COMMON MISTAKES ON THE AP MACRO EXAM BY: Mr. Veit

The difference between a change in demand and the resultant movement along a demand curve vs. Shifting of the demand curve

GRAPHING DEMAND What if Demand Increases? P QD $5 4 3 2 1 10 20 35 55 Price of Corn What if Demand Increases? P $5 4 3 2 1 CORN P QD $5 4 3 2 1 10 20 35 55 80 D o 10 20 30 40 50 60 70 80 Q Quantity of Corn

GRAPHING DEMAND Increase in Quantity Demanded P QD $5 4 3 2 1 10 20 35 Price of Corn P Increase in Quantity Demanded $5 4 3 2 1 CORN P QD $5 4 3 2 1 10 20 35 55 80 30 40 60 80 + Increase in Demand D’ D o 10 20 30 40 50 60 70 80 Q Quantity of Corn

The difference between a change in supply and the resultant movement along a supply curve vs. Shifting of the supply curve

GRAPHING SUPPLY What if Supply Increases? P QS $5 4 3 2 1 60 50 35 20 Price of Corn What if Supply Increases? P S $5 4 3 2 1 CORN P QS $5 4 3 2 1 60 50 35 20 5 o 10 20 30 40 50 60 70 80 Q Quantity of Corn

GRAPHING SUPPLY Increase in Supply P QS $5 4 3 2 1 60 50 35 20 5 80 70 Price of Corn P Increase in Supply S’ S $5 4 3 2 1 CORN P QS $5 4 3 2 1 60 50 35 20 5 80 70 60 45 30 Increase in Quantity Supplied o 10 20 30 40 50 60 70 80 Q Quantity of Corn

Mislabeling or NOT labeling graphs correctly

EQUILIBRIUM: REAL OUTPUT AND THE PRICE LEVEL P AS Equilibrium in the Intermediate Range Price Level Pe P1 AD Q Q1 Qe Q2 Real Domestic Output, GDP

GROWTH IN THE AD-AS MODEL ASLR1 ASLR2 C A Price Level Capital Goods B D Q1 Q2 Consumer Goods Real GDP

ECONOMIC GROWTH IN THE EXTENDED AD – AS MODEL ASLR1 ASLR2 AS2 AS1 Price Level P2 P1 AD2 AD1 o Q1 Q2 Real GDP

Rate of interest, i (percent) Amount of money demanded THE MONEY MARKET Sm1 Sm 10 7.5 5 2.5 A temporary shortage of money will require the sale of some assets to meet the need. ie Rate of interest, i (percent) Dm 0 50 100 150 200 250 300 Amount of money demanded (billions of dollars)

Net effects of Monetary Policy and/or Fiscal Policy on Interest Rate (I%)

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION AS Fiscal Policy And Inflation Price level P1 AD1 AD2 $495 $505 $515 Real GDP (billions)

Expansionary Fiscal Policy >> Interest Rate INCREASE Draw Money Market Increase Spending (AD)>>Increase Demand for Money>>Increase Interest Rate Higher Price Level>>Increase Demand for Money>>Increase Interest Rate

Expansionary Monetary Policy>> Interest Rate DECREASE

Quantity of money demanded and supplied MONETARY POLICY AND EQUILIBRIUM GDP Sm1 Sm2 Investment Demand 10 8 6 10 8 6 Real rate of interest, i Dm Quantity of money demanded and supplied Amount of investment, i If the money supply increases to stimulate the economy... AS Money Supply Increases Interest Rate Decreases Price level Investment Increases P2 P1 AD & GDP Increases with slight inflation AD1 AD2 Real domestic output, GDP

Quantity of money demanded and supplied MONETARY POLICY AND EQUILIBRIUM GDP Sm1 Sm2 Sm3 Investment Demand 10 8 6 10 8 6 Real rate of interest, i Dm Quantity of money demanded and supplied Amount of investment, i If the money supply increases again… AS More Money Supply P3 Lower Interest Rates Price level More Investment P2 P1 Still higher AD & GDP with significant inflation AD1 AD2 AD3 Real domestic output, GDP

MULTIPLIER(S) CONFUSION

Income (Spending) Multiplier Multiplier = 1/ 1 – MPC or 1/ MPS Initial Change in Spending X MULTIPLIER = Change in Output

MONEY MULTIPLIER 1 / Required Reserve Ratio Maximum Multiple $$$ Money Expansion

MULTIPLE DEPOSIT EXPANSION PROCESS Bank Acquired reserves and deposits Required reserves Excess Amount bank can lend - New money created A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 21.97 $20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40 $80.00 17.57 Total amount of money created by the banking system $400.00

Balanced Budget Multiplier = 1 (Net Result on GDP)

Remembering the difference between the Amount of Money Created and the Change in the Money Supply when dealing with the Money Multiplier and Money Creation

FEDERAL RESERVE PURCHASE OF BONDS New reserves $200 Required reserves Purchase of a $1000 bond from a bank... $800 Excess Reserves $4000 Bank System Lending $1000 Initial Deposit Total Increase in Money Supply ($5000)

Confusing Comparative Advanatge Calculations

Remembering the difference between Real and Nominal

Nominal: with Inflation Real: without Inflation

GDP Nominal 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

INCOME NOMINAL INCOME: number of dollars received by an individual or group for its resources during some period of time REAL INCOME: amount of goods and services which can be purchased with nominal income during some period of time; nominal income adjusted for inflation

INTEREST RATE (I%) NOMINAL I%: interest rate expressed in terms of annual amounts currently charged for interest; not adjusted for inflation REAL I%: interest rate expressed in dollars of constant value (adjusted for Inflation) and equal to the NOMINAL I% minus the EXPECTED RATE OF INFLATION

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

WAGES NOMINAL WAGES: amount of money received by a worker per unit of time (hour, day, etc.); Money Wage REAL WAGES: amount of goods and sevices a worker can purchase with their NOMINAL WAGE; purchasing power of the nominal wage. (Real = Nominal – Inflation rate)

NONIMAL/REAL TIPs If 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.

Confusing calculations using MPC / MPS to determine changes necessary to correct Recessionary and Inflationary Gaps

FULL-EMPLOYMENT GDP Recessionary Gap Recessionary Gap = $5 Billion AE0 530 510 490 AE1 Recessionary Gap = $5 Billion Aggregate Expenditures (billions of dollars) Full Employment 45 o o 490 510 530 Real domestic product, GDP (billions of dollars)

FULL-EMPLOYMENT GDP Inflationary Gap Inflationary Gap = $5 Billion AE2 Inflationary Gap = $5 Billion AE0 530 510 490 Aggregate Expenditures (billions of dollars) Full Employment 45 o o 490 510 530 Real domestic product, GDP (billions of dollars)

Demand-Pull Inflation vs. Cost-Push Inflation

DEMAND-PULL INFLATION ASLR AS2 AS1 c P3 Price Level P2 b P1 a AD2 AD1 o Q1 Real domestic output

COST-PUSH INFLATION Occurs when short-run AS shifts left Price Level o ASLR AS2 AS1 Price Level P2 b P1 a AD1 o Q2 Q1 Real domestic output

COST-PUSH INFLATION Even higher price levels Government response with increased AD ASLR AS2 AS1 Even higher price levels c P3 Price Level P2 b P1 a AD2 AD1 o Q2 Q1 Real domestic output

COST-PUSH INFLATION If government allows a recession to occur ASLR AS2 AS1 Price Level P2 b P1 a AD1 o Q2 Q1 Real domestic output

COST-PUSH INFLATION If government allows a recession to occur Nominal ASLR AS2 AS1 Nominal wages fall & AS returns to its original location Price Level P2 b P1 a AD1 o Q2 Q1 Real domestic output

Phillips Curve vs. Laffer Curve

Annual rate of inflation Unemployment rate (percent) THE PHILLIPS CURVE CONCEPT 7 6 5 4 3 2 1 As inflation declines... Unemployment increases Annual rate of inflation (percent) 1 2 3 4 5 6 7 Unemployment rate (percent)

THE LAFFER CURVE 100 Tax rate (percent) l Tax revenue (dollars)

THE LAFFER CURVE 100 Tax rate (percent) m l Tax revenue (dollars)

THE LAFFER CURVE 100 n Tax rate (percent) m l Tax revenue (dollars)

THE LAFFER CURVE Maximum Tax Revenue Tax rate (percent) 100 n Tax rate (percent) m m Maximum Tax Revenue l Tax revenue (dollars)

Quantity of Loanable Funds THEORY OF INTEREST S i = 8% Interest Rate, (percent) D F0 Quantity of Loanable Funds