATE (r)
INTEREST
RATE (r)
In the Monetarist Model
I
I
INVESTMENT
SPENDING (I)
INVESTMENT
SPENDING (I)
IX. The Labour Market
(a) Equilibrium in the labour market (where (W/P)E - real wage, LE – equilibrium quantity of labour,
LD – demand for labour, and LS – supply of labour)
REAL WAGE
(W/P)
LS
E
(W/P)E
LD
LE
QUANTITY OF
LOANABLE FUNDS (F)
(b) Changes in the demand for labour (the main cause are the changes in the labour productivity MPL)
Decrease in LD
Increase in LD
REAL WAGE
(W/P)
LS
REAL WAGE
(W/P)
S
LF S2
B
(W/P)2
A
(W/P)2
(W/P)1
A
LD(MPL2)
LD(MPL1)
L1
L2
QUANTITY
OF LABOUR (L)
(W/P)1
B
L2
LD(MPL1)
LD(MPL2)
L1
QUANTITY
OF LABOUR (L)
(c) Changes in the supply of labour
Increase in LS
Decrease in LS
REAL WAGE
(W/P)
(W/P)1
LS1
LS2
LS2
REAL WAGE
(W/P)
LFSS21
(W/P)2
A
B
(W/P)1
(W/P)2
A
B
LD
LD
L1 L2
L2 L1
QUANTITY OF
LABOUR (L)
QUANTITY OF
LABOUR (L)
X. Aggregate Demand and Aggregate Supply Model
(a) Aggregate Demand Curve
PRICE
LEVEL (P)
B
P2
A
P1
AD
Y2
Y1
REAL
OUTPUT (Y)
PRICE
LEVEL (P)
Decrease in AD
(b) Shifting Aggregate Demand
PRICE
LEVEL (P)
Increase in AD
Aggregate Demand
AD2
AD1
Aggregate Demand
AD1
AD2
REAL
OUTPUT (Y)
REAL
OUTPUT (Y)
(c) Aggregate Supply Curve
AS
PRICE
LEVEL (P)
Classical Range
Intermediate Range
Depression or
Keynesian Range
Full Physical
Employment
Output (YF) Limit
(d)
Shifting Aggregate Supply
Increase in AS
PRICE
LEVEL (P)
REAL
OUTPUT (Y)
Decrease in AS
AS1
Aggregate Demand
AS
PRICE
LEVEL (P)
2
2
Aggregate AS
Demand
AS1
REAL
OUTPUT (Y)
REAL
OUTPUT (Y)
(e)
Equilibrium in the AD-AS Model
Point A - Long-run Equilibrium (where YF - equilibrium full-employment level of real output and PE –
equilibrium price level, AD – aggregate demand curve, SRAS – short-run aggregate supply curve, and
LRAS – long-run aggregate supply curve)
PRICE
LEVEL
(P)
LRAS
SRAS
PE
E
AD
YF
REAL
OUTPUT (Y)
(f)
Output gaps in the AD-AS model
PRICE
LEVEL (P)
Recessionary Gap
PRICE
LEVEL (P)
Inflationary Gap
LRAS
LRAS
SRAS
SRAS
A
P
A
P
AD
AD
REAL
OUTPUT (Y)
Y < YF
(g)
Shocks of Aggregate Demand
Positive (= increase in AD)
PRICE
LEVEL
(P)
Negative (= decrease in AD)
PRICE
LEVEL
(P)
LRAS
REAL
OUTPUT (Y)
YF < Y
LRAS
SRAS
SRAS
B
P2
P1
P1
P2
A
AD2
A
B
AD1
AD2
AD1
REAL
OUTPUT (Y)
YF Y2
REAL
OUTPUT (Y)
Y2 YF
E
(h)
PRICE
LEVEL
(P)
P1
P2
Shocks of Aggregate Supply
Favorable
(= increase in SRAS)
LRAS
SRAS1
SRAS2
PRICE
LEVEL
(P)
A
P2
P1
Adverse
(= decrease in SRAS)
LRAS
SRAS2
SRAS1
B
A
B
AD
AD
YF Y2
REAL
OUTPUT (Y)
Y2 YF
REAL
OUTPUT
(Y)
(i)
Shifts in LRAS curve
Increase in production
possibilities
PRICE
LEVEL
(P)
LRAS1 LRAS2
PRICE
LEVEL
(P)
SRAS1
SRAS2
LRAS2 LRAS1
SRAS2
SRAS1
B
P2
P1
A
P1
P2
Decrease in production
possibilities
A
B
AD
AD
REAL
OUTPUT (Y)
Y F Y F’
(j)
REAL
OUTPUT (Y)
Y F’ Y F
Self-correction of the economy after a negative aggregate demand shock (classical view)
PRICE
LEVEL
(P)
LRAS
SRAS1
SRAS2
A
P1
P2
B
C
AD1
AD2
REAL
OUTPUT (Y)
Y2 YF
(f) Effects of fiscal and monetary policy actions
Expansionary Policy (= increase in AD)
PRICE
LEVEL (P)
Contractionary Policy (= decrease in AD)
PRICE
LEVEL (P)
LRAS
LRAS
SRAS
A
P2
P1
P1
P2
B
A
B
AD2
AD1
Y1 YF
SRAS
AD2
AD1
REAL
OUTPUT (Y)
YF
Y1
REAL
OUTPUT (Y)
(g) Fiscal policy – the ‘supply-siders’ approach
PRICE
LEVEL (P)
LRAS
SRAS1
SRAS2
A
P1
P2
B
AD
REAL
OUTPUT (Y)
Y1 YF
XII. Economic Growth
(a) The change in real GDP over time
REAL
GDP
TREND
1970
1980
1990
2000
TIME (years)
2010
(b) The increase in production possibilities of the economy
INVESTMENT
GOODS
B
PPC2
A
PPCPossibilities
1
Curve
Possibilities
Curve
CONSUMPTION
GOODS
(c) Increase in the long-run aggregate supply and in the potential level of output
PRICE
LEVEL (P)
LRAS1 LRAS
2
P1
P2
SRAS1
SRAS2
A
B
AD
Y F Y F’
REAL
OUTPUT (Y)