2 Actual Test Day: You need: You can not have: Pencils Pen (blue or black only)Personal IDYou can not have:PhonesCalculators
3 Part 1: The ContentWhat is in the AP Curriculum?
4 Basic Economic Concepts . (8–12%) A. Scarcity, choice, and opportunity costsB. Production possibilities curveC. Comparative advantage, specialization, and exchangeD. Demand, supply, and market equilibriumE. Macroeconomic issues: business cycle, unemployment, inflation, growth
5 A. Scarcity, choice, and opportunity costs All resources that are both desirable and in limited supply are considered scarceResources can be placed into four categoriesLandLaborCapital (Physical AND Human)EntrepreneurshipChoiceBecause of scarcity, we have to make choicesWhen ever a choice is made, alternatives are forgoneOpportunity costMost desirable alternative forgone when a choice is made
6 B. Production possibilities curve Shows various ways an economy can allocate scarce resources between the production of two thingsEach axis represents a good or service that could be producedThe line/curve itself represents different combinations that utilize all available resources.Called the “Frontier”Economic growth is shown by an outward shift of the frontier. Can be caused by:More resourcesBetter technology
7 C. Comparative advantage, specialization, and exchange Focusing on the good or service that can be made at the lowest opportunity costWhen calculating remember:Input problem? IOU (Input = Other goes Under)Output problem? OOO (Output = Other goes Over)SpecializationBasis for global tradeCountries focus on producing whatever good they can make the most efficiently and trade with other nationsExchangeAs long as both parties benefit, there is a net gain from trade.Trade between countries allows them to consume outside their production possibilities curves.
8 D. Demand, supply, and market equilibrium Represents consumersNegative SlopeDeterminants (things that shift it)Consumer TastesPrice of related goodsPopulationConsumer IncomeFuture PricesSupplyRepresents producersPositive slopeDeterminantsTechnologyInput costs# of suppliersFuture prices
9 E. Macroeconomic issues: business cycle, unemployment, inflation, growth Four Phases:Expansion/recovery – growing GDPPeakRecession/contraction – shrinking GDPTroughUnemploymentMeasured by the Unemployment Rate(# of unemployed)/(total labor force) = Unemployment rateThree types:Cyclical – caused by recession/economic downturnStructural – skills do not match available jobsFrictional – chose to leave job to find another/looking for first jobInflationMeasured by the Consumer Price Index (CPI)[(Price in current year)/($ in base year)] x 100 = CPIValues > 100 indicate inflation since base year
10 Measurement of Economic Performance (12–16%) A. National income accounts1.Circular flow2.Gross domestic product3.Components of gross domestic product4.Real versus nominal gross domestic productB. Inflation measurement and adjustment1.Price indices2.Nominal and real values3.Costs of inflationC. Unemployment1.Definition and measurement2.Types of unemployment3.Natural rate of unemployment
11 National Income Accounts: Circular Flow – Part 1 Simple Circular FlowShows interaction between producers (firms) and consumers (households)
12 National Income Accounts: Circular Flow – Part 2 Expanded Circular FlowMore realistic picture of money moving through an economyREMEMBER: Money going into each square MUST EQUAL money going out
13 National Income Accounts: Gross Domestic Product GDP is the total dollar value of all final goods in services produced in a country in a given yearFinal goods – goods in the final form they are soldProduced within a country – only domestically produced goods count toward GDPNot countedIntermediate goods – used to make final goodsUsed goods – already have been countedTransfers – money changing hands (stock, bonds, social security, etc…)Foreign Produced – count toward other nations GDPUnderground Economy – illegal goods and “under the table” payments
14 National Income Accounts: Components of GDP Expenditure Approach – measures total spendingC+I+G+NX = GDPC = consumer spending. Largest component.I = investment (business spending, inventories)G = government spendingNX = net exports (imports – exports)Income Approach – measures total incomeSum of all income sourcesWages for laborRents from landInterest from capitalProfits from entrepreneurshipRemember: Aggregate spending = Aggregate income
15 National Income Accounts: Real and Nominal GDP Nominal GDP – Value of current production using current pricesReal GDP – Value of current production, but using prices from a fixed point in timeAlso called “constant dollar GDP”Accounts for inflationMore accurate“Deflating” Nominal GDPReal GDP = 100 x (nominal GDP)/(Price Index)
16 Inflation measurement and adjustment: Price Indexes Main measure of inflation is the CPICalculated by the Bureau of Labor StatisticsEstablishes the rate of inflation by comparing prices of a “market basket” of goods to a base yearCalculating a price indexPrice Index = 100 x [Current year $/Base year $]
17 Inflation measurement and adjustment: Nominal and Real Values “Nominal” = Not adjusted for inflation“Real” = Adjusted for inflation
18 Nominal V Real GDPNominal GDP: GDP measured in terms of current Price Level at the time of measurement. (Unadjusted for inflation)Real GDP: GDP adjusted for inflation; GDP in a year divided by a GDP deflator (Price Index) for that year
19 Nominal V Real INCOMENOMINAL INCOME: number of dollars received by an individual or group for its resources during some period of timeREAL INCOME: amount of goods and services which can be purchased with nominal income during some period of time; nominal income adjusted for inflation
20 Nominal V Real INTEREST RATE NOMINAL I%: interest rate expressed in terms of annual amounts currently charged for interest; not adjusted for inflationREAL I%: interest rate expressed in dollars of constant value (adjusted for Inflation) and equal to the NOMINAL I% minus the EXPECTED RATE OF INFLATION
22 Nominal V Real WAGESNOMINAL WAGES: amount of money received by a worker per unit of time (hour, day, etc.);Money WageREAL WAGES: amount of goods and services a worker can purchase with their NOMINAL WAGE; purchasing power of the nominal wage.(Real = Nominal – Inflation rate)
23 NOMINAL/REAL TIPsIf nominal rates INCREASE and Price Level INCREASE, the CHANGE in Real is “indeterminable.”If nominal Wage rates do NOT change and Price Level fall. REAL WAGES increase.NOMINAL RATES “PIGGY-BACK” REAL RATES & NOT VICE VERSA.
24 Inflation measurement and adjustment: Costs of Inflation Unexpected Inflation Hurts:Businesses that have to change pricesmenu costsPeople of Fixed incomespension receivers & minimum wage earnersPeople saving money at fixed interestPeople loaning money at fixed interestUnexpected Inflation HelpsPeople borrowing money at fixed interest
25 Unemployment: Definition and Measurement Measurements:Labor Force – Sum of all individuals over 16 that are employed or unemployedRemember: Unemployed MUST BE searching for workNot searching for work = “discouraged worker”Unemployment Rate – Unemployed/Labor Force
26 Unemployment: Types of Unemployment Frictional – Someone new enters labor market OR chooses to switch jobsSeasonal – periodic/predictable job lossStructural – Jobs lost because skills are no longer in demandCyclical – Jobs lost as a result of an economic downturn
27 Unemployment: Natural Rate of Unemployment Full Employment:NO CYCLICAL UNEMPLOYEMENTTraditionally 5-6%Natural Rate of UnemploymentUnemployment rate associated with full employment
28 National Income and Price Determination (10–15%) A. Aggregate demand1.Determinants of aggregate demand2.Multiplier and crowding-out effectsB. Aggregate supply1.Short-run and long-run analyses2.Sticky versus flexible wages and prices3.Determinants of aggregate supplyC. Macroeconomic equilibrium1.Real output and price level2.Short and long run3.Actual versus full-employment output4. Business cycle and economic fluctuations
29 Aggregate demand: Determinants AD Always slopes downWealth effect – As prices rise purchasing power of wealth fallsAD Shifts when…There is a change in consumer spendingThere is a change in government spendingThere is a change in investment spendingThis includes changes in taxes and transfersThere is a change in net exports
30 Aggregate demand: Multipliers Consumption and SavingsMPC = △Consumption/ △Disposable IncomeMPS = △Savings/ △Disposable IncomeMPC + MPS = 1Spending Multiplier1/MPS or 1/(1-MPC)Tax MultiplierMPC/MPSALWAYS smaller then spending multiplierTaxes have a smaller impact than government spending!Commonly Used Multipliers…If MPC isThe Spending Multiplier is...9010.805.754.502
31 Aggregate supply: Short-run v Long-run Short Run ASInput costs and wages are “sticky” in the short run and do not change quicklyThis lag between changes in output price and input prices create a positive slopeLong Run ASAll inputs prices are flexible in the long run regardless of price level
32 Aggregate supply: Determinants of AS Short run shifts△ input prices△ taxes on producers△ regulationsLong Run Shifts△ Quantity and Quality of resources△ Technology△ Human capital (education and training of labor force)Policy initiativesGovernment programs designed to encourage investment
33 Macroeconomic equilibrium: Real output and price level Macroeconomic equilibrium occurs when real output demanded is equal to real output supplied
34 Macroeconomic equilibrium: short and long run Short Run EquilibriumLong Run Equilibrium OR “economy at full employment”
35 Macroeconomic equilibrium: Actual vs Full Employment Output
36 Macroeconomic equilibrium: Business Cycle and Fluctuations
37 IV. Financial Sector (15–20%) A. Money, banking, and financial markets1. Definition of financial assets: money, stocks, bonds2. Time value of money (present and future value)3. Measures of money supply4. Banks and creation of money5. Money demand6. Money market and the equilibrium nominal interest rateB. Loanable funds market1. Supply of and demand for loanable funds2. Equilibrium real interest rate3. Crowding outC. Central bank and control of the money supply1. Tools of central bank policy2. Quantity theory of money3. Real versus nominal interest rates
42 Loanable funds market1. Supply of and demand for loanable funds
43 Loanable funds market 2. Equilibrium real interest rate Found at the intersection of Slf and Dlf
44 Loanable funds market 3. Crowding out Government deficits increase the demand for loanable funds because the government bust borrow money to continue operationsThis drives up interest rates, and lowers business and personal investment in the economy.
45 Central bank and control of the money supply 1. Tools of central bank policyOpen Market OperationsBuying and selling bonds to influence the amount of money in circulation.Buy Bonds = Bigger Bucks - MS and AD increase, IR decreasesSell Bonds = Smaller Bucks - MS and AD decrease, IR increasesDiscount RateInterest rate a central bank charges member banks for loansHigher discount rate = Lower MS, AD decreases, IR increasesLower discount rate = Higher MS, AD increases, IR decreasesReserve RequirementThe amount of money banks are required to hold in reserves. Influenced the money multiplierLower RR = higher MS, AD increases, IR decreasesHigher RR = Lower MS, AD decreases, IR increases
46 Central bank and control of the money supply 2. Quantity theory of moneyVelocity of money is defined simply as the rate at which money changes hands.If velocity is high, money is changing hands quickly, and a relatively small money supply can fund a relatively large amount of purchases.if velocity is low, then money is changing hands slowly, and it takes a much larger money supply to fund the same number of purchases.The relationship between velocity, the money supply, the price level, and output is represented by the equation M * V = P * YM is the money supplyV is the velocityP is the price levelY is the quantity of output.
47 Stabilization Policies . (20–30%) A. Fiscal and monetary policies1.Demand-side effects2.Supply-side effects3.Policy mix4.Government deficits and debtB. The Phillips curve1.Short-run and long-run Phillips curves2. Demand-pull versus cost-push inflation3.Role of expectations
48 Crowding-Out EffectAn Expansionary Fiscal Policy as previously diagrammed will lead to higher interest rates.At higher interest rates, businesses will take out fewer loans and there will be a decrease in INVESTMENT (I)At the same time there will be a decrease in CONSUMER SPENDING (C) as they will take out fewer loans as well.This CROWDING OUT EFFECT will reduce the gain made by the expansionary fiscal policy.
49 Economic Philosophies Classical: Believes that the government SHOULD NOT interfere in the economy. And believes in self-correction of economic problems.Keynesian: Believes that GOVERNMENT SHOULD interfere in the economy (taxes, government spending). Most “mainstream” economists are KeynesiansRational Expectations: Believes that monetary and fiscal policy have certain effects on the economy and take action to make these policies ineffective.
50 Economic Growth . (5–10%) A. Definition of economic growth B. Determinants of economic growth1.Investment in human capital2.Investment in physical capital3.Research and development, and technological progressC. Growth policy
51 Definition of economic growth Defined as an increase in “Real GDP per capita”Per capita is used in order to isolate the effect of changes in populationSustained growth in real GDP per capita occurs ONLY WHEN the amount produced by the average worker increases steadilyProductivity = output per worker
52 Determinants of economic growth Investment in Human CapitalEducation and knowledge improve a nations work- force, making it more productiveInvestment in Physical CapitalEquipment used to produce a good or serviceTechnologyTechnical means for the production of a good or service
53 Growth Policy Policies that promote economic growth Promote investments in technology, education, and capital investment
54 Open Economy: International Trade and Finance . (10–15%) A. Balance of payments accounts1.Balance of trade2.Current account3.Financial account (formerly known as capital account)B. Foreign exchange market1.Demand for and supply of foreign exchange2.Exchange rate determination3.Currency appreciation and depreciationC. Imports, exports, and financial capital flowsD. Relationships between international and domestic financial and goods markets
55 Balance of Payments:The sum of all transactions between U.S. residents and residents of all foreign nationsCurrent Account: a country’s exports and imports of goods and services.Capital/Financial Account: Shows the country’s investment (financial as well as capital-plants and factories) abroad and Foreign investment in the countryCredits: A credit are those transactions for which the country receives income (exports, foreign purchase of assets)Debits: Those transactions that the country must pay for: imports and purchasing of assets abroad.
56 Balance of Payments [continued] The Current Account and Financial/Capital Account must be equal.Official Reserves Account: The Central Banks of all nations hold foreign currency to make up any deficit in the combined capital and current accounts.If the U.S. has more credits than debits it finances this difference by dipping into its reserve account.
57 Foreign exchange market The value of a foreign nation’s currency in relation to your own currency is called the exchange rate.An increase in the value of a currency is called appreciation.A decrease in the value of a currency is called depreciation.Multinational firms convert currencies on the foreign exchange market, a network of about 2,000 banks and other financial institutions.
58 Types of Exchange Rate Systems Fixed Exchange-Rate SystemsA currency system in which governments try to keep the values of their currencies constant against one another is called a fixed exchange-rate system.Flexible Exchange- Rate SystemsFlexible exchange-rate systems allow the exchange rate to be determined by supply and demand.
59 Demand for and supply of foreign exchange Let’s say a U.S. citizen travels to Japan. This transaction will provide a supply of the U.S. dollar and result in a demand for yen. It will become cheaper for the Japanese to buy the dollar and more expensive for Americans to buy the Yen. The Yen is Appreciating and the dollar is Depreciating.Yen Price ofdollar(Y/$)Dollar Priceof Yen($/Y)SY1S$1P2S$2P1P1DY2P2DY1D$1Q1Q2Q1Q2Quantity of YenQuantity of U.S. Dollars
60 Part 2: The GraphsYou must be able to draw/label/manipulate these graphs
69 Economic Growth Causes of Economic Growth Increased investment in physical capitalEquipment and machineryIncreased investment in human capitalEducation and trainingNew TechnologyIncrease in quality/quantity of resources