1. AP MACRO MID-TERM REVIEW
MODULES 1-23
Mr. Lipman

2. UNIT 1: THE BASICS
Economics- The study of scarcity and choice.
Macroeconomics- A focus on the overall ups and downs in the economy

3. 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

4. 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.

5. Key Economic Assumptions
Wants are unlimited, resources are limited (scarcity).
Due to scarcity, choices must be made. Every choice has a cost (a trade-off).
Everyone acts rationally by comparing the marginal costs and marginal benefits of every choice
Ceteris paribus: “other things being equal”

6. 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.

7. The Various Business Cycles
Depression
Recession
Expansion or growth (which leads to inflation)
Graph demonstrates changes happening over time as cycles change 7

8. 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) 8

9. 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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10. 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”

11. 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

12. 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 12

13. 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

14. Demand Will Shift because of:
1. Market Size
2. Expectations
3. Related Prices (compliments/substitutes)
4. Income (normal & inferior)
5. Tastes

15. 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)

16. Unit 3 Measuring Economic Performance
GROSS DOMESTIC PRODUCTION (GDP)
UNEMPLOYMENT
INFLATION

17. 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

18. What is NOT included in GDP?
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

19. Circular Flow Diagram: Inflow of money into each market or sector must equal the outflow of money coming from that market or sector 19

20. How can you measure growth from year to year?
% Change
in GDP =
Year 2 - Year 1
Year 1
X 100 20

21. GDP = C + I + G + Xn (exports-imports)
Expenditures Approach-Add up all the spending on final goods and services produced in a given year.
GDP = C + I + G + Xn (exports-imports)
C IS CONSUMER SPENDING
I IS INVESTMENT SPENDING
G IS GOVERNMENT PURCHASES OF GOODS AND SERVICES
Xn IS EXPORTS - IMPORTS 21

22. $5M Increase in defense expenditures $45 for used economics textbook
For each situation, identify if it is included in GDP the identify the category C, I, G, or Xn AND WHAT IS TOTAL GDP
$10.00 for movie tickets
$5M Increase in defense expenditures
$45 for used economics textbook
Ford makes new $2M factory
$20K Toyota made in Mexico
$10K Profit from selling stocks
$15K car made in US, sold in Canada
$10K Tuition to attend college
$120 Social Security payment to Bob
Farmer purchases new $100K tractor 22

23. Included or not Included in GDP?
$10.00 for movie tickets
$5M Increase in defense expenditures
X $45 for used economics textbook
Ford makes new $2M factory
X $20K Toyota made in Mexico
X $10K Profit from selling stocks
$15K car made in US, sold in Canada
$10K Tuition to attend college
X $120 Social Security payment to Bob
Farmer purchases new $100K tractor 23

24. 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! 24

25. #1. Frictional Unemployment
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 25

26. #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 26

27. #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 27

28. 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. 28 28

29. Three Causes of Inflation
1. Printing too much Money
2.Demand-Pull Inflation
3. Cost-Push Inflation

30. 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.

31. Key Inflation Terms Shoe-leather costs Menu 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

32. Cost-of-Living-Adjustment (COLA)
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

33. 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 =
Price of market
basket in base year
x 100
CPI
Price of market basket

34. Problems with using CPI as a Measurement
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)
New Products- The CPI market basket may not include the newest consumer products. (Result: CPI measures prices but not the increase in choices)
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)

35. 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. =
Real GDP
x 100
GDP
Deflator
Nominal GDP

36. Calculating GDP Deflator=
Real GDP
x 100
GDP
Deflator
Nominal GDP =
100
Nominal
GDP
(Deflator) x (Real GDP)

37. = x 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

38. 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 38

39. 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

40. Because people can either save or consume
MPS = 1 - MPC
Why is this true?
Because people can either save or consume 40

41. 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).

42. Aggregate Demand Curve
AD is the demand by consumers, businesses, government, and foreign countries
Price
Level
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

43. Shifters of Aggregate Demand An increase in Aggregate Demand means a shift of the curve to the right and may include the following factors: Changes in expectations 2. Changes in wealth Size of firm capacity Government Policies
GDP = C + I + G + Xn 43

44. 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

45. Shifters of Aggregate Demand Shifters of Aggregate Supply
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 Resource Prices
Change in Actions of the Government
Change in Productivity (Investment) 45

46. Assume the government increases spending. What happens to PL and Output?
LRAS
Price Level AS
PL and Q will Increase
PL1
PLe
AD1 AD QY Q1
GDPR 46

47. How the Government Stabilizes the Economy
The Government has two different tool boxes it can use:
1. Fiscal Policy-
Actions by Congress & the President OR
2. Monetary Policy-Actions by the Federal Reserve Bank (aka Central Bank actions) 47

48. 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

49. 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

50. KEY TERMS TO KNOW: unit 5 Budget Surplus
Budget Deficit and Budget Debt
Budget Balance
National Savings v. Private Savings
Capital inflow
OK, what if the economy isn’t so simple.
Add the government (public sector) to the private sector.
The government spends on goods and services (G) and pays transfers to some. The government collects tax revenue to pay for these things.
If the government budget is balanced:
Tax revenue = government spending + transfer payments
Rearrange this equation and call it Budget Balance (BB)
Budget Balance = Tax Revenue – G – transfers
If BB >0, the government has a budget surplus and is actually saving money.
If BB<0, the government has a budget deficit and is borrowing money (dissaving).
We can now include public sector savings to the savings-investment identity.
S + BB: simply total national savings.
S + BB = I
If BB>0 on the left side (a surplus), I must increase on the right side.
If BB<0 on the left side (a deficit), I must decrease on the right side.
Final level of complexity.
Add the foreign sector.
An American can save her money in the US or in another nation.
A foreign citizen can save his money in his home country, or in the US.
So the US receives inflows of funds—foreign savings that finance investment spending in the US.
The US also generates outflows of funds—domestic savings that finance investment spending in another country.
Let’s define:
Capital inflow into the US =total inflow of foreign funds - total outflow of domestic funds to other countries.
Capital inflow (CI) can be positive or negative so it can increase or decrease the total funds available for investment in the US economy.
S + BB + CI = I
If CI > 0 on the left side (more foreign funds coming into the US, than US funds going out), I must increase on the right side.
If CI < 0 on the left side (fewer foreign funds coming into the US, than US funds going out), I must decrease on the right side. 50

51. Examples: Gold, silver, cigarettes, etc.
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

52. 3 Functions of Money 1. A Medium of Exchange 2. A Unit of Account
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

53. 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

54. 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

55. These tools are used to increase or decrease the money supply.
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. 55