COMMON MISTAKES ON THE AP MACRO EXAM Compiled by: John Ostick Malvern Prep Malvern, PA 19355

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

P Q o $ PQDQD $ D Price of Corn Quantity of Corn CORN What if Demand Increases? GRAPHING DEMAND

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

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

S P Q o $ $ PQSQS Price of Corn Quantity of Corn CORN What if Supply Increases? GRAPHING SUPPLY

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

Mislabeling or NOT labeling graphs correctly

Price Level Real Domestic Output, GDP Q P AS AD Equilibrium in the Intermediate Range QeQe Q1Q1 Q2Q2 EQUILIBRIUM: REAL OUTPUT AND THE PRICE LEVEL P1P1 PePe

GROWTH IN THE AD-AS MODEL A B C D Capital Goods Consumer Goods Price Level Real GDP AS LR1 AS LR2 Q1Q1 Q2Q2

ECONOMIC GROWTH IN THE EXTENDED AD – AS MODEL Price Level Real GDP o P1P1 AS 2 AS LR1 AD 2 Q1Q1 AS LR2 Q2Q2 AD 1 AS 1 P2P2

Rate of interest, i (percent) Amount of money demanded (billions of dollars) DmDm ieie SmSm A temporary shortage of money will require the sale of some assets to meet the need. S m1 THE MONEY MARKET

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

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Price level Real GDP (billions) AS AD 2 $495$515 P1P1 AD 1 Fiscal Policy And Inflation $505

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

Real domestic output, GDP DmDm Investment Demand Real rate of interest, i Quantity of money demanded and supplied Amount of investment, i MONETARY POLICY AND EQUILIBRIUM GDP S m1 AS AD 1 P1P S m2 AD 2 P2P2 Money Supply Increases Interest Rate Decreases Investment Increases AD & GDP Increases with slight inflation If the money supply increases to stimulate the economy... Price level

AD 3 Price level Real domestic output, GDP DmDm Investment Demand Real rate of interest, i Quantity of money demanded and supplied Amount of investment, i MONETARY POLICY AND EQUILIBRIUM GDP S m1 AS AD 1 P1P S m2 AD 2 P2P2 More Money Supply Lower Interest Rates More Investment Still higher AD & GDP with significant inflation S m3 P3P3 If the money supply increases again…

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 reserves Amount bank can lend - New money created A B C D E F G H I J K L M N Other banks $ $ $ $ $ Total amount of money created by the banking system

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

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

Confusing Comparative Advantage 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

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

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)

NOMINAL/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 Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) AE 0 Recessionary Gap AE Recessionary Gap = $5 Billion Full Employment

FULL-EMPLOYMENT GDP Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) AE 0 Inflationary Gap AE Inflationary Gap = $5 Billion Full Employment

Demand-Pull Inflation vs. Cost-Push Inflation

DEMAND-PULL INFLATION o P1P1 AS 1 AS LR AD 1 a Q1Q1 Price Level Real domestic output b P2P2 P3P3 AD 2 AS 2 c

Q2Q2 COST-PUSH INFLATION o P1P1 AS 1 AS LR AD 1 a Q1Q1 Price Level Real domestic output b P2P2 AS 2 Occurs when short-run AS shifts left

Q2Q2 COST-PUSH INFLATION o P1P1 AS 1 AS LR AD 1 a Q1Q1 Price Level Real domestic output b P2P2 P3P3 AD 2 AS 2 Government response with increased AD c Even higher price levels

COST-PUSH INFLATION o P1P1 AS 1 AS LR AD 1 a Q1Q1 Price Level Real domestic output b P2P2 AS 2 If government allows a recession to occur Q2Q2

Q2Q2 COST-PUSH INFLATION o P1P1 AS 1 AS LR AD 1 a Q1Q1 Price Level Real domestic output b P2P2 AS 2 If government allows a recession to occur Nominal wages fall & AS returns to its original location

Phillips Curve vs. Laffer Curve

Annual rate of inflation (percent) Unemployment rate (percent) As inflation declines... THE PHILLIPS CURVE CONCEPT Unemployment increases

0 100 l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)

0 100 m l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)

0 100 m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)

0 100 m m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent) Maximum Tax Revenue