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AP Macro Economics Review Peggy Pride, Presenter.

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Presentation on theme: "AP Macro Economics Review Peggy Pride, Presenter."— Presentation transcript:

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2 AP Macro Economics Review Peggy Pride, Presenter

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4 Production Possibility Curve A C F B D E W Capital goods Consumer goods B2B2 D Capital goods Consumer goods D2D2 B

5 Market Equilibrium Demand Supply PePe QeQe Quantity PricePrice

6 A change in Demand versus a change in the Quantity Demanded Change in Demand Moves the curve Moves the curve IncomeIncome Future ExpectationsFuture Expectations # of Buyers# of Buyers Consumer InformationConsumer Information Taste and PreferenceTaste and Preference Substitues and ComplementsSubstitues and Complements Change in Quantity Demanded Moves Along the SAME curve Moves Along the SAME curve Caused only by Price change. Caused only by Price change.

7 P Q o $ PQDQD $ D Price of Corn Quantity of Corn CORN Price Change

8 P Q o $ PQDQD $ D Price of Corn Quantity of Corn CORN D Increase in Demand Increase in Quantity Demanded GRAPHING DEMAND

9 A change in Supply versus a change in the Quantity Supplied Change in Supply Moves the curve Moves the curve Costs of ProductionCosts of Production Future ExpectationsFuture Expectations # of Sellers# of Sellers Taxes and SubsidiesTaxes and Subsidies Prices of goods using same resourcesPrices of goods using same resources Time period of productionTime period of production Change in Quantity Supplied Moves Along the SAME curve Moves Along the SAME curve Caused only by Price change. Caused only by Price change.

10 P Q o $ PQDQD $ S Price of Corn Quantity of Corn CORN Price Change

11 S P Q o $ Price of Corn Quantity of Corn $ PQSQS CORN S Increase in Supply Increase in Quantity Supplied GRAPHING SUPPLY

12 Verbal Clues Use a correctly labeled graph and show…Use a correctly labeled graph and show… Analyze the effect…Analyze the effect… Explain the mechanism …Explain the mechanism … Identify the area of …Identify the area of … Show the impact …Show the impact … Calculate (number and process)…Calculate (number and process)… Show price and output …Show price and output … Compare before and after…Compare before and after… Two separate graphs correctly labeled graphTwo separate graphs correctly labeled graph Side-by-sideSide-by-side What is the relationship…What is the relationship…

13 Distinguish between: Price and price level AS and S AD and D o PL 1 AS sr AS lr AD 1 QfQfQfQf Price Level Real domestic output

14 GROSS DOMESTIC PRODUCT Market Value of the total goods and services produced within the boundaries of the US whether by Americans or foreigners in one year. Defining…

15 GROSS DOMESTIC PRODUCT Consumption by Households Investment by Businesses GovernmentPurchases Expenditures by Foreigners Expenditures Approach Income Approach Wages Rents Interest Profits StatisticalAdjustments = = GDPGDP

16 NOMINAL GDP vs. REAL GDP Nominal GDP … reflects the current price level of goods and services and ignores the effect of inflation on the growth of GDP. … this measure is called Current Dollar GDP. Real GDP … measures the value of goods and services adjusted for change in the price level. It will reflect the real change in output. … This measure is called the Constant Dollar GDP. … indicates what the GDP would be if the purchasing power of the dollar has not changed from what it was in a base year. The government currently uses 2000 as its base year for Real GDP measurement.

17 GDP Price Index Price Index in a given year = Price of market basket in specific year Price of same market basket in base year x 100 Real GDP = Nominal GDP Price Index (in hundredths)

18 Disposable Income By subtracting from Personal Income, the dollars lost to taxes, we have the Disposable Income. This is the bottom line of national income accounting. Disposable Income = C + S

19 Unemployment Rate = Unemployed Labor Force Frictional – temporary, transitional, short-term (between jobs or search unemployment) (seasonal work) Structural – technological or long term. basic changes in the structure of the labor force which make certain skills obsolete. Cyclical – economic downturns in the business cycle.

20 The Full employment rate of unemployment or the Natural Rate of Unemployment (NRU) is present when the economy is producing its potential output. The Natural Rate of Unemployment exists when the cyclical unemployment is zero.

21 Inflation A rising of the general level of prices = Price of the same market basket in 2000 x 100 CPI Price of the market basket in the particular year Producer Price Index (PPI) Producer Price Index (PPI) Prices at the wholesale or production level which are early indicators of inflation.

22 Real and Nominal Income Nominal income … is the number of dollars earned as rent, wages, interest or profit Real income… measures the amount of goods and services nominal income can buy. If nominal income rises faster than price level, real income will rise. If nominal income rises faster than price level, real income will rise. If the price level increases faster than nominal income, then real income will fall. If the price level increases faster than nominal income, then real income will fall. Your real income falls only when nominal income fails to keep up with inflation. Your real income falls only when nominal income fails to keep up with inflation.

23 o PL 1 AS sr AS lr AD 1 QfQfQfQf Price Level Real domestic output Long Run Equilibrium In the extended AD-AS model, equilibrium occurs at the intersection of AD and the AS lr and the AS sr. Q f is the amount of Real GDP at full employment.

24 DEMAND-PULL INFLATION and Self-Correction DEMAND-PULL INFLATION and Self-Correction Long Run Nominal Wages rise and AS 2 sr moves left. RGDP returns to previous level on As lr But…PL rises even more to PL 3 ! o PL 1 [2%] AS sr AS lr AD 1 a QfQfQfQf Price Level Real domestic output b PL 2 [5%] AD 2 Y2Y2Y2Y2 c AS 2 sr PL 3 [7%] Short Run Increase in AD shows point b

25 COST-PUSH INFLATION with government action COST-PUSH INFLATION with government action If government stimulates AD to dotted line, an inflationary spiral will occur…PL 3 at Q f. We have Full Employment but at a higher price level. o PL 1 [ 2 %] AS sr AS lr AD 1 a QfQfQfQf Price Level Real domestic output b AS 2 sr PL 2 [ 3 %] Y2Y2Y2Y2 AD 2 c PL 3 [ 5 %]

26 COST-PUSH INFLATION with NO government action COST-PUSH INFLATION with NO government action o PL 1 [ 2 %] AS sr AS lr AD 1 a QfQfQfQf Price Level Real domestic output AS 2 sr If government lets the recession take its course, nominal wages will fall in the long run and return to point a…PL 1 at Q f. c PL 3 [ 5 %]

27 o PL 3 [ 2 %] AS 2 sr AS lr AD 2 a QfQfQfQf Price Level Real domestic output b PL 2 [ 3 %] AD 1 Y2Y2Y2Y2 c AS 1 sr PL 1 [ 5 %] RecessionRecession This decline in the price level will eventually shift the AS 1 sr to AS 2 sr. Price level declines to PL 3 at Q f. Shown at point c.

28 Annual rate of inflation Unemployment rate (percent) As inflation declines... The Phillips Curve Concept Unemploymentincreases PC

29 In the long run, there is not a stable relationship between unemployment and inflation. In the long run, there is not a stable relationship between unemployment and inflation. The long-run Phillips curve is the vertical line at the natural rate of unemployment. The long-run Phillips curve is the vertical line at the natural rate of unemployment. The Phillips Curve Summary The short run Phillips Curve is downward sloping. Aggregate Demand changes move along the same short run Phillips curve. Aggregate Supply changes create new short run Phillips curves.

30 Expansionary Fiscal Policy Increase Government Spending Increase Government Spending Decrease Tax Rates Decrease Tax Rates …Or Combination of the Two Goal: To Reduce Unemployment and Effects of Recession… Contractionary Fiscal Policy Decrease Government Spending Decrease Government Spending Increase Tax Rates Increase Tax Rates …Or Combination of the Two Goal: To Reduce DemandPull Inflation…

31 Price level Real GDP (billions) EXPANSIONARY FISCAL POLICY $60 billion increase in AggregateDemand AD 1 AD 2 $20 billion decrease in tax rates; $15 billion in new consumption spending the multiplier at work... P1P1 $550 AS $490 P2P2 MPS =.25

32 Price level Real GDP (billions) CONTRACTIONARY FISCAL POLICY $60 billion decrease in AggregateDemand AD 4 AD 3 $20 billion increase in tax rates; $15 billion lost in consumption spending the multiplier at work... P1P1 $550 AS $490 P2P2 MPS =.25

33 Crowding Out Effect Real Interest Rate, (percent) Quantity of Loanable Funds i% D LF 0 S Increased demand for loanable funds by government raises the interest rate. D2D2 i% LF 1

34 MI Checkable deposits Checkable deposits Travelers checks Travelers checks Currency Currency Money market accounts Money market accounts Savings deposits Savings deposits Small time deposits Small time deposits Large time deposits Large time deposits M2 M3 + + MONEY MEASURES

35 i% $$ demanded DmDm i% 1 SmSm The Money Market Supply of money is a vertical line since monetary authorities (FED) and financial institutions have provided the economy with a certain stock of money.

36 MaximumDemand-Depositcreation= Excessreserves x MoneyMultiplier MoneyMultiplier Required reserve ratio 1= The Money Multiplier One bank can loan only its excess reserves and is limited by those reserves in creating money. One bank can loan only its excess reserves and is limited by those reserves in creating money. The banking system creates a multiplied amount. The banking system creates a multiplied amount. Currency drain and no creditable customers will decrease the amount multiplied.

37 MS i% I n C AD PL RGDP EASY MONEY Goal: Cheap, available credit; increase the money supply Easy money is reinforced by the Net Export Effect

38 Real domestic output, GDP DmDmDmDm InvestmentDemand Real rate of interest, i Quantity of money demanded and supplied Amount of investment, i S m1 AS AD 1 (I=$15) PL S m2 AD 3 (I=$25) PL 2 If the Money Supply Increases to Stimulate the Economy… Interest Rate Decreases Interest Rate Decreases Investment Increases Investment Increases AD & GDP Increases AD & GDP Increases with slight inflation with slight inflation Price level AD 2 (I=$20) PL 3 S m3 Increasing money supply Increasing money supply continues the growth – continues the growth – but, watch Price Level. but, watch Price Level. Easy Monetary Policy And Equilibrium GDP

39 MS i% I n C AD PL RGDP Tight Money Goal: Restrict credit; decrease the money supply Tight money is reinforced by the Net Export Effect

40 Real domestic output, GDP DmDm InvestmentDemand Real rate of interest, i Quantity of money demanded and supplied Amount of investment, i S m3 AS AD 3 (I=$15) PL S m2 AD 1 (I=$25) PL 2 If the Money Supply Decreases to cool the Economy… Interest Rate Increases Interest Rate Increases Investment Decreases Investment Decreases AD & GDP Decreases AD & GDP Decreases with lower PL with lower PL Price level AD 2 (I=$20) PL 1 S m1 Decreasing money supply Decreasing money supply continues the cooling – continues the cooling – as Price Level falls. as Price Level falls. Tight Monetary Policy And Equilibrium GDP

41 Nominal Rate = Real Interest rate + expected rate of inflation Real Interest Rate = Nominal rateexpected rate of inflation Nominal Rate = Real Interest rate + expected rate of inflation Real Interest Rate = Nominal rateexpected rate of inflation

42 Nominal Interest Rate Real Interest Rate Inflation Premium = 11% 5% 6% + ANTICIPATED INFLATION

43 SmSmSmSm i%i%i%i% Q of $$ demanded DmDm The supply of money is vertical no matter what the interest rate is on the vertical axis. The FED controls the supply of money. The demand for money is composed of the transaction demand and asset demand. Money Market GraphNominal Interest Rate QeQeQeQe i% e

44 r rererere Q of LF QeQeQeQe S LF D LF Loanable Funds MarketReal Interest Rate Changes in the real interest rate caused by movements of demand (from borrowers) and supply (from savers). Demand is: Business for investment Business for investment Consumer for spending Consumer for spending Government for Deficit spending Government for Deficit spending Supply is mostly from private savings

45 Classical View: AS is vertical and determines the output at Q f AS is vertical and determines the output at Q f AD is stable and determines the price level as long as money supply is stable. AD is stable and determines the price level as long as money supply is stable. If AD is unstable, prices and wages adjust. If AD is unstable, prices and wages adjust. P1P1 QfQf AS AD 1 Price Level Real Domestic Output A shift to AD 2 shows that the price level declines. AD 2 P2P2

46 Keynesian View : Product prices and wages are downward inflexible Product prices and wages are downward inflexible AS is horizontal up to Qf then becomes AS is horizontal up to Qf then becomes vertical vertical If AD is unstable, changes in AD have no effect on PL but affect RGDP. If AD is unstable, changes in AD have no effect on PL but affect RGDP. Movement from AD 1 to AD 2 reduces the Real GDP but the PL remains constant. P1P1 QfQf AS AD 1 Price Level Real Domestic Output AD 2 Q2Q2

47 NEW CLASSICAL VIEW OF SELF-CORRECTION P2P2 Q1Q1 Price Level Real Domestic Output AD 2 AD 1 AS LR P1P1 AS 1 AS 2 P3P3 Self-Correction a b c AD increases moves economy from a to b. Price level rises (P 2 ) and then self-correction to c by shifting left to AS 2 as Nominal Wages rise.

48 The National or Public Debt is the accumulated deficits and surpluses of the government over time. Deficits, Surpluses and Debt A budget deficit is the amount by which the government expenditure exceeds the government revenue in a particular year. A budget surplus is the amount by which the government revenue exceeds the government expenditure in a particular year.

49 Comparative Advantage …is the ability to produce an item at a lower opportunity cost. Resources are scarce, so that one can only produce more of one product by taking the resources away from another. It means that total world output will be greatest when each good is produced by the nation which has the lowest domestic opportunity cost. Comparative Advantage …is the ability to produce an item at a lower opportunity cost. Resources are scarce, so that one can only produce more of one product by taking the resources away from another. It means that total world output will be greatest when each good is produced by the nation which has the lowest domestic opportunity cost. As a result of trade, countries that trade products based on their own specialization will have more of BOTH products (produced and traded for). As a result of trade, countries that trade products based on their own specialization will have more of BOTH products (produced and traded for). Terms of Trade…the exchange ratio between goods traded. This ratio explains how the gains from international specialization and trade are divided among the trading nations; it depends on the world supply and demand for the two products. Terms of Trade…the exchange ratio between goods traded. This ratio explains how the gains from international specialization and trade are divided among the trading nations; it depends on the world supply and demand for the two products.

50 S D $ Price of Foreign Currency Quantity of Foreign Currency The intersection will be the exchange rate. Flexible exchange rates Q fc $ fc

51 A nations Balance of Payments records all the transactions that take place between its residents and the residents of a foreign nation. Current Account Mdse. Trade Services Trade Net Investment Income Net Transfers Capital Account Real Investment Financial Investments Official Reserves Account + to balance a deficit to balance a surplus =

52 p Changes in tastes p Changes in relative incomes p Changes in relative prices p Changes in relative interest rates p Speculation in currencies Determinants of exchange rates:


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