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:
 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
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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
3
Price in Base
Year
Price in
Current Year
$15
$20
Foot-Long
Subs
5
$5
$6
Guns
1
$30
$40
Shoes
 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?
 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 fullemployment (overheating)
 Recessionary Gap-Equilibrium occurs BEFORE
full-employment (recession)
Supply Shocks
 Positive 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
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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
Lower
Raise
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 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