AP Macro Exam Cumulative Review and Common Mistakes Students Make General Stuff- MC’s To Guess Or Not To Guess On MC’s: The general rule of thumb: choose your best answer, and don’t skip the question if you can confidently rule out at least one of the multiple choice answers as not being the correct answer. Guessing if one can eliminate at least one answer as not correct provides a statistical, but not guaranteed, advantage in the students favor as the 1 point awarded for the correct answer has a larger payoff than the smaller 1/4 point deduction for selecting the wrong answer. However, there are other factors to consider; be especially careful on the earlier multiple choice questions since usually these questions are often somewhat easier than those questions towards the end of the multiple choice section (maximize your overall score by omitting "stupid mistakes" or mistakes due to rushing). General Stuff- MC’s Cont’d The first half of the MC portion of the test is a bit easier than the second half. If you have extra time (finish early) on the multiple choice, go back and look over your first 3 or four answers (many students screw up in the very beginning of most tests). Only change an answer if it is obvious that a mistake was made. Warm-up- do some simple S and D problems before the exam starts out of your PR book to get the brain going. General Stuff- FRQ’s Bring two blue pens, two black pens and two (or more) or more sharpened pencils) Three questions, no pick and choose as in US History, do them all, one is the 'long' essay' worth the value of the other two put together. Spend half your time there. You get 60 minutes (10 review/50 write). Read the question. See what it is about. Then read it again now that you know what it is about and its direction. Then read and sketch an answer. If you can see where nine or ten questions are buried in the long question, try to nail one more than half. Don't waste time trying to figure out an extra point until you have attempts at all three. On the short-essays, see if you can identify four, five or six points in the format of the question. Once again, nail down one more than half on each of the shorties. Anything over that and it is pure gravy. The vast majority of Q's on AP econ FRQ situations ask for ONE and ONLY ONE shift. If you feel compelled to shift two things you’re probably overanalyzing the question. Unless there are TWO SEPARATE actions, you should not look for two separate reactions or effects. General Stuff- FRQ’s Cont’d Remember, pure declarative answers generally get you nothing. An answer of "increases" just doesn't win a point. It is your defense of why increases is correct. And remember that one point is not a lot of heavy lifting. If you’re going on-and-on for one point, then you probably don't know the answer. No calculators, no cheat sheets, no copying. Essays do not have to use complete sentences. Many of the best essays use very few words. And abbreviations are fine right from the get go. NI is National Income, GDP is..well you know. An arrow pointing up is read as increases or increasing or increased as grammar befits. General Stuff- FRQ’s Cont’d Write big and neat--If I can’t read it, it’s wrong. Write clearly, skipping lines between responses. Make bigger graphs. Use the symbols and abbreviations we’ve used in class; don’t invent your own on the spot. DO NOT put an LRAS line on a loanable funds market graph… The difference between a change in demand and the resultant movement along a demand curve vs. Shifting of the demand curve GRAPHING DEMAND Price of Corn P CORN P $5 4 3 2 1 QD 10 20 35 55 80 $5 4 3 2 What if Demand Increases? 1 o D 10 20 30 40 50 60 70 80 Quantity of Corn Q GRAPHING DEMAND Price of Corn Increase in Quantity Demanded P CORN P $5 4 3 2 1 QD 10 30 20 40 35 60 55 80 80 + $5 4 3 2 1 o Increase in Demand 10 20 30 40 50 60 70 80 Quantity of Corn D’ D Q The difference between a change in supply and the resultant movement along a supply curve vs. Shifting of the supply curve GRAPHING SUPPLY Price of Corn P $5 4 3 2 S What if Supply Increases? 1 o 10 20 30 40 50 60 70 80 Quantity of Corn CORN P QS $5 4 3 2 1 Q 60 50 35 20 5 GRAPHING SUPPLY Price of Corn P $5 4 3 2 1 Increase in Supply S S’ CORN P QS $5 4 3 Increase 2 in Quantity 1 Supplied o 10 20 30 40 50 60 70 80 Quantity of Corn Q 60 80 50 70 35 60 20 45 5 30 Mislabeling or NOT labeling graphs correctly EQUILIBRIUM: REAL OUTPUT AND THE PRICE LEVEL Price Level P AS Equilibrium in the Intermediate Range Pe P1 AD Q1 Qe Q2 Real Domestic Output, GDP Q GROWTH IN THE AD-AS MODEL ASLR1 ASLR2 C Price Level Capital Goods A B D Consumer Goods Q1 Q2 Real GDP ECONOMIC GROWTH IN THE EXTENDED AD – AS MODEL ASLR1 ASLR2 AS2 Price Level AS1 P2 P1 AD2 AD1 o Q1 Real GDP Q2 Rate of interest, i (percent) THE MONEY MARKET Sm1 Sm 10 7.5 ie 5 Dm 2.5 0 A temporary shortage of money will require the sale of some assets to meet the need. 0 50 100 150 200 250 300 Amount of money demanded (billions of dollars) Net effects of Monetary Policy and/or Fiscal Policy on Interest Rates (Ir%) FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Price level AS Fiscal Policy And Inflation P1 AD1 AD2 $495 $505 $515 Real GDP (billions) Expansionary Fiscal Policy >> Interest Rate INCREASE Draw Money Market Increase Spending (AD)>>Increase Demand for Money>>Increase Interest Rate Higher Price Level>>Increase Demand for Money>>Increase Interest Rate Expansionary Monetary Policy>> Interest Rate DECREASE MONETARY POLICY AND EQUILIBRIUM GDP Real rate of interest, i Sm1 S m2 10 10 8 8 6 6 Investment Demand Dm 0 Quantity of money demanded and supplied Price level AS P2 P1 0 Amount of investment, i Money Supply Increases If the money supply increases Investment Increases to stimulate the economy... AD & GDP Increases Interest Rate Decreases AD1 AD2 Real domestic output, GDP with slight inflation MONETARY POLICY AND EQUILIBRIUM GDP Real rate of interest, i Sm1 S S m2 m3 10 10 8 8 6 6 Dm 0 Quantity of money demanded and supplied AS Price level Investment Demand P3 P2 P1 0 Amount of investment, i More Money Supply If theInterest moneyRates Lower supply increases More Investment again… AD1 AD2 AD3 Real domestic output, GDP Still higher AD & GDP with significant inflation MULTIPLIER(S) CONFUSION Income (Spending) Multiplier Multiplier = 1/ 1 – MPC or 1/ MPS Initial Change in Spending X MULTIPLIER = Change in Output MONEY MULTIPLIER 1/ Required Reserve Ratio Maximum Multiple $$$ Money Expansion MULTIPLE DEPOSIT EXPANSION PROCESS Bank Acquired reserves Required and deposits reserves Excess reserves Amount bank can lend - New money created $80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57 Total amount of money created by the banking system $400.00 A $100.00 B 80.00 C 64.00 D 51.20 E 40.96 F 32.77 G 26.22 H 20.98 I 16.78 J 13.42 K 10.74 L 8.59 M 6.87 N 5.50 Other banks 21.97 $20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40 $80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57 Balanced Budget Multiplier =1 (Net Result on GDP) Remembering the difference between the Amount of Money Created and the Change in the Money Supply when dealing with the Money Multiplier and Money Creation FEDERAL RESERVE PURCHASE OF BONDS Purchase of a $1000 bond from a bank... New reserves $800 Excess Reserves $4000 Bank System Lending $200 Required reserves $1000 Initial Deposit Total Increase in Money Supply ($5000) Confusing Comparative Advantage Calculations Input—IOU Output- OOO Comparative and Absolute Advantage Haiti Coffee Haiti’s DCC 4 C 100 1B = __ 1/4 B = 1C __ 80 can produce at a lower productive opportunity cost] “A prisoner of my own PPC.” 90 Coffee [Comparative Advantage Cuba “I can consume only on my PPC.” Cuba’s DCC 6 C 1B = __ 1/6 B = 1C __ Terms of Trade 5 coffees 1 bread = __ World CC 5 Coffees 1 Bread=__ 1/__ 5 Bread=1 Coffee 0 Bread 15 18 20 “Trade is the free lunch of economics.” o Bread 1. (Haiti/Cuba) has an absolute advantage in coffee and (Haiti/Cuba) has an absolute advantage in bread. 2. Haiti will export (bread/coffee) [comparative advantage] and import (bread/coffee). [comparative disadvantage] & Cuba will export (bread/coffee) & import (bread/coffee). 3. Mutually advantageous trade can occur between Haiti & Cuba when 1 bread is exchanged for (3/5/7) tons of coffee. Production in both is subject to (increasing/constant) opportunity costs. “Export” what it can produce at a lower relative price and “import” goods it can buy at a lower relative price. Absolute Advantage - more efficient, can produce more with the “Do what you do best same number of inputs [who can do the most in absolute numbers] & trade for the rest.” Remembering the difference between Real and Nominal Nominal: with Inflation Real: without Inflation GDP 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 INCOME 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 INTEREST RATE (I%) 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 ANTICIPATED INFLATION 11% = + 5% Nominal Interest Rate Real Interest Rate 6% Inflation Premium WAGES NOMINAL WAGES: amount of money received by a worker per unit of time (hour, day, etc.); Money Wage REAL WAGES: amount of goods and sevices a worker can purchase with their NOMINAL WAGE; purchasing power of the nominal wage. (Real = Nominal – Inflation rate) Demand-Pull Inflation vs. Cost-Push Inflation DEMAND-PULL INFLATION ASLR AS2 Price Level AS1 c P3 b P2 a P1 AD2 AD1 o Q1 Real domestic output COST-PUSH INFLATION Occurs when short-run AS shifts left ASLR AS2 Price Level AS1 b P2 a P1 AD1 o Q2 Q 1 Real domestic output COST-PUSH INFLATION Government response with increased AD ASLR AS2 Price Level AS1 c P3 b P2 a P1 Even higher price levels AD2 AD1 o Q2 Q 1 Real domestic output COST-PUSH INFLATION If government allows a recession to occur ASLR AS2 Price Level AS1 b P2 a P1 AD1 o Q2 Q 1 Real domestic output COST-PUSH INFLATION If government allows a recession to occur ASLR AS2 Price Level AS1 b P2 a P1 Nominal wages fall & AS returns to its original location AD1 o Q2 Q 1 Real domestic output Phillips Curve vs. Laffer Curve THE PHILLIPS CURVE CONCEPT Annual rate of inflation (percent) 7 As inflation declines... 6 5 Unemployment increases 4 3 2 1 0 1 2 3 4 5 6 7 Unemployment rate (percent) THE LAFFER CURVE Tax rate (percent) 100 l 0 Tax revenue (dollars) THE LAFFER CURVE Tax rate (percent) 100 m l 0 Tax revenue (dollars) THE LAFFER CURVE 100 Tax rate (percent) n m l 0 Tax revenue (dollars) THE LAFFER CURVE Tax rate (percent) 100 n m m Maximum Tax Revenue l 0 Tax revenue (dollars) Appreciation of the Dollar Increase in taste for U.S. goods Increase in U.S. Interest Rates Decrease in U.S. Growth Rate The Market for Dollars Decrease in U.S. Price Level Yen Price of Dollar Exchange Rate: $1 = ¥100 P Decrease in U.S. Currency Price D1$ Y looking for $’s Y150 Y100 S$ D2 $’s looking for Y E2 D A Yen depreciates E1 Yen appreciates Y50 E3 D3 Depreciation of $ Decrease in Taste 0 Decrease in In. Rates Increase Growth Rate Increase Price Level Increase in Currency Price D Q A Quantity E of Dollars 1. Increase in taste [more demand for a country’s products or assets] 2. Increase in interest rates [Overseas investors increase their investments there.] 3. Decrease in price level [overseas buyers want to buy our cheaper goods.] 4. Decrease in growth rate [A country’s declining economy results in them buying less from other countries; decreasing demand for their currency and thus appreciating the declining economy’s currency] 5. Decrease in the price of a currency relative to the other 1. If Japan buys 2 million more American cars the dollar would (appreciate/depreciate) and our imports from Japan would (increase/decrease). 2. If U.S. interest rates are increasing faster than Japan’s, the dollar would (appreciate/depreciate) & and our exports would (increase/decrease). 3. If prices are dropping more in Japan than in the U.S., the yen will (appreciate/depreciate) and Japan’s imports will (increase/decrease). 4. If the U.S. growth rate is faster than that of Japan, the dollar will (appreciate/depreciate) and U.S. imports from Japan will (increase/decrease). 5. If the dollar price of the yen decreases, the dollar has (appreciated/depreciated) and our our imports from Japan will (increase/decrease).