AP Macroeconomics

1. AP Macroeconomics FINAL REVIEW

2. Unit One: Intro to Economics

3. A. What is Economics? Study of decisions. Why do we make decisions? Scarcity Each decision comes with an… Opportunity Cost-next best option Choices are also called TRADEOFFS Two types: Micro-individual and business decisions Macro-government and economy-wide decisions

4. PPC or PPF: A picture of choices

5. Economic Growth

6. Absolute Advantage • A country has an absolute advantage in the production of a good when it can produce it using few resources than another country or individual • TIP: Always plug data given into a Production Possibilities Table!

7. Absolute Advantage, Cont. • A country has an absolute advantage in the production of a good when it can produce it using few resources than another country or individual • TIP: Always plug data given into a Production Possibilities Table! • In this example, the US has the Absolute Advantage in both cell phones and apples

8. Comparative Advantage • A country has a comparative advantage in production of a certain product when it can produce that product at a lower relative opportunity cost than another country

9. Comparative Advantage, Cont. • To grow 39 million apples, the US must give up 13 million cell phones. Therefore each apple costs the US 13/39 = .33 cell phones • To grow 24 million apples in Korea, 12 million cell phones must be given up. Each apple costs Korea 12/24= .5 cell phones • The US has a comparative advantage in apples because it costs the US fewer cell phones to make an apple than it costs Korea

10. B. How does an economy function? Three types: Command Traditional Market-capitalism, free-enterprise, etc. For this class we use a market. Market-where resources follow prices (profits), which are determined by supply and demand. Adam Smith, incentives, equilibrium, Wealth of Nations, invisible hand, self-interest.

11. Simple Supply and Demand: All individual products D: Taste Buyers Income Related Goods S: Cost of Inputs (Production costs) Number of sellers Related Goods

12. Shortages If prices are BELOW equilibrium: There will be a shortage as more quantity is demanded than is supplied. Prices will RISE until they reach equilibrium. If the price is SET below equilibrium it is a PRICE CEILING.

13. Surpluses If prices are ABOVE equilibrium: There will be a surplus as more quantity is supplied than is demanded. Prices will FALL until they reach equilibrium. If the price is SET above equilibrium it is a PRICE FLOOR.

14. Applied Supply and Demand: The Foreign Exchange Market Determinants (the five I’s): Interest Rates Inflation Inflows Income Interest (Taste)

15. FX MARKET TO PURCHASE FOREIGN GOODS YOU NEED THAT COUNTRIES CURRENCY. To buy goods from Europe, we need EUROS. To import, we go to the FX Market (increasing demand for Euros) and trade in dollars (increasing the supply of dollars) and get Euros (decreasing the supply of Euros).

16. Inflation Higher price levels encourage more imports due to their relatively lower price (Demand for other currency goes up). Lower price levels encourage more exports due to their relatively lower price on the foreign market (Demand for our currency goes up).

17. Interest Rates Higher interest rates encourage more inflows of funds as foreign investors try to save their money in America (Demand for our currency increases). Lower interest rates encourage more outflows of funds as foreign investors try to save their money in other countries (Demand for other currency increases).

18. Interest (Taste) Increased taste for American products encourages greater exports (Demand for dollar increases). Increased taste for European products encourages greater imports (Demand for other currency increases).

19. Inflows Investor worries about America would cause them to move their money to other countries, increasing outflows. (Demand for other currency would go up). Investor worries in other countries would cause them to move their money to America, increasing inflows (Demand for dollars increases).

20. Income Recession in America causes American incomes to decrease, causing imports to decrease (Demand for other currencies decreases). Expansion in America causes incomes to rise, thus Americans import more (Demand for other currency increases).

21. Unit Two: The Macroeconomy

22. I. Players in the Macro Economy A. Buyers-AD B. Sellers-short-term=SRAS; long-term=LRAS C. Cost of goods-Price level D. Goods and Services produced-Real GDP E. Employed Workers-Unemployment/Employment F. How workers spend income-MPC/MPS G. Consumption=C H. Business Purchases=Ig I. Government Purchases=G J. Net Exports=Exports-Imports

23. A. AD-Aggregate Demand Aggregate Demand-all buyers in an economy who are willing and able to purchase a good or service AD=C+Ig+G+NX (all four represent the four potential buyers=consumers, businesses, government and foreigners)

24. 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.

25. B. SRAS/LRAS AS-willingness of producers to sell goods and services at specific price levels. SRAS represents short-term changes to the cost of production. Input price changes-ex, oil costs rising Productivity gains ASSUME A QUESTION IS SHORT RUN LRAS represents LONG-TERM changes. Four Factors of production/PPC changes: Land Labor Capital Entrepreneurship Technology

26. C. Price Level Price level-average of all prices in a countries economy. CPI (Consumer Price Index)-best measure of PL, picks several items to be a representative market basket of goods. 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. Increase in price level=Inflation Decrease in price level (but still positive)=Disinflation Negative Inflation = Deflation

27. Two ways to solve: Market basket CPI way=EASY and COMMON SENSE (New-old)/old=rate of inflation

28. Inflation 2 Calculate rate of inflation:

29. Basket Answers Inflation Rate=30% from base year to current GDP Deflator=100 in base and 130 in current

30. 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

31. D. GDP 1 Nominal GDP has not been adjusted for inflation Real GDP is output that HAS been adjusted for inflation (this is what you use on AD/AS graph) GDP-Gross (Total) Domestic (In America) Product (Stuff Produced). GDP is the total amount of stuff produced in America in a given year.

32. 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

33. E. Unemployment 1 Four Types Frictional-I’m between jobs Structural-My skills don’t match the existing jobs Cyclical-Caused by a recession, this is all unemployment below full-employment. Expansionary policy targets this. Seasonal-Freebie.

34. 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.

35. F. MPC/MPS National Income=MPC+MPS You can spend or you can save. I give you $500 and you spend $400, your MPC is .80. MPS=.2 Marginal Propensity to Consume or Save

36. G. Consumption How much consumers are spending TAX CUTS TARGET THIS The amount consumers spend is dependent on the MPC/MPS. Consumers save some portion of all increases in income.

37. H. Gross Investment Ig is HIGHLY sensitive to Interest Rates. As IR goes up, Ig goes DOWN Inverse Relationship AS IR goes down, Ig goes UP Best way to target this is by altering interest rates.

38. I. Government Spending NO PORTION OF G IS LOST THROUGH SAVING. 100% of an increase in GS goes into the economy.

39. J. Net Exports=Exports-Imports Appreciation=Net Exports go towards DEFICIT as we import more. Depreciation=Net exports move towards SURPLUS as we export more (our goods are cheaper). NE Increase=AD Increase NE Decrease=AD Decrease

40. II. Big Picture Cause effects to know: AD INCREASE -> Real GDP INCREASE -> Income INCREASE -> Unemployment DECREASE THE GRAPHS: AD/AS Phillips Curve

41. AD/AS Graph

42. Phillips Curve (The MISERY Index)

43. Unit Three: Congress We Have a Problem (The TWIN terrors and Fiscal Policy)

44. Economies face TWO problems: Recession and Inflation Recession-decreases in Output Caused by decreases in AD or AS Its like the economy doesn’t have enough coffee (energy) Real problems: Unemployment, decreased income, vicious cycle. All policies to fight recessions are EXPANSIONARY (by increasing AD)

45. Inflation Inflation Economy is experiencing increases in the price level. Its like the economy has had too MUCH caffeine. Short-run equilibrium is above full-employment. Increasing AD ONLY increases PL (vertical portion/classical range) Causes uncertainty in the market and various problems. All policies to fight inflation: contractionary.

46. Other Problems: Supply Shocks Positive Supply Shocks (this is good) Increase AS Negative Supply Shocks Contractionary Decreases AS Causes Stagflation Ask me what we should do if we have stagflation?

47. THIS IS THE GOAL OF ALL ECONOMIC POLICIES

48. Where do these come from?Classical Economists and Keynesian Classical Given flexible prices and wage, a classical economist would deal with a recession by doing nothing. They believe a recession would cause wages to drop ( as employers cut costs) and thus increasing AS back to full-employment. THIS IS A NO ACTION QUESTION, YOU HAVE TO BE ABLE TO DO THIS.

49. 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).

50. What can the federal government do to solve this? First off, you’re voting for these people so you BETTER care about the decisions that they make and the effectiveness of those decisions. Federal government can do TWO things: Monetary and/or Fiscal Policy. Fiscal Policy=Congress Monetary Policy=Fed or Central Bank