1. UNIT 1 Basic Economic Concepts
AP Exam Review
UNIT 1 Basic Economic Concepts

2. Scarcity
Society has unlimited wants
Economic resources are scarce

3. Economic Resources include:
land – all gifts of nature
Labor – all physical and mental talents
Capital – manufactured aids used in producing goods and services
Entrepreneurial ability – takes initiative and risk

4. Opportunity Cost
what must be given up in order to get something

5. Production Possibilities Model
Graphic representation of opportunity cost
Each point on the curve represents some
maximum output of two products

6. Law of increasing opportunity cost –
the more of a product that is produced, the greater its opportunity cost
Shape of the curve illustrates the law
Guns and butter is a classic economics comparison. Guns represent capital goods and butter represents consumer goods.

7. Production possibilities curve may shift if:
Increase in resources
Advances in technology

8. Production Possibilities Curve Practice

9. Assume the economy represented is presently producing 12 units of Good B and 0 units of good A.
The opportunity cost of increase production of Good A from 0
units to 1 unit is the loss of _____________ unit(s) of Good B.
The opportunity cost of increasing production of Good A from 1
unit to 2 units is the loss of ________ units(s) of Good B.
The opportunity cost of increasing production of Good A from 2 units to 3 units is the loss of ______ unit(s) of Good B.
This is an example of ________________ opportunity cost per unit for Good A.

10. Assume the economy represented is presently producing 12 units of Good B and 0 units of good A.
The opportunity cost of increase production of Good A from 0
units to 1 unit is the loss of unit(s) of Good B.
The opportunity cost of increasing production of Good A from 1
unit to 2 units is the loss of units(s) of Good B.
The opportunity cost of increasing production of Good A from 2 units to 3 units is the loss of unit(s) of Good B.
This is an example of constant opportunity cost per unit for Good A.

11. More Production Possibilities Practice

12. Assume the economy represented
Is currently producing 12 units of Good B and 0 units of Good A.
The opportunity cost of increasing production of Good A from 0 units to 1 unit is the loss of _____unit(s) of Good B.
The opportunity cost of increasing production of Good A from 1 unit to 2 units is the loss of _____ unit(s) of Good B.
The opportunity cost of increasing production of Good A from 2 units to 3 units is the loss of ____ unit(s) of Good B.
This is an example of _____ opportunity cost per unit for Good A.

13. Assume the economy represented
Is currently producing 12 units of Good B and 0 units of Good A.
The opportunity cost of increasing production of Good A from 0 units to 1 unit is the loss of unit(s) of Good B.
The opportunity cost of increasing production of Good A from 1 unit to 2 units is the loss of unit(s) of Good B.
The opportunity cost of increasing production of Good A from 2 units to 3 units is the loss of unit(s) of Good B.
This is an example of increasing opportunity cost per unit for Good A.

14. More Production Possibilities Practice

15. Production Possibilities Curve Practice
Assume that the following data represents 4 years of GDP for the US.
Assume that “Efficient” levels of production would create 5% unemployment.
Show the four years on a single PPC graph.
Show each year as a point on the graph and show new frontiers if appropriate.
Label the PPC graph correctly.
GDP for the year
Unemployment %
Year A
10 Trillion Dollars
10%
Year B
11 Trillion Dollars 5%
Year C
15 Trillion Dollars
Year D
16.5 Trillion Dollars

16. HINT – start like this Consumer Goods Capital Goods GDP for the year
GDP for the year
Unemployment %
Year A
10 Trillion Dollars
10%
Year B
11 Trillion Dollars 5%
Year C
15 Trillion Dollars
Year D
16.5 Trillion Dollars

17. Consumer Goods A Capital Goods GDP for the year Unemployment % Year A
11 trillion A
Capital Goods
GDP for the year
Unemployment %
Year A
10 Trillion Dollars
10%
Year B
11 Trillion Dollars 5%
Year C
15 Trillion Dollars
Year D
16.5 Trillion Dollars

18. Consumer Goods B A Capital Goods GDP for the year Unemployment %
11 trillion B A
Capital Goods
GDP for the year
Unemployment %
Year A
10 Trillion Dollars
10%
Year B
11 Trillion Dollars 5%
Year C
15 Trillion Dollars
Year D
16.5 Trillion Dollars

19. Consumer Goods B C A Capital Goods GDP for the year Unemployment %
16.5 trillion
Consumer Goods
11 trillion B C A
Capital Goods
GDP for the year
Unemployment %
Year A
10 Trillion Dollars
10%
Year B
11 Trillion Dollars 5%
Year C
15 Trillion Dollars
Year D
16.5 Trillion Dollars

20. Consumer Goods D B C A Capital Goods GDP for the year Unemployment %
16.5 trillion
Consumer Goods D
11 trillion B C A
Capital Goods
GDP for the year
Unemployment %
Year A
10 Trillion Dollars
10%
Year B
11 Trillion Dollars 5%
Year C
15 Trillion Dollars
Year D
16.5 Trillion Dollars

21. Supply and Demand Change in quantity supplied Caused by a price change
Movement along the curve
Change in supply
caused by determinants of supply
Shift of the curve
Change in quantity demanded
Caused by price change
Movement along the curve
Change in demand
Caused by determinants of demand
Shift of the curve

22. Price Ceiling

23. Price Floor

24. Basic Economic Concepts Test Questions

25. If an effective price floor is removed from a market for good, then the price and quantity of the good sold will change in which of the following ways?
Price Quantity
a. Increase Increase
b. Increase Decrease
c. Decrease Decrease
d. No change Increase
e. Decrease Increase

26. Which of the following would best explain an inward shift of the production possibilities curve?
a. A decrease in the quantity of inputs required to produce a unit of output.
b. An increase in the rate of savings.
c. A decrease in the quality of human capital
d. A decrease in the government’s budget deficit that leads to lower real interest rates.
e. An increase in the labor force participation rate.

27. The best combination of belts and coats for this economy is
a. 95 belts and 1 coat
b. 85 belts and 2 coats
c. 70 belts and 3 coats
d. 40 belts and 4 coats
e. indeterminate with the available information

28. Which of the following could explain the movement from point B to point A?
a. An increase in consumer income.
b. An increase in the price of a complementary good.
c. An increase in the price of a substitute good.
d. An increase in the price of the good
e. None of the above.

29. UNIT 2 Measure of Economic Performance
AP Exam Review
UNIT 2 Measure of Economic Performance

30. Formula Cards

31. GDP GDP = C + Ig + G + Xn Consumption Net Exports Exports – Imports
X-M
Gross Business Investment
Government
Spending
Consumption

32. Nominal GDP
Nominal GDP = Units of output x price

33. Real GDP
Real
GDP
Nominal GDP__
price index
(in hundredths) =

34. Real GDP = X Real Price of good in quantity of good sold
GDP base year in given year = X

35. Unemployment Rate
Unemployment
Rate
unemployed
labor force =
X 100

36. change
Percent
change
Year 2 – Year 1
Year 1 =
X 100

37. Circular Flow Diagram
Resource Market and Factor Market
Households own factors of production – sell them to Firms
Firms buy factors of production – pay wages, rent etc.
Product Market
Firms sell goods and services to households
Households pay for goods and services

38. GDP Formula The expenditures approach - C + Ig + G + Xn = GDP
C = Personal Consumption
Purchases of finished goods and services
NOT houses or other construction
Ig = Gross Private Business Investment
a. Factory equipment maintenance
New factory equipment
New Construction (houses or factory)
Unsold inventory of products build in a year, but not sold in that year
G = Government Spending
Xn = Net foreign factor of Trade: Exports minus Imports
Exports = dollars in
Imports = dollars out
Since WWII, Xn has usually been a negative number
C + Ig + G + Xn = GDP
GDP

39. What doesn’t count in GDP
Second hand goods
Gifts or transfers (social security welfare etc.)
Stock market transactions
Unreported business activities
Illegal activities
Financial transactions between banks and businesses
Non market activities like volunteer work

40. Does it Count?

41. The bicycle you got at the neighbor’s garage sale.

42. The designer shoes you found half price at Nordstrom

43. Your new back to school lunchbox

44. Grandma’s Social Security Check

45. The value of the time you spend volunteering at the local animal shelter

46. The $20 cash you earned babysitting.

47. The $20 you paid for a pedicure.

48. The $20 you paid to a “street pharmacist”

49. The $20 worth of girl scout cookies you bought

50. GDP Practice Question

51. GDP in an economy is $3452 billion
GDP in an economy is $3452 billion. Consumer expenditures are $2343 billion, government purchases are $865 billion and gross investment is $379 billion. What are Net exports?

52. GDP in an economy is $3452 billion
GDP in an economy is $3452 billion. Consumer expenditures are $2343 billion, government purchases are $865 billion and gross investment is $379 billion. What are Net exports?
Formula to use -- C + Ig + G + Xn = GDP
$ $379 + $865 + Xn = $3452
$ Xn = $3452
Xn = -135

53. Business Cycle – alternating rises and declines in economic activity
A. Peak – business activity has reached a temporary maximum
B. Recession – decline in total output, income, employment, and trade
C. Trough – output and employment are at their lowest levels
D. Recovery – output and employment rise toward full employment

54. Who isn’t in the labor force 1. under 16 2. in the military
3. institutionalized
4. retired
5. homemakers
6. students
7. discouraged workers
Who does count as part of the labor force
1. full time workers
2. part time workers (even if they would rather be working full time
3. unpaid family workers
4. those on sick leave, vacation, or strike
5. looking for work

55. Frictional unemployment – those between jobs Structural unemployment
Types of Unemployment
Frictional unemployment – those between jobs
Structural unemployment
Caused by changes in consumer demand
Change in technology
Geographical changes
Cyclical unemployment – in the recession stage of the business cycle
What does the rate mean
1. 0% - 3% - overextended economy
2. 4 – 5% - full employment
3. 6% + - weak or recession economy
4. 25% - highest unemployment 1933

56. What Type of Unemployment is it?
Frictional
Cyclical
Structural
Not unemployed

57. A computer programmer is laid off because of a recession.
Cyclical

58. An unemployed college graduate is looking for his first job.
Frictional

59. A college graduate works at a job that does not require a college education.
Not unemployed

60. Advances in technology make the assembly-line worker’s job obsolete.
Structural

61. UNIT 3 National Income and Price Determination
AP Exam Review
UNIT 3 National Income and Price Determination

62. Marginal Propensity to consume
A. Marginal = extra
B. proportion of any change in income that is consumed
C. MPC = change in consumption
change in income
Marginal Propensity to Save
A. proportion of any change in income that is saved
B. MPS = change in saving
C. MPC + MPS = 1

63. leads to an even bigger change in GDP
Multiplier
A small change in
Investment spending
Consumption
Net exports
Government purchases
leads to an even bigger change in GDP
Multiplier determines how large the change will be
Multiplier =
___1___
1 - MPC
_1__
MPS

64. NOTICE
For each person getting $1,000, several consumption events will occur.
The spending multiplier Formula is used to estimate the amount of money that is “created.”
__1__ _1_
1 – MPC MPS

65. THEREFORE . . .
If the MPC is .9, what is the multiplier?

66. THEREFORE . . . If the MPC is .9, what is the multiplier?
__1___ __1__ _1_
1 – MPC
Multiplier =
= 10

67. THEREFORE . . .
How many new dollars of consumption will be created if government increases it’s spending by $1000.
multiplier x initial spending event
10 x $1000 = $10,000 total addition to GDP

68. What if the MPC is .5?
If the MPC is only .5 what is the multiplier?

69. What if the MPC is .5? If the MPC is only .5 what is the multiplier?
__1___ __1__ _1_
1 – MPC
Multiplier = = =
= 2

70. What if the MPC is .5?
How many new dollars of consumption will be created if government increases it’s spending by $1000.
multiplier x initial spending event
2 x $1000 = $2000 total addition to GDP

71. The same formula works for AD AD = C + I + G + Xn
Remember this formula?
Instead of X – M we used Xn
The same formula works for AD
AD = C + I + G + Xn
When part of the formula changes the curve will shift

72. Aggregate Demand Movement along the AD curve
1. caused by a change in price level
2. movements along a fixed aggregate demand curve represent changes in real GDP

73. Shift in the curve or demand shock
Rightward shift shows increase in AD
Leftward shift shows decrease in AD
Shifts caused by a change in the determinants of AD
a. Consumer spending - C
b. Investment spending - Ig
c. Government spending - G
d. Net export spending - Xn
Real GDP

74. Aggregate Supply
Shows the level of real domestic output firms will produce at each price level
AS curve is upward sloping showing a positive relationship between price and output
Movement along the curve caused by a change in price
SRAS

75. Shift in the curve or Supply Shock Leftward shift – decrease in SRAS
Rightward Shift – increase in SRAS
Changes in factors other than price shift curve
Change in price of resources (input)
Change in wages (input)
Changes in productivity

76. Long Run Equilibrium
Where short run equilibrium and LRAS curve intersect
The economy self corrects

77. AP Exam Review
UNIT 4 Stabilization

78. Tools of fiscal policy
Taxes
Government Spending

79. Expansionary Policy on the graph
During a recession, short run equilibrium is below full employment level of output.
AD is too low
Government can increase AD by:
Spending more (in the formula G )
Cutting taxes (which means you will spend more and in the formula C )

80. Contractionary Policy on the graph
When there is inflation, short run equilibrium is above full employment level of output.
AD is too high
Government can decrease AD by:
Spending less (in the formula G )
Raising taxes (which means you will spend less and in the formula C )

81. Discretionary and Automatic Stabilizers
A. Discretionary
1. a specific action that has to be taken by
government
2. passing a law to change taxes or spending
B. Automatic stabilizers
1. policies or laws already in place
2. unemployment insurance – payments keep
AD from falling as much as they would otherwise

82. The Political Business Cycle
A. Fiscal policy happens in the political arena and is
handled by politicians
B. Election results are determined by the economy
C. Economic policy can be used to serve political ends.
D. Monetary policy in the hands of the Fed can be a solution

83. Short Run Phillips Curve
A. Inverse relationship between inflation and unemployment
1. Low unemployment leads to rising wages which leads to inflation
2. high unemployment leads to falling wages which keeps inflation low

84. Phillips Curve
Example

85. The SRPC illustrates the inverse relationship between the inflation rate and the unemployment rate.
The SRPC is drawn with a given level of expected inflation. If expected inflation changes SRPC will shift.
In the long run, no matter what the expected inflation rate is, the economy will settle at the natural rate of unemployment. The natural rate of unemployment is where LRPC is.

86. SRPC crosses LRPC where:
The Phillips Curve
SRPC crosses LRPC where:
actual inflation rate = expected inflation rate
Inflation
You get what you expect
When AD shifts
Move along the Phillips Curve
When AS shifts
Phillips curve shifts

87. AD Price Output Inflation unemployment This corresponds to Price Level
LRAS
LRPC
SRAS B B
PL1 A
PLe A
AD1 AD
SRPC Ye Y1
Real GDP
unemployment

88. AD Price Output Inflation unemployment Price Level inflation LRAS LRPC
SRAS A
PLe A B
PL1 B AD
SRPC
AD1 Y1 Ye
Real GDP
unemployment

89. SRAS Price Output Inflation unemployment Price Level inflation LRAS
LRPC
SRAS1
SRAS B B
PL1 A
PLe A
SRPC1 AD
SRPC Y1 Ye
Real GDP
unemployment

90. SRAS Price Output Inflation unemployment Price Level inflation LRAS
LRPC
SRAS
SRAS1 A
PLe A B
PL1 B AD
SRPC
SRPC1 Ye Y1
Real GDP
unemployment

91. AP Exam Review
UNIT 5 Financial Sector

92. Store of Value - a way of holding purchasing power over time
I. Roles of Money
Medium of exchange – an asset that individuals use to trade for goods and services
Store of Value - a way of holding purchasing power over time
Unit of account – measure individuals use to set prices and make economic calculations

93. Definition of Money
A. M1
1. currency
2. checkable deposits
3. traveler’s checks
B. M2
1. M1
2. Near Monies – financial assets that are highly liquid but not directly usable
a. Savings deposits
b. Money market funds
c. Small time deposits – CDs
C. M3
1. M1 and M2
2. large time deposits

94. Bank T accounts
A. Financial spreadsheet that displays an institution’s financial position
B. Assets
1. economic resources, things of value
2. on the left side of the T-account
C. Liabilities
1. debts
2. on the right side of the T-account

95. Assets and Liabilities must be equal --- Are they?
Work through this example:
Suppose Narvaizville has a single bank that has:
$20,000 of deposits
$4000 of reserves
$16,000 of loans
Narvaizville’s central bank has 10% reserve requirement.
Construct a T-account depicting this situation. Make sure you:
differentiate between required and excess reserves
Have assets equal to liabilities.
Assets
Liabilities
Required Reserves $2,000
Excess Reserves $2,000
Loans $16,000
Deposits $20,000
Assets and Liabilities must be equal --- Are they?

96. Work through this example:
Remember the reserve requirement is 10%
What is the multiplier ?
1/rr = 1/.1 = 10
Assets
Liabilities
Required Reserves $2,000
Excess Reserves $2,000
Loans $16,000
Deposits $20,000

97. Work through this example:
Suppose the bank in Narvaizville lends all its excess reserves (the amount you calculated in the previous problem) until it reaches the point where its excess reserves equal zero.
How much additional money will the bank lend out?
$2,000
How much money will this additional lending add to the money supply?
$2,000 x 10 (multiplier) = $20,000

98. Work through this example:
How much money will this additional lending add to the money supply?
$2000 x 10 (multiplier) = $20,000
Assume that all of the money that is created will be deposited in the bank and that the bank will loan out all excess reserves. Create a t-account that shows this.
Assets
Liabilities
Required Reserves $4,000
Excess Reserves $0
Loans $36,000
Deposits $40,000

99. a. Banks that need reserve can borrow
Monetary Policy Tools
Reserve Requirement
a. Banks that need reserve can borrow
1. from one another – pay federal funds rate
2. from the FED at the discount window
Discount Rate
a. Interest rate the Fed charges on loans
b. Normally set above federal funds rate to discourage borrowing from the FED
Open Market Operations
a. Fed buys and sells U.S. Treasury Bills (Bonds)
b. Buying increases the money supply
c. Selling decreases the money supply
FOMC meeting

100. To help remedy these problems we should. . .
Inflationary Gap
Recessionary Gap
Price Level
LRAS
LRAS
Price Level
SRAS
SRAS E E AD AD
Real GDP
Real GDP
To help remedy these problems we should. . .
Money supply
Reserve Requirements
Discount Rate
_______ bonds
Money Supply
Reserve Requirements
Discount Rate
________ bonds
buy
sell

101. Money Market Curve

102. Interest Rate and Equilibrium
1. Increase money supply moves curve right.
a. Lowers interest rate
b. Caused by FED action
1. buy bonds
2. lower reserve requirement
3. lower discount rate
Interest Rate
MS MS1 MD
Quantity of money

103. Interest Rate and Equilibrium
1. decrease money supply moves curve left.
a. Raises interest rate
b. Caused by FED action
1. sell bonds
2. raise reserve requirements
3. raise discount rate
Interest Rate
MS MS MD
Quantity of money

104. Loanable Funds

105. Loanable Funds

106. What Crowding Out looks like
Interest rate
The Government increases spending and funds this increase by borrowing.
Increase in demand for loanable funds S re D Qe
Quantity of loanable funds

107. What Crowding Out looks like
Interest rate
The Government increases spending and funds this increase by borrowing.
Increase in demand for loanable funds
Interest rates increase and “crowd out” private investment S r1 re D1 D Qe
Quantity of loanable funds