AP Macro Economics
Semester Final Study Guide
Fall 2015
Unit One:
1. What is the primary concern for studying economics? (pg. 3)
 The efficient use of scarce resources to achieve the maximum satisfaction
of economic wants.
 For citizenship: to be well-informed citizens
 For professional and personal applications: helps develop analytical skills,
understand activity around us, and make profitable businesses
2. Define the term “economic perspective.” (Back of the book)
 A viewpoint that envisions individuals and institutions making rational
decisions by comparing the marginal benefits and marginal costs
associated with their actions
 An economic way of thinking
3. Why are economic models limited to only two variables? (pg. 7-8)
 Ceteris paribus assumption – Assumption that factors other than those
being considered are held constant.
 Economics is not a laboratory science. Economics experiments are
conducted in the real world where not all variables can be controlled, so
by simplifying the variables, economists can better analyze the desired
variables.
4. List the eight economic goals and group those goals that conflict with each other.
Then group those goals to complement each other. (pg. 9)
1. Economic Growth – Produce more and better goods and services, or,
more simply, develop a higher standard of living.
2. Full Employment – Provide suitable jobs for all citizens who are
willing and able to work.
3. Economic Efficiency – Achieve the maximum fulfillment of wants
using the available productive resources.
4. Price-level Stability – Avoid large upswings and downswings in the
general price level; that is, avoid inflation and deflation.
5. Economic Freedom – Guarantee that businesses, workers, and
consumers have a higher degree of freedom in their economic
activities.
6. Equitable Distribution of Income – Ensure that no group of citizens
faces poverty while most others enjoy abundance.
7. Economic Security – Provide for those who are chronically ill,
disabled, laid off, aged, or otherwise unable to earn minimal levels of
income.
8. Balance of Trade – Seek a reasonable overall balance with the rest of
the world in international trade and financial transactions.
 Compliments: (6 + 2)
 Conflicts: (6 + 1) (5 + 7)
5. Explain the difference between macro and micro economics. (pg 9-10)
 Macroeconomics examines either the economy as a whole or its basic
subdivisions or aggregates, such as the government, household, and
business sectors. Seeks to obtain an overview of the structure of the
economy and the relationships of its major aggregates
 Microeconomics looks at specific economic units such as specific
products, number of workers of a single firm, or revenue of a particular
firm.
 Macro examines big picture, micro examines small picture
6. Explain the difference between positive and normative statements. (pg 10)
 Positive statements focus on facts and cause-and effect relationships.
(Includes description, theory development, and theory testing). Avoid
value judgments, tries to establish scientific statements about economic
behavior, and deals with what the economy is actually like.
 Normative statements – Part of economics involving value judgments
about what the economy should be like; focused on which economic goals
and policies should be implemented; policy economics.
7. List and explain the four factors of production (resources). (pg 23)
 Land – All natural resources used in production process (land, forests,
water, mineral and oil).
 Capital – (Capital goods or investment goods) – All manufactured aids
used in producing goods/services (tools, machines, factories…). Consumer
goods satisfy wants directly while capital goods do so indirectly by aiding
the production of consumer goods. Does not refer to money.
 Labor - All physical and mental talents of individuals available and usable
in producing goods and services.
 Entrepreneurial Ability – Distinct from labor, takes initiative in combining
resources to produce a good/service. Entrepreneur makes basic business
policy decisions, innovates, and bears the risk.
8. List the payments for each of the four resources. (pg 24)
 Land – Rental income
 Capital – Interest income
 Labor – Wages
 Entrepreneurial – Profits/losses
9. What basic principle does the production possibilities curve illustrate?
 Law of Increasing opportunity costs
10. Know what each point on the above diagram represents.
 A, B, C – Producing at full employment.
 D – Under producing
 E – Overextension of resources
11. Define the term “capital investment.” (back of the book)
 Human-made resources (buildings, machinery, and equipment) used to
produce goods and services
South Cantina Production Possibilities
A
B
C
Capital
5
4
3
goods
Consumer 0
8
15
Goods
D
2
E
1
F
0
21
25
27
12. Refer to the above tables. If South Cantina is producing at production alternative
D, the opportunity cost of the third unit of capital goods will be:
 6 units of consumer goods
13. Define scarcity. (pg 3-4)
 Since human and property resources are scare, goods and services are
limited, limiting our options and necessitating that we make choices. We
can’t have it all.
14. Define opportunity cost (pg 27)
 The amount of other products that must be forgone or sacrificed to obtain
1 unit of a specific good is called the opportunity cost of that good
15. Define “The Law of Increasing Opportunity Cost.” (pg 27)
 The more of a product that is produced, the greater is its opportunity cost
16. List the three factors that lead to economic growth. (pg 29)
 Increases in Resource Supplies
 Advances in Technology
 Present Choices and Future Possibilities – Choosing to produce more
capital goods currently, over consumer goods, will result in increased
production capacity later
17. Know the flows of the circular flow model. (pg 35)
Unit Two:
18. Define the term “market.” (pg 40)
 Institution or mechanism that brings together buyers and sellers of
particular goods, services, or resources
19. Explain the difference between “complementary goods” and competing goods.”
(pg 45)
 Complementary Good is one that is used together with another good.
 Substitute Goods (competing good) is one that is used instead with another
good.
 When two products are substitutes, the price of one and the demand for the
other movie in the same direction
 When two products are complements, the price of one good and the
demand for the other good move in opposite directions.
20. Explain the difference between “normal goods” and “inferior goods” (pg 44)
 Normal good – Product whose demand varies directly with money
income. So products that are purchased more when income goes up.

Inferior good – Good whose demand varies inversely with income. So
products that are purchased less as income goes up (used goods, etc…)
21. How do you illustrate deceasing and increasing demand on a graph? What about
increasing and decreasing supply? (pg 45-46)
 Shift the curve left or right to demonstrate increase or decrease of demand
and supply
22. Define “The Law of Supply.” (pg 47)
 As price rises, the quantity supplied rises; as price falls, the quantity
supplied falls
23. Define “The Law of Demand.” (pg 41)
 All else equal, as price falls, the quantity demanded rises, and as price
rises, the quantity demanded falls
24. Refer to the above diagram. The equilibrium price and quantity in this market will
be:
 Equilibrium Price: $1.00
 Equilibrium Quantity: 200
25. Refer to the previous diagram, which shows demand and supply conditions in the
competitive market for product X. If the initial demand and supply curves are D0
and S0 , equilibrium price and quantity will be:
 Equilibrium Price: F

Equilibrium Quantity: C
26. Which of the above diagrams illustrate(s) the effect of an increase in automobile
worker wages on the market for automobiles?
 D
27. Which of the above diagrams illustrate(s) the effect of an increase in the price of
Budweiser beer on the market for Coors beer?
 A
28. Explain how the use of money contributes to economic efficiency. (pg 62-63)
 Money is a medium of exchange, it makes trade easier. Money is
acceptable to sellers in exchange for their goods and services. It allows for
specialization, because it eliminates the need for a coincidence of interests,
allowing trade to take place.
29. Define the term “creative destruction.” (pg 68)
 The creation of new products and production methods completely destroys
the market positions of firms that are wedded to existing products and
older ways of doing business. Ex: The advent of personal computers and
word processing software demolished the market for electric typewriters.
30. Explain the “Invisible hand.” (pg 68)
 Firms and resource suppliers, seeking to further their own self-interest and
operating within the framework of a highly competitive market system,
will simultaneously, as though guided by an invisible hand, promote the
public or social interest.
Unit Three
31. Define the term “Gross Domestic Product.” (pg 117)
 The total market value of all final goods and services produced in a given
year
32. Define the phrase “final goods and services.” (pg 117)
 Goods and services that are purchased for final use by the consumer, not
for resale or for further processing or manufacturing
33. Define the term “Intermediate Good.” (pg 117)
 Goods and services that are purchased for resale or for further processing
or manufacturing
34. List the items not counted in GDP. (pg118)
 Intermediate goods (non-production transactions)
i. Financial Transactions: Purely financial transactions
1. Public transfer payments – Social security payments,
welfare payments, and veterans’ payments that government
makes directly to households
2. Private transfer payments – (Allowances, cash gifts at
Christmas, not producing output so not included in GDP)
3. Stock market transactions – Buying and selling of stocks is
just swapping paper, does not create output, so not included
in GDP.
 Secondhand Sales – Secondhand sales contribute nothing to current
production so are excluded from GDP. If you sell an old car, the money
made is not new production, so it is not included in GDP
35. How is GDP calculated? (pg 122)
 GDP = Consumption expenditures by households + Investment
expenditures by businesses + Government purchases of goods and services
+ Expenditures by foreigners (GDP = C + Ig + G + Xn)
 Also, GDP = Wages + Rents + Interest + Profits + Statistical Adjustments
36. When are net exports positive to GDP and when are they negative? (pg 121)
 Net exports are positive to GDP when U.S. exports are greater than U.S.
imports
 Net exports are negative to GDP when U.S. imports are greater than U.S.
exports
37. When are net investments positive to GDP and when are they negative? (pg 120)
 Net investments = Gross investment – Depreciation
 N.I is positive when Gross investment is greater than depreciation
 N.I. is negative when Gross investment is less than depreciation
38. How do you calculate GDP down to Disposable income? (pg 124-125)
 GDP – Consumption of fixed capital = Net domestic product
 Net domestic product – Net foreign factor income earned – Indirect
business taxes = National income
 National income – Social security contributions – Corporate income taxes
– Undistributed corporate profits – Transfer payments = Personal income
 Personal Income – Personal taxes = Disposable Income
39. Define the term “Value Added.” (pg 118)

Value added is the market value of a firm’s output less the value of the
inputs the firm has bought from others.
 Essentially, it is the worth that a firm adds to a product in each stage of
manufacturing.
40. What is the difference between “Real” and “nominal” GDP? (pg 127)
 Nominal GDP – GDP based on the prices that prevailed when the output
was produced is called unadjusted GDP, or nominal GDP
 Real GDP – GDP that has been deflated or inflated to reflect changes in
the price level is called adjusted GDP, or real GDP
41. How do you calculate nominal GDP? (pg 128)
 Price index in hundredths = (Nominal GDP) / (Real GDP)
42. How do you calculate real GDP? (pg 128)
 Real GDP = (Nominal GDP/ price index in hundredths) X 100
43. What is the rule of 70? (pg 137)
 The number of years it will take for some measure to double, given its
annual percentage increase, by dividing that percentage increase into the
number 70
 Approximate number of years required to double real GDP = ( 70 / annual
percentage rate of growth)
44. Explain the differences between seasonal, frictional, structural, and cyclical
unemployment (pg141-142)
 Seasonal unemployment – Workers unemployed due to low demand in
certain fields during certain seasons (Corn farmers can only grow corn in
certain seasons and Santa’s can only work during winter)
 Frictional unemployment – Unemployed workers who are either searching
for jobs or waiting to take jobs in the near future. Not considered bad.
Many of these workers seeking better jobs meaning greater income for
workers, better allocation of labor resources, and larger real GDP. These
workers have salable skills and either live in areas where jobs exist or are
able to move to areas where they do. Frictional unemployment is usually
short term.
 Structural unemployment – Unemployed workers whose skills become
obsolete due to changes in technology and consumer demand. These
workers find it hard to obtain new jobs without retraining, gaining
additional education, or relocating. This is long term.
 Cyclical unemployment (deficient-demand unemployment) – Caused by a
decline in total spending (common in recessionary phase). As demand for
goods and services falls, employment falls and unemployment rises.
45. Define “Okun’s Law.” (pg 143)
 For every 1 percentage point by which the actual unemployment rate
exceeds the natural rate, a GDP gap of about 2 percent occurs.
46. How do you calculate the rate of inflation between two years? (pg 146)
 The rate of inflation for any given year is found by subtracting the
preceding year’s price index from that year’s index, dividing by the
preceding year’s index, and multiplying by 100 to express the result as a
percentage.

Rate of inflation = ( Price index of year – Price index of preceding year) /
(Price index of preceding year) X 100
47. Explain the difference between “demand-pull” and “cost-push” inflation. (pg 147)
 Demand-pull inflation – Inflation caused by an excess of total spending
beyond the economy’s capacity to produce. “Too much spending chasing
too few goods.”’
 Cost-push inflation – Rising per-unit production costs squeeze profits and
reduce the amount of output firms are willing to supply at existing price
level so economy’s supply decreases and price levels increase. Often
caused by supply shocks\
 So demand-pull inflation is caused by an increase in demand while costpush inflation is caused by a decrease in supply
48. How do you calculate the “GDP Gap?” (pg 143)
 GDP Gap – Amount by which actual GDP falls short of potential GDP.
 GDP Gap – Potential GDP – Actual GDP
Unit Four:
49. How do you calculate APC and APS? (pg 163)
 APC = (Consumption) / (Income)
 APC – (Average Propensity to Consume) - Fraction or percentage of total
income that is consumed
 APS – (Average Propensity to Save) – Fraction of total income that is
saved
 APS = (Saving) / (Income)
 APC + APS = 1
50. How do you calculate MPC and MPS? (pg 163-164)
 MPC = (Change in consumption) / (Change in income)
 MPC – Fraction of any change in income consumed
 MPS = (Change in saving) / (Change in income)
 MPS – Fraction of any change in income saved
 MPC + MPS = 1
51. Define the term “dissavings.” (back of the book)
 Spending for consumer goods and services in excess of disposable
income; the amount by which personal consumption expenditures exceed
disposable income.
52. What causes the consumption curve to shift upward? (pg 164-165)
 Non-income Determinants of Consumption and Saving
i. Wealth – The greater the wealth households have accumulated, the
larger is their collective consumption at any level of current
income. So increased wealth will move the curve up.
ii. Expectations – Household expectations about future prices and
income may affect current spending and saving. If prices are
expected to rise, people will buy right now before they rise. So
expectations of rising prices will cause the current consumption
curve to rise.
iii. Taxation – A government tax decrease will move both the
consumption and savings curves upward.
iv. Household Debt – When consumers as a group increase their
household debt, they can increase current consumption. However,
when debt gets abnormally high, households may decide to reduce
their consumption to pay off some of their loans.
53. What causes a movement along the consumption curve? (pg 160)
 A movement along the consumption curve is caused by an
increase/decrease of disposable income
54. Where is the brake even point (APC=1) on this graph?
 Point A
 Break-even income – Income level at which households plan to consume
their entire incomes
55. What causes a shift of the investment demand curve? (pg 168-169(
 Non-interest-rate determinants
i. Acquisition, Maintenance, and Operating Costs – When costs fall,
the expected rate of return from prospective investment projects
rise, shifting the investment demand curve to the right.
ii. Business Taxes – Firms look to expected returns after taxes in
making their investment decisions, so when business taxes are
reduced, investment curve shifts to the right
iii. Technological Change – Increased technological progress (new
products, improvement in existing products, and the creation of
new machinery and production processes) stimulates investment
shifting the investment curve right
iv. Stock of Capital Goods on Hand – The stock of capital goods on
hand, relative to output and sales, influences investment decisions
by firms. When firms are overstocked with capital goods, they will
not invest in new capital, while when firms are selling their output
quickly and need increased production, rate of return on new
investments increases and the investment curve shifts rightward
v. Expectations – If firms become more optimistic about future sales,
costs, and profits, the investment demand curve will shift to the
right
56. What causes a movement along the investment demand curve? (pg 169)
 Real Interest Rate
57. Explain the difference between “nominal” and “real” interest rates. (pg 167)
 Real Interest Rates – Nominal rate less the rate of inflation
 Real Interest Rates is stated in dollars of constant or inflation-adjusted
value
 Nominal Interest Rates is expressed in dollars of current value
58. Define “Say’s Law.” (Back of the book)
 The largely discredited macroeconomic generalization that the production
of goods and services (supply) creates an equal demand for those goods
and services.
 Say’s law says supply creates its own demand
59. How do you calculate the expenditure multiplier? (pg 183 / pg 185)
 Multiplier = (Change in real GDP) / (Initial change in spending)
 Multiplier = 1 / MPS = (1) / (1-MPC)
60. Explain how the expenditure multiplier affects GDP. (pg 185)
 Multiplier Effect – A change in a component of aggregate expenditures
leads to a larger change in equilibrium GDP.
 A small change in the investment plans of businesses or in the
consumption and saving plans of households can trigger a larger change in
the equilibrium GDP
 Magnifies the fluctuations in business activity initiated by changes in
spending.
61. How do you calculate GDP in an open economy? (pg 187) (pg 190)
 If the economy is open, the GDP is calculated C + Ig + Xn, or C + Ig + G +
Xn if including public sector, but calculating GDP for an OPEN economy
MUST have C + Ig + Xn.
Unit Five:
62. What does the aggregate demand curve show? (pg 303)
 Aggregate demand curve shows the amounts of real output that buyers
collectively desire to purchase at each possible price level.
63. Define CIG-X and explain how it affects aggregate demand. (pg 207-208)
 CIG-X are the determinants of aggregate demand, meaning when anything
in CIG-X changes, the AD curve changes
 CIG-X
i. Consumer Spending
ii. Investment Spending
iii. Government Spending
iv. Net Export Spending
64. Explain the similarities between aggregate expenditure and aggregate demand.
(pg 208)
 The determinants are the same for both.
 When one shifts, the other shifts
65. Define RAP and explain how it affects aggregate supply. (pg 211-212)
 R - Resource Prices – Decreases in resource prices increases supply
sending
 A - Actions of Government – Fewer taxes and government regulations as
well as more government subsidies tend to decrease per unit production
cost resulting in increased supply and a rightward shift of the supply curve
 P - Productivity Changes – Increased productivity reduces the per-unit
production cost of goods and services resulting in increased supply and a
right-ward shift of the supply curve
66. How do you calculate per-unit production cost? (pg 213)
 Per-unit production cost = (total input cost) / (total output)
67. How does the appreciation of the dollar affect aggregate demand? (pg204)
 Dollar appreciation allows Americans to import more goods, and because
the dollar becomes more expensive elsewhere, foreigners will buy less
American exports, so net exports will go down and as a result, aggregate
demand will down.
68. Define the term “efficiency wage.”
 Wages that elicit maximum work effort and thus minimize labor cost per
unit of output.
69. Define expansionary fiscal policy, and explain how it works. (back of the book)
 An increase in government purchases of goods and services, a decrease in
net taxes, or some combination of the two for the purpose of increasing
aggregate demand and expanding real output.
70. Define contractionary fiscal policy, and explain how it works. (back of the book)
 A decrease in government purchases for goods and services, an increase in
net taxes, or some combination of the two, for the purpose of decreasing
aggregate demand and thus controlling inflation
71. Explain the “crowding-out effect.” (pg 234)
 An expansionary fiscal policy (deficit spending) is designed to increase
spending, but a side effect (crowding out) of the policy is that when the
government borrows funds in the money market to pay for the policy, the
interest rates will go up reducing private spending, thus weakening or
canceling the intended increase in spending of the original expansionary
policy.
72. Due to automatic stabilizers, when income rises, government transfer spending:
(pg 229-230)
 When income rises, governments collect more money as tax revenues.
This is consistent with the contractionary (surplus) policy that the
government might also be enacting, and is appropriate to control inflation
that might arise when incomes rise.
73. What does our progressive tax system offer the economy? (pg 230)
 In a progressive tax system, the average tax rate (= tax revenue/GDP) rises
with GDP.
 Our progressive tax system offers us great built-in stability
 The more progressive a tax system, the greater the stability
74. Define the term “full-employment deficit.” (pg 231)
 Full-employment deficit – Actual government expenditures minus tax
revenues that would have occurred if full-employment GDP would have
prevailed
Unit Six:
75. What is meant when money is used as the following; medium of exchange, store
of value, and unit of accounts? (pg 244-245)
 These are the three functions of money
 Medium of exchange – Usable to buy and sell goods and services. Allows
society to escape the complications of barter, and allows society to gain
the advantages of geographic and human specialization.
 Store of value – Money enables people to transfer purchasing power from
the present to the future.
 Unit of accounts – Money allows for an acceptable and agreeable
measurement of a good’s worth.
76. What is the largest component of (M1) money? (pg 245)
 Checkable Deposits (Money placed in checking account)
77. What backs (supports) U.S. currency? (pg 248)
 The government’s ability to keep the value of money relatively stable is all
that backs U.S. currency, nothing more.
78. What is the relationship between price levels and value of currency? (pg 249)
 The amount a dollar will buy varies inversely with the price level; When
the consumer price index or “cost-of-living” index goes up, the value of
the dollar goes down, and vice versa.
79. How do you calculate the change in the value of money? (pg 249)
 Dollar value = (1) / (Price Level as an index number)
80. Who issues currency in the U.S.? (pg 257)
 The Federal Reserve Bank issues currency
81. How do you calculate the transactional demand for money? (pg 251)
 Transactional Demand = (Nominal GDP) / (Velocity of money)
 Transactional Demand – Demand for money for the purposes of
purchasing everyday goods and services
 Velocity of money – Average # of times money is spent per year
82. What will happen if the demand for money increases but the supply of money
remains constant? (pg 253)
 Rate of interest will increase as is shown on the money market graph
83. How do you calculate the new price for secondary bonds? (pg 253)
 Value of bond = (Rate of Return of old bond) / (New Interest Rate)
84. If given the rate of return and new price of a secondary bond, how do you
calculate the current interest rates for new bonds?
 New Interest Rate = (Rate of Return of Old Bond) / (New Value of Bond)
85. What are the three structures of the Fed? (pg 255-256)
 Central Bank – Serves as the U.S.’s central bank working to implement
the basic policy of the Board of Governors

Quasi-Public Banks – Each private bank is required to purchase shares of
stock in the Fed, so the banks are privately owned, although they are under
the control of the Board of Governors. Public bank owners who have
invested in the Fed actually have no control. Fed banks in reality public.
 Bankers’ Bank – The Fed banks perform essentially the same functions for
banks and thrifts as those institutions perform for the public.
86. What are the functions of the Fed? (pg 257)
 Issuing currency – Fed issues paper currency
 Setting reserve requirements and holding reserves – Fed sets reserve
requirements, which are the fractions of checking account balances that
banks must maintain as currency reserves. Also accept as deposits from
the banks and thrifts any portion of their mandated reserves not held as
vault cash.
 Lending money to banks and thrifts – Occasionally, Fed lends money to
banks and thrifts and charges them an interest rate called the discount rate.
 Providing for check collection – Fed handles check collecting by adjusting
the reserves of the two involved banks of a check (bank of writer and bank
of receiver) to reflect new balance.
 Acting as fiscal agent – Fed provides financial services to the Federal
government
 Supervising banks – Fed supervises operation of banks making
examinations, checking up on Bank cooperation with regulations, and
uncovering questionable practices of fraud.
 Controlling the money supply – Fed regulates the money supply to
influence interest rates according to the economies needs
87. What is the money multiplier and how is it calculated?
 The money multiplier is the is the amount times an initial increase in
money supply that the total money supply can be increased
 Money multiplier = (1) / (Reserve Ratio)
 Reserve Ration is the percentage of checking account $ that banks are
required to keep in the vault in cash.
 So if the feds add $100 million to the money supply, and the reserve ration
is 10%, then the banks can loan out 10 (1 / .1) X $100 million = $1 billion.
88. How do you calculate actual bank reserves?
 Bank reserves = (Checking Deposits) X (Reserve Ratio) + Excess
Reserves
89. List the tools of monetary policy and explain how they operate. (pg 284-289)
 Open-Market Operations – This is the buying and selling of bonds in order
to increase the money supply. When the Fed buys bonds, it puts money
into banks (or public) that can then be loaned out increasing money
supply. Selling securities will have the opposite effect
 Reserve Ration – The Fed can increase or decrease the reserve ratio to
change the amount of required reserves a bank must have. If the Fed
lowers the reserve ration, banks will have excess reserves to lend out
because the required reserve ratio has gone down, and the money
multiplier will increase also because the reserve ratio has decreased.
 Discount Rate – The Fed can increase or decrease the discount rate that it
charges banks for a temporary loan. If the Fed lowers the discount rate,
banks will be more likely to borrow from the Fed resulting in an increased
money supply
 All of these policies can either be used to increase aggregate demand,
output, and employment (easy money policy), or decrease it (tight money
policy)
90. What is the Fed Fund Rate? (pg 296)
 Federal funds rate is the interest rate that banks charge one another on
overnight loans of reserves
 The Fed fund rate is how the Federal Reserve Bank signals to the world
the type of monetary policy it is trying to enforce (easy or tight)
Unit Seven:
91. Explain the difference between short-run and long-run aggregate supply. (pg 307)
 The short run is a period in which nominal wages (and other input prices)
remain fixed as the price level increases or decreases.
 After a while, employees realize the price level has changed and contracts
expire, thus, eventually employees will renegotiate contracts based on the
new and prevailing price level. At this point, it becomes the long run
 Long run – Period in which nominal wages are fully responsive to
previous changes in the price level.
92. Explain the short-run changes brought on by demand-pull inflation. (pg 309)
 In the short run, demand-pull inflation occurs when an increase in
aggregate demand pulls up price level and increase output.
93. Explain the long-run changes brought on by demand-pull inflation. (pg 309)
 In the long run, the increase in price level will eventually lead to an
increase in nominal wages and thus a leftward shift of the short-run
aggregate supply curve resulting in even higher price level at the original
output level.
94. What does the Philips Curve illustrate? (pg 312)
 The Philips curve illustrates the short-run tradeoff between the rate of
inflation and the rate of unemployment
95. What is stagflation? (pg 313)
 Stagflation is when inflation and unemployment rise simultaneously,
contrary to the Philips curve.
96. What does a supply-side shock do to the Philips Curve? (pg 313)
 A supply side shock increases unemployment rate while inflation goes up,
proving that the Philips curve is not stable.
97. List the three assumptions concerning the Philips Curve. (pg 312)
 Under normal circumstances, there is a short-run tradeoff between the rate
of inflation and the rate of unemployment.

Aggregate supply shocks can cause both higher rates of inflation and
higher rates of unemployment.
 There is no significant tradeoff between inflation and unemployment over
long periods of time.
98. What is disinflation? (pg 316)
 Reductions in the inflation rate from year to year
99. Explain the similarities between the SRAS and the SRPC.
 The SRAS is basically a mirror image of the SRPC. When demand pulls
equilibrium up the SRAS, it also pulls equilibrium up the SRPC. When the
SRAS moves inward due to supply shock, the SRPC moves rightward.
100.
Where is the LRPC located? (pg 316)
 Long Run Philips Curve is located at the natural rate of unemployment
101.
Explain the argument of Supply-side economics. (pg 317)
 Supply-side economists focus attention on government policies such as
high taxation that impede the expansion of aggregate supply. They say that
by decreasing taxes, the incentive to work, save, and invest increase in
higher productivity. This expands aggregate supply, which in turn keeps
unemployment rates and inflation low.
102.
List the criticisms of Supply-side economics. (pg 318)
 Taxes, Incentives, and Time - The impact of a tax cut on incentives is
small, of uncertain direction, and relatively slow to emerge. For example,
some people who get more money due to a decreased tax rate will simply
work less and enjoy the leisure time.
 Inflation- Tax cuts undertake when the economy is at or near its fullemployment level of output may produce increase in aggregate demand
that overwhelm any increase in aggregate supply, likely resulting in
demand-pull inflation
 Position of the Curve – The position on the Laffer curve is ambiguous, so
it is impossible to tell whether an increase in tax rates will increase tax
revenues or decrease them.
103.
Define the term “Federal Debt.” (pg 340)
 Total accumulation of the deficits (minus the surpluses) the Federal
government has incurred throughout time.
104.
How do you calculate debt to GDP ration? (pg 344)
 Debt to GDP ration = (Debt of year) / (GDP of year)
105.
Explain the philosophy and criticism of an annual balanced budget.
 Holds that the goal of public finance is to have the budged balanced each
year
 It is bad because this will merely intensify the business cycle instead of
dampen it.
 If we were in a recession, the decrease in tax revenues would result in a
deficit, and if we had to balance annually, this would mean that we would
have to cut spending or increase taxes DURING the recession, which is
counter-cyclical.
106.
Explain he philosophy and criticism of a cyclical balanced budget.


107.



Want the budget balanced every business cycle so that the surplus of the
inflationary period of the business cycle can counter the recessionary
period of the business cycle.
The only problem is that sometimes the trough is bigger than the crest, or
the recessionary deficit is bigger than the inflationary surplus.
Explain the philosophy of functional finance.
Functional finance contends that the primary purpose of Federal finance is
to provide for non-inflationary full employment to balance the economy
rather than the budget.
So we shouldn’t worry about the debt as much as having a noninflationary full employment economy. The problem of deficits or
surpluses are minor compared with prolonged recession or persistent
inflation
Governments should not hesitate to incur deficits and surpluses to achieve
macroeconomic stability and growth
Unit Eight:
108.
What is the effect if the equilibrium exchange rate changes so that fewer
dollars are needed to buy a South Korean won?
 Dollar appreciates
109.
Depreciation of the dollar will lead to what?
 Increased foreign investment, increased in exports and decrease in imports
110.
U.S. export transactions create what? (pg 753)
 U.S. exports create a foreign demand for dollars, and the fulfillment of
that demand increases the supply of foreign currencies owned by U.S.
banks and available to U.S. buyers