AP MACRO
MID-TERM REVIEW
MODULES 1-23
Mr. Lipman
UNIT 1: THE BASICS
Economics- The study of scarcity and choice.
Macroeconomics- A focus on the overall ups and
downs in the economy
The Four Factors of Production
•Producing goods and services requires the use of
resources.
•ALL resources can be classified as one of the
following four factors of production:
Land
Labor
Capital
Entrepreneurship
3
ALL decisions involve trade-offs.
Trade-offs are all the alternatives that we give up
whenever we choose one course of action over others.
(Examples: going to the movies or going to a game)
The most desirable alternative given up as a result
of a decision is known as opportunity cost.
Key Economic Assumptions
1. Wants are unlimited, resources are limited (scarcity).
2. Due to scarcity, choices must be made. Every choice
has a cost (a trade-off).
3. Everyone acts rationally by comparing the marginal
costs and marginal benefits of every choice
4. Ceteris paribus: “other things being equal”
In economics the term marginal = additional
“Thinking on the margin”, or MARGINAL ANALYSIS
involves making decisions based on the difference
of additional benefit vs. the additional cost.
Everyone will continue to do the same thing until the
marginal cost outweighs the marginal benefit being gained
and then they will stop doing it.
The Various Business Cycles
Depression
• Recession
• Expansion or growth
(which leads to
inflation)
• Graph demonstrates
changes happening
over time as cycles
change
When using a PPC always remember that if a point is
inside or on the curve it is feasible but if it lies outside
the curve then it is not feasible. Being on the curve is
most efficient (aka no missed opportunities)
• An individual has a comparative advantage
in producing a good or service if the
opportunity cost of producing the good is
lower for that individual than for other people.
• An individual has an absolute advantage in
an activity if he or she can do it better than
other people. Having an absolute advantage
is not the same thing as having a comparative
advantage.
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5 KEY ELEMENTS TO SUPPLY & DEMAND
• THE DEMAND CURVE
• THE SUPPLY CURVE
• FACTORS THAT CAUSE CURVES TO
SHIFT
• MARKET EQUILIBRIUM
• HOW MARKET EQUILIBRIUM CHANGES
WHEN SUPPLY OR DEMAND CURVE
“SHIFTS”
Demand is the different quantities of goods
that consumers are willing and able to buy at
different prices.
The law of demand states there is an
INVERSE relationship between price and
quantity demanded :
AS PRICE GOES UP THE QUANTITY DEMANDED
WILL DROP & AS PRICE DROPS DEMAND RISES
11
The law of demand has 3 parts
1.The Substitution effect as price of
good goes up consumers will purchase a
substitute good
2. The Income effect as price drops the
purchasing power increases
3. Law of Diminishing Marginal Utility
the more you buy of ANY GOOD the less
satisfaction you get from each new unit of
that good.
12
Keys to Graphing Supply & Demand
• 1. The slope of the curve is always down
and to the right
• 2. A change in demand at the same price
requires a SHIFT but a change in demand
due to a change in price is show as
MOVEMENT along the curve
Demand Will Shift because of:
• 1. Market Size
• 2. Expectations
• 3. Related Prices
(compliments/substitutes)
• 4. Income (normal & inferior)
• 5. Tastes
Key Terms
• Substitute good is one whose demand goes up
when the price of another good goes up (coffee
and tea are examples of this)
• Compliment goods are ones usually used
together and thus if demand for one falls then
demand for the other will also fall (cars and
gasoline are examples of this)
• Most goods are “normal” (demand increases as
income rises) but some are “inferior” (demand
drops as income rises…for example buses…as
income rises people tend to then take taxis)
Unit 3
Measuring Economic Performance
• GROSS DOMESTIC PRODUCTION
(GDP)
• UNEMPLOYMENT
• INFLATION
The most important measure of growth is GDP.
Gross Domestic Product (GDP) is the dollar value of all
final goods and services produced within a country’s
borders in one year.
• Dollar value- GDP is measured in dollars.
• Final Goods-GDP does not include the value of
intermediate goods. Intermediate goods are
goods used in the production of final goods and
services.
• One Year-GDP measures annual economic
performance.
17
What is NOT included in GDP?
1. Intermediate Goods
• No Multiple Counting, Only Final Goods
• EX: Price of finished car, not the radio,
tire, etc.
2. Nonproduction Transactions
•Financial Transactions (nothing produced)
•Ex: Stocks, bonds, Real estate
•Used Goods
•Ex: Old cars, used clothes
3. Non-Market (Illegal) Activities
•Ex: Illegal drugs, unpaid work
18
Circular Flow Diagram: Inflow of money into each market or sector must
equal the outflow of money coming from that market or sector
How can you measure growth from
year to year?
% Change
in GDP
=
Year 2 - Year 1
Year 1
X 100
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1. Expenditures Approach-Add up all
the spending on final goods and
services produced in a given year.
GDP = C + I + G + Xn (exportsimports)
C IS CONSUMER SPENDING
I IS INVESTMENT SPENDING
G IS GOVERNMENT PURCHASES OF
GOODS AND SERVICES
21
For each situation, identify if it is included in GDP the identify the
category C, I, G, or Xn AND WHAT IS TOTAL GDP
1. $10.00 for movie tickets
2. $5M Increase in defense expenditures
3. $45 for used economics textbook
4. Ford makes new $2M factory
5. $20K Toyota made in Mexico
6. $10K Profit from selling stocks
7. $15K car made in US, sold in Canada
8. $10K Tuition to attend college
9. $120 Social Security payment to Bob
10.Farmer purchases new $100K tractor
22
Included or not Included in GDP?
GDP=$7,125,010
1. $10.00 for movie tickets
2. $5M Increase in defense expenditures
X $45 for used economics textbook
4. Ford makes new $2M factory
X $20K Toyota made in Mexico
X $10K Profit from selling stocks
7. $15K car made in US, sold in Canada
8. $10K Tuition to attend college
X $120 Social Security payment to Bob
10.Farmer purchases new $100K tractor
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Real vs. Nominal GDP
Nominal GDP is GDP measured in current
prices. It does not account for inflation
from year to year.
Real GDP is GDP expressed in constant, or
unchanging, dollars.
Real GDP adjusts for inflation.
REAL GDP IS THE BEST MEASURE OF
ECONOMIC GROWTH!
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3 Types of Unemployment
#1. Frictional Unemployment
•“Temporarily unemployed” or being between
jobs.
•Individuals with transferable skills
•Seasonal Unemployment
•Examples: College Grads, Santa Claus Workers
25
#2. Structural Unemployment
•Workers DO NOT have transferable skills and
these jobs will never come back.
•Technological Unemployment
•Workers must learn new skills to get a job.
Examples:
•VCR repairmen
•Carriage makers
•Automobile Workers replaced by robots
26
#3 Cyclical Unemployment
•Unemployment that results from economic
downturns (recessions).
•As demand for goods and services falls,
demand for labor falls and workers are fired.
Examples:
•Steel workers laid off during recessions.
•Restaurant owners fire waiters after months
of poor sales due to recession.
27
The Natural Rate of Unemployment
2 of 3 types of unemployment are unavoidable:
•Frictional unemployment
•Structural unemployment
•They are natural rate of unemployment (NRU).
We are at full employment if we have only
the natural rate of unemployment.
•This is the normal amount of unemployment that
we SHOULD have.
•The number of jobs seekers equals the number
of jobs vacancies.
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Three Causes of Inflation
1. Printing too much Money
2.Demand-Pull Inflation
3. Cost-Push Inflation
Measuring Inflation
• Inflation Rate Percentage =‘s
Price Yr 2 - Price Yr 1 x 100
Price Yr 1
The process of bringing the inflation rate down
is known as Disinflation and it is difficult to do
because you must temporarily slow growth or
even depress the economy.
Key Inflation Terms
• Shoe-leather costs
– Increased transaction costs of shopping
around
• Menu Costs
– $ it costs to change prices
• Unit of Accounts Costs
– inflation makes $ less reliable as a unit of
measurement
Hurt by Inflation
Helped by Inflation
• Lenders-People who
lend money (at fixed
interest rates)
• People with fixed
incomes
• Savers
• Borrowers-People
who borrow money
• A business where the
price of the product
increases faster than
the price of resources
Cost-of-Living-Adjustment (COLA)
Some works have salaries that mirror inflation.
They negotiated wages that rise with inflation
The most commonly used method to determine inflation
for consumers is the Consumer Price Index
Here is how it works:
• The base year is given an index of 100
• To compare, each year is given an index # as well
CPI =
Price of market basket
Price of market
basket in base year
x 100
Problems with using CPI as a Measurement
1. Substitution Bias- As prices increase for the fixed
market basket, consumers buy less of these products
and more substitutes that may not be part of the
market basket. (Result: CPI may be higher than what
consumers are really paying)
2. New Products- The CPI market basket may not include
the newest consumer products. (Result: CPI measures
prices but not the increase in choices)
3. Product Quality- The CPI ignores both improvements
and decline in product quality. (Result: CPI may
suggest that prices stay the same though economic
well being has improved significantly)
CPI vs. GDP Deflator
The GDP deflator measures the price of all goods
produced, whereas the CPI measures prices of only the
goods and services bought by consumers.
An increase in the price of goods bought by firms or the government
will show up in the GDP deflator but not in the CPI.
The GDP deflator includes only those goods and services produced
domestically.
GDP
Deflator
=
Nominal GDP
Real GDP
x 100
Calculating GDP Deflator
GDP
Deflator
Nominal
GDP
=
=
Nominal GDP
Real GDP
x 100
(Deflator) x (Real GDP)
100
UNIT 4: How is Spending “Multiplied”?
Assume the MPC is .5 for everyone
•Assume that when the Super Bowl comes to town
there is an increase of $100 in Ashley’s restaurant.
•Ashley now has $100 more income.
•She saves $50 and spends $50 at Carl’s Salon
•Carl now has $50 more income
•He saves $25 and spends $25 at Dan’s fruit stand
•Dan now has $25 more income.
This continues until every penny is spent or saved
Change in
GDP
= Multiplier x
Initial Change
in Spending
37
Marginal Propensity to Consume (MPC)
•How much people consume rather than save when
there is an change in income.
•It is always expressed as a fraction (decimal).
MPC=
Change in Consumer Spending
Change in Income
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Marginal Propensity to Save (MPS)
•How much people save rather than consume when
there is an change in income.
•It is always expressed as a fraction (decimal)
MPS=
Change in Saving
Change in Income
39
MPS = 1 - MPC
Why is this true?
Because people can either save or consume
40
Two factors can change Aggregate Consumption
Function
• 1. Changes in expected future disposable
income
– (higher expected future income tends to lead
to lower savings today…this is known as the
permanent income hypothesis)
• 2. Changes in aggregate wealth
– (wealth has an effect on consumer spending
and consumers generally plan their spending
over their lifetime and not just based on
current disposable income…the life-cycle
hypothesis).
Aggregate Demand Curve
Price
Level
AD is the demand by consumers,
businesses, government, and
foreign countries
Changes in price level cause a
move along the curve not a
shift of the curve
AD = C + I + G + Xn
Real domestic output (GDPR)
42
Shifters of Aggregate Demand
------------------------------------------An increase in Aggregate Demand
means a shift of the curve to the right
and may include the following factors:
1. Changes in expectations
2. Changes in wealth
3. Size of firm capacity
4. Government Policies
GDP = C + I + G + Xn
43
Aggregate Supply
The amount of goods and services (real GDP) that
firms produce in an economy at different price
levels.
Aggregate Supply differentiates between short run
and long-run and has two different curves.
Short-run Aggregate Supply
•Wages and Resource Prices will not increase as
price levels increase.
Long-run Aggregate Supply
•Wages and Resource Prices will increase as price
levels increase.
44
Shifters of Aggregate Demand
AD = C + I + G + X
Change in Consumer Spending
Change in Government Spending
Change in Investment Spending
Net EXport Spending
Shifters of Aggregate Supply
AS = I + R + A + P
Change in Inflationary Expectations
Change in
Change in
Change in
Resource Prices
Actions of the Government
Productivity (Investment)
45
Assume the government increases spending.
What happens to PL and Output?
Price
Level
LRAS
AS
PL and Q will
Increase
PL1
PLe
AD
QY Q1
GDPR
AD1
46
How the Government Stabilizes the Economy
The Government
has two different
tool boxes it can
use:
1. Fiscal PolicyActions by Congress &
the President
OR
2. Monetary PolicyActions by the
Federal Reserve
Bank (aka Central
Bank actions)
47
Two Types of Fiscal Policy
Discretionary Fiscal Policy• Congress creates a law designed to change AD
through government spending or taxation.
•Problem is time lags due to bureaucracy.
•Takes time for Congress to act.
•Ex: In a recession, Congress increases spending.
Non-Discretionary Fiscal Policy
•AKA: Automatic Stabilizers
•Permanent spending or tax laws enacted to counter
cyclical problem to stabilize the economy
•Ex: Welfare, Unemployment, Min. Wage, etc.
•When there is high unemployment, unemployment
benefits to citizens increase consumer spending.
48
Contractionary Fiscal Policy
(The BRAKE)
Laws that reduce inflation, decrease GDP
Either Decrease Government Spending or Enact
Tax Increases
• Combinations of the Two
Expansionary Fiscal Policy
(The GAS)
Laws that reduce unemployment and increase GDP
• Increase Government Spending or Decrease Taxes
on consumers
• Combinations of the Two
How much should the Government Spend?
49
KEY TERMS TO KNOW: unit 5
•Budget Surplus
•Budget Deficit and Budget Debt
•Budget Balance
•National Savings v. Private Savings
•Capital inflow
Money is anything that is generally accepted in
payment for goods and services
Commodity Money- Something that performs the
function of money and has alternative uses.
– Examples: Gold, silver, cigarettes, etc.
Fiat Money- Something that serves as money but
has no other important uses.
– Examples: Paper Money, Coins
51
3 Functions of Money
1. A Medium of Exchange
• Money can easily be used to buy goods and
services with no complications of barter system.
2. A Unit of Account
• Money measures the value of all goods and
services. Money acts as a measurement of value.
• 1 goat = $50 = 5 chickens OR 1 chicken = $10
3. A Store of Value
• Money allows you to store purchasing power for
the future.
• Money doesn’t die or spoil.
52
Types of Money
Liquidity- ease with which an asset can be
accessed and converted into cash (liquidized)
M1 (High Liquidity) - Cash, Traveler’s Checks
and Checkable Deposits. In general, this is known
as the MONEY SUPPLY
M2 (Medium Liquidity) - M1 plus other “near
money” such as savings accounts (CD’s) and
mutual funds
M3 (Low Liquidity) – No longer used
53
To Protect Against Bank Runs the
Following Regulations are in effect
• FDIC : Insured to $250K
• Capital Requirements: Owners must hold
more assets then the value of the deposits
(usually at least 7% more)
• Reserve Requirements: Reserve ratio is
presently 10% of all checkable deposits
• Discount Window: Ability to borrow from
the Fed to avoid having to sell assets at
below market prices
• The Federal Reserve uses three primary
tools in the pursuit of monetary policy:
– Reserve Requirements
– The Discount Rate
– Open Market Operations
These tools are used to
increase or decrease the money
supply.