1. Macro Review Day #2

2. The Spending Multiplier
multiplier effect: increase in GDP greater (or less) than the increase (or decrease) in spending
*a spending increase of $1 creates more than $1 of GDP
Spending Multiplier = 1/MPS OR 1/1-MPC
Ex: Consumers spend 0.8 & save 0.2 of extra income.
Multiplier?
1/.2 = 5

3. The Tax Multiplier
When gov’t taxes…multiplier works in reverse (money is leaving the circular flow)
TAX CUT = higher multiplier

4. The Balanced Budget Multiplier
Gov’t spending = Gov’t revenues (taxes)
BBM always = 1
MPC/MPS = 1

5. Aggregate Demand (AD)
&
Aggregate Supply (AS)

6. Aggregate Demand Curve
Goods & Services (real GDP)
Price level AD
A reduction in the price level will increase the quantity of goods & services demanded P 1 P 2 Y 1 Y 2
Downward Sloping Demand Curve:
total GDPR from private, public & foreign sector

7. Causes of movements on AD curve:
Wealth Effect: at higher PL the real value (or purchasing power) of wealth diminishes
Interest-Rate Effect: as PL rise so will i%
- higher PL’s increase the demand for money…i%?
Foreign Purchases Effect: domestic PL rises, U.S. buyers purchase more imports…dollar appreciated or depreciated?

8. Shifts in Aggregate Demand (non-price level determinants)
I. Change in Consumer Spending:
- wealth, expectations, debt, taxes
II. Change in Investment Spending:
- interest rates, profits, business taxes, tech., inventory levels
Change in Government Spending
Change in Net Exports
-national income abroad & exchange rates

9. Shifts in Aggregate Demand
Goods & Services (real GDP)
Price level AD AD 1 AD 2
Increase in real wealth increases aggregate demand, shifting entire curve to right (AD0 to AD1)
Reduction in real wealth decreases demand for goods & services, causing AD to shift to left (AD0 to AD2)

10. 1. Explain how and why each of the
following factors would influence current
aggregate demand in the United States:
(a) An increased fear of a recession. (b) An increased fear of inflation.
(c) The rapid growth of real income in Canada & W. Europe. (d) A reduction in the real interest rate.
(e) A higher price level.

11. Short-Run (SRAS) & Long-Run (LRAS) Aggregate Supply
Short-run AS:
input prices are “sticky” & do NOT adjust to PL
In SR GDPR directly related to PL
Long-run AS:
input prices completely flexible & households/businesses adjust to changes in PL
In LR GDPR independent of PL!

12. Goods & Services (real GDP)
SRAS Curve
Goods & Services (real GDP)
Price level
SRAS
(P100)
An increase in the price level will increase the quantity supplied in the short run. P
105 P
100 P 95 Y 1 Y 2 Y 3
Upward sloping supply curve

13. (full employment rate of output)
LRAS Curve
Goods & Services (real GDP)
Price level
LRAS Y F
(full employment rate of output)
Change in price level does not affect quantity supplied in the long run.
-full employment rate of output (YF): maximum sustainable output
- LRAS curve is always vertical!

14. Shifts in Aggregate Supply (non-price level determinants)
Factors that change SRAS:
I. Change in Resource Prices
II. Change in Productivity:
-training & tech.
III. Change in Legal-Institutional Environment:
-business taxes, subsidies, gov’t regs

15. Shifts in Aggregate Supply
Goods & Services (real GDP)
Price level
LRAS1 Y
F,1
Goods & Services (real GDP)
Price level
SRAS1
LRAS2 Y
F,2
SRAS2
Increases in resources & tech., or government deregulation EXPAND potential output (shift LRAS to right)

16. 1. Indicate how each of the following would influence U. S
1. Indicate how each of the following would influence U.S. aggregate supply in the short run:
An increase in real wage rates.
A severe freeze that destroys half the orange crop in Florida.
An increase in the expected rate of inflation in the future.
An increase in the world price of oil.
Abundant rainfall during the growing season of agricultural states.

17. Short-Run Equilibrium
Goods & Services (real GDP)
Price level
SRAS
(P100) AD
Intersection of AD and SRAS
determines output P Y

18. (full employment rate of output)
Long-Run Equilibrium
LRAS
Goods & Services (real GDP)
Price level
SRAS
(P100)
AD100
Quantity demanded just equals quantity supplied P
100 Y F
(full employment rate of output)
current output (YF) = potential GDP (full employment)

19. SR Increase in AD demand-pull inflation Price level LRAS SRAS1 AD2 AD1
Goods & Services (real GDP)
Price level P
100 Y F
SRAS1
AD1
AD2
Short-run effects of an unanticipated increase in AD P
105 Y 2
Effect of SR increase in AD???
demand-pull inflation

20. SR Decrease in AD Effects of SR decrease in AD???
LRAS
Goods & Services (real GDP)
Price level P
100 Y F
SRAS1
AD1
AD2
Short-run effects of an unanticipated reduction in AD P 95 Y 2
Effects of SR decrease in AD???
- recessionary output & cyclical unemployment

21. The “Sticky” Short-Run vs. “Flexible” Long-Run
Ratchet Effect: PL’s "sticky" or inflexible in downward direction
Reasons:
wage contracts, morale & productivity, minimum wage, “menu” costs, price wars

22. Goods & Services (real GDP)
LRAS Shift Outward
LRAS1
Goods & Services (real GDP)
Price level Y F AD P 1
SRAS1 F1 Y F2
LRAS2
SRAS2 P 2 Y F2
LRAS shift outward = economic growth
Shift inward of SRAS?
PL increases & cost-push inflation

23. Real Disposable Income (trillions of dollars)
Aggregate Consumption Schedule 3 6 9
Planned Consumption Expenditures (trillions of dollars)
Real Disposable Income (trillions of dollars) 12
45º
45º Line
Saving C
Dis-saving
Keynesian model: positive relationship b/n consumption & income

24. Free Response Clues: -Do NOT restate question!
-Use correct economic jargon!
-Use outline #’s will answering question!
-You CAN use short-hand (AD ↑, PL ↓).
-Analyzing a problem!!!
-“Show” means graph, “Indicate” means direction (↑ or ↓),
and “Explain” means explain!

25. 1. Assume that the United States economy is currently in equilibrium at the full-employment level of real gross domestic product.
(a) Draw a correctly labeled graph of aggregate demand and aggregate supply showing each of the following in the United States.
(i) Output level
(ii) Price level
(b) Japan is a major importer of United States products. Assume that the Japanese economy goes into a recession.
(i) Explain the impact of the Japanese recession on the United States equilibrium output and price levels.
(ii) Show the effects on your graph in part (a).
(c) Assume that the Federal Reserve takes action to curb the effects of the Japanese recession on the United States economy.
(i) What open-market operations would the Federal Reserve undertake?
(ii) Use a correctly labeled graph of the money market to show how the
Federal Reserve policy action will affect the nominal interest rate.
(iii) Explain how the change in the nominal interest rate in part (c) (ii) will
affect aggregate demand, price level, and real output in the United States.
(d) Define the real interest rate.
(e) Indicate the effect of the open-market operation you identified in part (C) (i) on the real interest rate in the United States.

26. Productivity = total output/total inputs
More productivity = lower costs
SRAS?

27. PPC Growth .
Capital
Goods .
PPC
PPC1
Consumer Goods

28. SR PHILLIPS CURVE SR tradeoff: inflation declines, unemployment7 6 5 4 3 2 1
SR tradeoff:
inflation declines,
unemployment
increases
Inflation
Unemployment

29. *Natural rate of unemployment constant
LR Phillips Curve
Inflation
LRPC
Unemployment
*Natural rate of unemployment constant

31. Fiscal Policy Gov’t efforts to promote FE output & price stability
Recession = expansionary policy
increase G
decrease T
Inflation = contractionary policy
decrease G
increase T
WHICH IS MORE OF A DIRECT INJECTION???

32. Expansionary Fiscal Policy
SRAS
LRAS PL P1 P ↑
AD2
AD1 Y YF
GDPR
IN RECESSION:
↑G, AD↑, GDPR↑, PL↑, u%↓, π%↑ OR
T↓, DI↑, C↑, AD↑, GDPR↑, PL↑, u%↓, π%↑

33. Discretionary v. Automatic Fiscal Policies
Discretionary: increase or decrease G & T
Problems:
time lags
political motivations
Automatic:
unemployment benefits, marginal tax rates

34. Expansionary fiscal policy side-effect: ‘Crowding-out’
SLF i% i% r1 r
DLF 1 ID
DLF IG q q1
QLF I1 I
Gov’t deficit spending (G↑ or T↓) causes DLF↑, i%↑, IG↓

35. Crowding-Out in an Open Economy
Decline in Private Investment
Increase In Budget Deficit
Higher Real Interest Rates
Inflow of Financial Capital from Abroad
Appreciation of the Dollar
Decline in Net Exports
Crowding-Out in an Open Economy

36. ‘Crowding-In’ Contractionary Fiscal Policy Side-effect:
‘crowding-in’ of IG & XN

37. medium of exchange store of value unit of account
Money:
medium of exchange
store of value
unit of account
Supply of Money:
Federal Reserve controls SM
M1 (currency, coin, demand deposits)
M2 (M1, time deposits, mutual funds)

38. Federal Reserve Districts10
Kansas City
San
Francisco 12 9
Minneapolis 7
Chicago 1
Boston 4
Cleveland 2
New York
Philadelphia 3 5
Richmond 8
St. Louis
Washington, D.C.
(Board of Governors) 6
Atlanta 11
Dallas
There are 12 Federal Reserve districts.
Each district bank monitors the commercial banks in their region and assists them with the clearing of checks.
The Board of Governors of the Fed is in Washington D.C.

39. “Velocity” of Money: MV = PQ M = money supply V = velocity of spending
P = price level (PL on the AS/AD diagram)
Q = GDPR
PQ = Nominal GDP

40. *↓i% = ↑bond prices; ↑i% = ↓bond prices
The Money Market
market where Fed & users of money interact
nominal interest rates (i%)
money demand (MD): households, firms, gov’t & foreign sector
money supply (MS): Fed determined
*↓i% = ↑bond prices; ↑i% = ↓bond prices

41. The Money Market i% MS i MD Q QM
MD downward sloping: i% is opportunity cost of holding money
MS vertical: independent of i%

42. MD dependent on PL & GDPR
Increase in MD i% MS i2 ↑
MD2 i1
MD1 Q QM
MD dependent on PL & GDPR
Nominal GDP↑:MD↑:i%↑

43. ↑ Increase in MS Expansionary Monetary Policy: MS↑:i%↓MD Q1 Q2 QM
Expansionary Monetary Policy: MS↑:i%↓
Contractionary Monetary Policy: MS↓:i%↑

44. excess reserves = actual reserves - required reserves
Reserve Requirement
Fed requirement for banks to have cash reserves
Required Reserve Ratio
% of demand deposits (checking account balances)
typically RR% = 10%
Excess reserves are loaned out
excess reserves = actual reserves - required reserves

45. Money multiplier = 1/ reserve ratio
shows impact of a change in demand deposits on MS
Money multiplier = 1/ reserve ratio
Ex.: Reserve ratio is 25%, money multiplier?
1/ .25 = 4
Maximum money creation = excess reserves x M multiplier
actual deposit multiplier less than potential:
Some will hold currency
Some banks may not use all excess reserves

46. Monetary Policy
Efforts by central banks (ie: The Fed) to promote full employment, PL stability, & LR growth
control of MS (i%)
Expansionary (Easy Money):
fight a recession
Contractionary (Tight Money):
counteract inflation
TOOLS:
Required Reserve Ratio
Discount Rate
Open Market Operations (OMO)
Term Auction Facility (TAF)…NEW!

47. TOOLS OF THE FED
RR%:
RR%↓ = MS↑ (easy money)
RR%↑ = MS↓ (tight money)
2. Discount rate (“window”): i% banks pay the Fed for overnight loans to meet RR%
Discount Rate%↓ = MS↑ (easy money)
Discount Rate%↑ = MS↓ (tight money)
OMO: purchase & sale of gov’t securities by Fed
Fed buys bonds = MS↑ = easy $
Fed sells bonds = MS ↓ = tight $
4. TAF: started in 2007 to promote discount window

48. Graphing Expansionary Monetary PolicyMS
MS1 i% i%
Graphing Expansionary Monetary Policy
Fed buys bonds, ↑TAF loans, or ↓discount rate i i i1 i1 ID MD Q Q1 QM I I1 IG
LRAS PL
SRAS P1 P
AD1 AD Y YF
GDPR

49. 1. Assume that the United States economy is currently in equilibrium at the full-employment level of real gross domestic product.
(a) Draw a correctly labeled graph of aggregate demand and aggregate supply showing each of the following in the United States.
(i) Output level
(ii) Price level
(b) Japan is a major importer of United States products. Assume that the Japanese economy goes into a recession.
(i) Explain the impact of the Japanese recession on the United States equilibrium output and price levels.
(ii) Show the effects on your graph in part (a).
(c) Assume that the Federal Reserve takes action to curb the effects of the Japanese recession on the United States economy.
(i) What open-market operations would the Federal Reserve undertake?
(ii) Use a correctly labeled graph of the money market to show how the
Federal Reserve policy action will affect the nominal interest rate.
(iii) Explain how the change in the nominal interest rate in part (c) (ii) will
affect aggregate demand, price level, and real output in the United States.
(d) Define the real interest rate.
(e) Indicate the effect of the open-market operation you identified in part (C) (i) on the real interest rate in the United States.

50. trade deficit: “unfavorable balance of trade,” or imports exceeding exports
trade surplus: “favorable balance of trade,” or exports exceed imports

51. Export Supply:
At the world price of Pw, the quantity (Qp – Qc) is exported
Price
Price
U.S. Market
World Market S w S d a P b S w w P w P n c D w D d Q Q Q Q
Soybeans
(bushels)
Soybeans
(bushels) c n p w
U.S. exports

52. At price Pw, U.S. consumers import (Qc – Qp)
Import Demand:
At price Pw, U.S. consumers import (Qc – Qp)
Price
Price
U.S. Market
World Market S d S w a P n b c S w P w P w D d D w Q p c Q n
Soybeans
(bushels) Q w
Soybeans
(bushels)
U.S. imports

53. Effects of Trade Protection
trade protection: gov’t policies that limit imports
- tariffs & import quotas
- both produce “deadweight losses”
tariff: tax on imports (raises domestic price)
import quota: legal limit on Q of imports

54. Impacts of Tariff

55. Balance of Payments Money flows b/n U.S. & World Balance of Payments:
inflows = CREDITS
outflows = DEBITS
Balance of Payments:
Current Account (XN; net foreign income; net transfers)
Capital/Financial Account (FDI)
Toyota Factory in TX = CREDIT
Intel Factory Costa Rica = DEBIT
Official Reserves Account (Fed foreign currency)

56. What causes Capital/Financial Flows?
differences in rates of return
Ceteris Paribus: $ flows toward higher returns
SLF 1
SLF USA r% r%
SLF China
SLF 1
DLF USA
DLF China
QLF China
QLF USA
Debit to the Chinese Capital Account
Credit to the U.S. Capital Account

57. Foreign Exchange (FOREX)
buying & selling of currency
Fixed Exchange Rate: pegged to a set value
exchange rates determined in FOREX markets
price of a currency
↑ supply = depreciation
↓ supply = appreciation
↑ demand = appreciation
↓ demand = depreciation
Ex. If German tourists flock to America to go shopping?

58. Exports & Imports Appreciation = relatively cheaper foreign goods
Depreciation = relatively cheaper domestic goods
exports ↑

59. Exchange Rate Determinants
Consumer Tastes
Relative Income
Relative Price Level
Speculation
Ex: If the price level is higher in Canada than in the United States?
Ex: If U.S. investors expect that Swiss interest rates will climb in the future?

60. Increase in Demand for £ relative to $
$/£ S£ e1 e
D£ 1 D£ Q£ q q1
D£ ↑ = £ appreciates

61. Increase in Supply of $ relative to €
€ / $ S$
S$ 1 e e1 D$ Q$ q q1
S$ ↑ = $ depreciates

62. Fiscal Policy & Exchange Rates:
Expansionary fiscal policy (crowding out):
1. i% ↑
2. inflow of capital
3. currency ↑
4. Imports ↑ = trade deficit…GDP???
Contractionary fiscal policy (crowding-in):
1. i% ↓
outflow of capital
currency ↓
Exports ↑ = trade surplus…GDP???

63. Monetary Policy & Exchange Rates:
Expansionary monetary policy (buying bonds):
1. i% ↓
outflow of capital
currency ↓
Exports ↑ = trade surplus…GDP???
Contractionary monetary policy (sell bonds) opposite:
1. i% ↑
2. inflow of capital
3. currency ↑
4. Imports ↑ = trade deficit…GDP???

64. REVIEW:
1. If the exchange rate between the U.S. dollar and Mexican peso fluctuates freely, indicate which of the following will cause the dollar to appreciate or depreciate relative to the peso.
(a) An increase in the quantity of drilling equipment purchased in the U.S. by Pemex (the Mexican oil company) as a result of a Mexican oil discovery?
(b) An increase in the U.S. purchase of crude from Mexico as a result of development of Mexican oil fields?
(c) Higher real interest rates in Mexico?
(d) Lower real interest rates in the U.S.?
(e) Inflation in the United States?
(f) An economic boom in Mexico?
(g) Attractive investment opportunities in Mexican firms?

65. AP Test Breakdown: Section I: 60 multiple choice (70 minutes)
*66% of exam score from multiple choice…
-percent correct on multiple choice for passing score of 3???
Section II: 3 FRQ’s (10 min. prep, 50 min. writing)
*33% of exam score from 3 free response, but question #1 is 50% of the 3…