1. AP Macro Review

2. Actual Test Day: You need: You can not have: Pencils
Pen (blue or black only)
Personal ID
You can not have:
Phones
Calculators

3. Part 1: The Content
What is in the AP Curriculum?

4. Basic Economic Concepts . (8–12%)
A. Scarcity, choice, and opportunity costs
B. Production possibilities curve
C. Comparative advantage, specialization, and exchange
D. Demand, supply, and market equilibrium
E. Macroeconomic issues: business cycle, unemployment, inflation, growth

5. A. Scarcity, choice, and opportunity costs
All resources that are both desirable and in limited supply are considered scarce
Resources can be placed into four categories
Land
Labor
Capital (Physical AND Human)
Entrepreneurship
Choice
Because of scarcity, we have to make choices
When ever a choice is made, alternatives are forgone
Opportunity cost
Most desirable alternative forgone when a choice is made

6. B. Production possibilities curve
Shows various ways an economy can allocate scarce resources between the production of two things
Each axis represents a good or service that could be produced
The line/curve itself represents different combinations that utilize all available resources.
Called the “Frontier”
Economic growth is shown by an outward shift of the frontier. Can be caused by:
More resources
Better technology

7. C. Comparative advantage, specialization, and exchange
Focusing on the good or service that can be made at the lowest opportunity cost
When calculating remember:
Input problem? IOU (Input = Other goes Under)
Output problem? OOO (Output = Other goes Over)
Specialization
Basis for global trade
Countries focus on producing whatever good they can make the most efficiently and trade with other nations
Exchange
As long as both parties benefit, there is a net gain from trade.
Trade between countries allows them to consume outside their production possibilities curves.

8. D. Demand, supply, and market equilibrium
Represents consumers
Negative Slope
Determinants (things that shift it)
Consumer Tastes
Price of related goods
Population
Consumer Income
Future Prices
Supply
Represents producers
Positive slope
Determinants
Technology
Input costs
# of suppliers
Future prices

9. E. Macroeconomic issues: business cycle, unemployment, inflation, growth
Four Phases:
Expansion/recovery – growing GDP
Peak
Recession/contraction – shrinking GDP
Trough
Unemployment
Measured by the Unemployment Rate
(# of unemployed)/(total labor force) = Unemployment rate
Three types:
Cyclical – caused by recession/economic downturn
Structural – skills do not match available jobs
Frictional – chose to leave job to find another/looking for first job
Inflation
Measured by the Consumer Price Index (CPI)
[(Price in current year)/($ in base year)] x 100 = CPI
Values > 100 indicate inflation since base year

10. Measurement of Economic Performance (12–16%)
A. National income accounts
1.Circular flow
2.Gross domestic product
3.Components of gross domestic product
4.Real versus nominal gross domestic product
B. Inflation measurement and adjustment
1.Price indices
2.Nominal and real values
3.Costs of inflation
C. Unemployment
1.Definition and measurement
2.Types of unemployment
3.Natural rate of unemployment

11. National Income Accounts: Circular Flow – Part 1
Simple Circular Flow
Shows interaction between producers (firms) and consumers (households)

12. National Income Accounts: Circular Flow – Part 2
Expanded Circular Flow
More realistic picture of money moving through an economy
REMEMBER: Money going into each square MUST EQUAL money going out

13. National Income Accounts: Gross Domestic Product
GDP is the total dollar value of all final goods in services produced in a country in a given year
Final goods – goods in the final form they are sold
Produced within a country – only domestically produced goods count toward GDP
Not counted
Intermediate goods – used to make final goods
Used goods – already have been counted
Transfers – money changing hands (stock, bonds, social security, etc…)
Foreign Produced – count toward other nations GDP
Underground Economy – illegal goods and “under the table” payments

14. National Income Accounts: Components of GDP
Expenditure Approach – measures total spending
C+I+G+NX = GDP
C = consumer spending. Largest component.
I = investment (business spending, inventories)
G = government spending
NX = net exports (imports – exports)
Income Approach – measures total income
Sum of all income sources
Wages for labor
Rents from land
Interest from capital
Profits from entrepreneurship
Remember: Aggregate spending = Aggregate income

15. National Income Accounts: Real and Nominal GDP
Nominal GDP – Value of current production using current prices
Real GDP – Value of current production, but using prices from a fixed point in time
Also called “constant dollar GDP”
Accounts for inflation
More accurate
“Deflating” Nominal GDP
Real GDP = 100 x (nominal GDP)/(Price Index)

16. Inflation measurement and adjustment: Price Indexes
Main measure of inflation is the CPI
Calculated by the Bureau of Labor Statistics
Establishes the rate of inflation by comparing prices of a “market basket” of goods to a base year
Calculating a price index
Price Index = 100 x [Current year $/Base year $]

17. Inflation measurement and adjustment: Nominal and Real Values
“Nominal” = Not adjusted for inflation
“Real” = Adjusted for inflation

18. Nominal V Real 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

19. Nominal V Real 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

20. Nominal V Real INTEREST RATE
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

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

22. Nominal V Real 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 services a worker can purchase with their NOMINAL WAGE; purchasing power of the nominal wage.
(Real = Nominal – Inflation rate)

23. 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.

24. Inflation measurement and adjustment: Costs of Inflation
Unexpected Inflation Hurts:
Businesses that have to change prices
menu costs
People of Fixed incomes
pension receivers & minimum wage earners
People saving money at fixed interest
People loaning money at fixed interest
Unexpected Inflation Helps
People borrowing money at fixed interest

25. Unemployment: Definition and Measurement
Measurements:
Labor Force – Sum of all individuals over 16 that are employed or unemployed
Remember: Unemployed MUST BE searching for work
Not searching for work = “discouraged worker”
Unemployment Rate – Unemployed/Labor Force

26. Unemployment: Types of Unemployment
Frictional – Someone new enters labor market OR chooses to switch jobs
Seasonal – periodic/predictable job loss
Structural – Jobs lost because skills are no longer in demand
Cyclical – Jobs lost as a result of an economic downturn

27. Unemployment: Natural Rate of Unemployment
Full Employment:
NO CYCLICAL UNEMPLOYEMENT
Traditionally 5-6%
Natural Rate of Unemployment
Unemployment rate associated with full employment

28. National Income and Price Determination (10–15%)
A. Aggregate demand
1.Determinants of aggregate demand
2.Multiplier and crowding-out effects
B. Aggregate supply
1.Short-run and long-run analyses
2.Sticky versus flexible wages and prices
3.Determinants of aggregate supply
C. Macroeconomic equilibrium
1.Real output and price level
2.Short and long run
3.Actual versus full-employment output
4. Business cycle and economic fluctuations

29. Aggregate demand: Determinants
AD Always slopes down
Wealth effect – As prices rise purchasing power of wealth falls
AD Shifts when…
There is a change in consumer spending
There is a change in government spending
There is a change in investment spending
This includes changes in taxes and transfers
There is a change in net exports

30. Aggregate demand: Multipliers
Consumption and Savings
MPC = △Consumption/ △Disposable Income
MPS = △Savings/ △Disposable Income
MPC + MPS = 1
Spending Multiplier
1/MPS or 1/(1-MPC)
Tax Multiplier
MPC/MPS
ALWAYS smaller then spending multiplier
Taxes have a smaller impact than government spending!
Commonly Used Multipliers…
If MPC is
The Spending Multiplier is..
.90 10
.80 5
.75 4
.50 2

31. Aggregate supply: Short-run v Long-run
Short Run AS
Input costs and wages are “sticky” in the short run and do not change quickly
This lag between changes in output price and input prices create a positive slope
Long Run AS
All inputs prices are flexible in the long run regardless of price level

32. Aggregate supply: Determinants of AS
Short run shifts
△ input prices
△ taxes on producers
△ regulations
Long Run Shifts
△ Quantity and Quality of resources
△ Technology
△ Human capital (education and training of labor force)
Policy initiatives
Government programs designed to encourage investment

33. Macroeconomic equilibrium: Real output and price level
Macroeconomic equilibrium occurs when real output demanded is equal to real output supplied

34. Macroeconomic equilibrium: short and long run
Short Run Equilibrium
Long Run Equilibrium OR “economy at full employment”

35. Macroeconomic equilibrium: Actual vs Full Employment Output

36. Macroeconomic equilibrium: Business Cycle and Fluctuations

37. IV. Financial Sector (15–20%)
A. Money, banking, and financial markets
1. Definition of financial assets: money, stocks, bonds
2. Time value of money (present and future value)
3. Measures of money supply
4. Banks and creation of money
5. Money demand
6. Money market and the equilibrium nominal interest rate
B. Loanable funds market
1. Supply of and demand for loanable funds
2. Equilibrium real interest rate
3. Crowding out
C. Central bank and control of the money supply
1. Tools of central bank policy
2. Quantity theory of money
3. Real versus nominal interest rates

38. Money, banking, and financial markets

39. Money, banking, and financial markets

40. Money, banking, and financial markets

41. Money, banking, and financial markets

42. Loanable funds market
1. Supply of and demand for loanable funds

43. Loanable funds market 2. Equilibrium real interest rate
Found at the intersection of Slf and Dlf

44. Loanable funds market 3. Crowding out
Government deficits increase the demand for loanable funds because the government bust borrow money to continue operations
This drives up interest rates, and lowers business and personal investment in the economy.

45. Central bank and control of the money supply
1. Tools of central bank policy
Open Market Operations
Buying and selling bonds to influence the amount of money in circulation.
Buy Bonds = Bigger Bucks - MS and AD increase, IR decreases
Sell Bonds = Smaller Bucks - MS and AD decrease, IR increases
Discount Rate
Interest rate a central bank charges member banks for loans
Higher discount rate = Lower MS, AD decreases, IR increases
Lower discount rate = Higher MS, AD increases, IR decreases
Reserve Requirement
The amount of money banks are required to hold in reserves. Influenced the money multiplier
Lower RR = higher MS, AD increases, IR decreases
Higher RR = Lower MS, AD decreases, IR increases

46. Central bank and control of the money supply
2. Quantity theory of money
Velocity of money is defined simply as the rate at which money changes hands.
If velocity is high, money is changing hands quickly, and a relatively small money supply can fund a relatively large amount of purchases.
if velocity is low, then money is changing hands slowly, and it takes a much larger money supply to fund the same number of purchases.
The relationship between velocity, the money supply, the price level, and output is represented by the equation M * V = P * Y
M is the money supply
V is the velocity
P is the price level
Y is the quantity of output.

47. Stabilization Policies . (20–30%)
A. Fiscal and monetary policies
1.Demand-side effects
2.Supply-side effects
3.Policy mix
4.Government deficits and debt
B. The Phillips curve
1.Short-run and long-run Phillips curves
2. Demand-pull versus cost-push inflation
3.Role of expectations

48. Crowding-Out Effect
An Expansionary Fiscal Policy as previously diagrammed will lead to higher interest rates.
At higher interest rates, businesses will take out fewer loans and there will be a decrease in INVESTMENT (I)
At the same time there will be a decrease in CONSUMER SPENDING (C) as they will take out fewer loans as well.
This CROWDING OUT EFFECT will reduce the gain made by the expansionary fiscal policy.

49. Economic Philosophies
Classical: Believes that the government SHOULD NOT interfere in the economy. And believes in self-correction of economic problems.
Keynesian: Believes that GOVERNMENT SHOULD interfere in the economy (taxes, government spending). Most “mainstream” economists are Keynesians
Rational Expectations: Believes that monetary and fiscal policy have certain effects on the economy and take action to make these policies ineffective.

50. Economic Growth . (5–10%) A. Definition of economic growth
B. Determinants of economic growth
1.Investment in human capital
2.Investment in physical capital
3.Research and development, and technological progress
C. Growth policy

51. Definition of economic growth
Defined as an increase in “Real GDP per capita”
Per capita is used in order to isolate the effect of changes in population
Sustained growth in real GDP per capita occurs ONLY WHEN the amount produced by the average worker increases steadily
Productivity = output per worker

52. Determinants of economic growth
Investment in Human Capital
Education and knowledge improve a nations work- force, making it more productive
Investment in Physical Capital
Equipment used to produce a good or service
Technology
Technical means for the production of a good or service

53. Growth Policy Policies that promote economic growth
Promote investments in technology, education, and capital investment

54. Open Economy: International Trade and Finance . (10–15%)
A. Balance of payments accounts
1.Balance of trade
2.Current account
3.Financial account (formerly known as capital account)
B. Foreign exchange market
1.Demand for and supply of foreign exchange
2.Exchange rate determination
3.Currency appreciation and depreciation
C. Imports, exports, and financial capital flows
D. Relationships between international and domestic financial and goods markets

55. Balance of Payments:
The sum of all transactions between U.S. residents and residents of all foreign nations
Current Account: a country’s exports and imports of goods and services.
Capital/Financial Account: Shows the country’s investment (financial as well as capital-plants and factories) abroad and Foreign investment in the country
Credits: A credit are those transactions for which the country receives income (exports, foreign purchase of assets)
Debits: Those transactions that the country must pay for: imports and purchasing of assets abroad.

56. Balance of Payments [continued]
The Current Account and Financial/Capital Account must be equal.
Official Reserves Account: The Central Banks of all nations hold foreign currency to make up any deficit in the combined capital and current accounts.
If the U.S. has more credits than debits it finances this difference by dipping into its reserve account.

57. Foreign exchange market
The value of a foreign nation’s currency in relation to your own currency is called the exchange rate.
An increase in the value of a currency is called appreciation.
A decrease in the value of a currency is called depreciation.
Multinational firms convert currencies on the foreign exchange market, a network of about 2,000 banks and other financial institutions.

58. Types of Exchange Rate Systems
Fixed Exchange-Rate Systems
A currency system in which governments try to keep the values of their currencies constant against one another is called a fixed exchange-rate system.
Flexible Exchange- Rate Systems
Flexible exchange-rate systems allow the exchange rate to be determined by supply and demand.

59. Demand for and supply of foreign exchange
Let’s say a U.S. citizen travels to Japan. This transaction will provide a supply of the U.S. dollar and result in a demand for yen. It will become cheaper for the Japanese to buy the dollar and more expensive for Americans to buy the Yen. The Yen is Appreciating and the dollar is Depreciating.
Yen Price of
dollar
(Y/$)
Dollar Price
of Yen
($/Y)
SY1
S$1 P2
S$2 P1 P1
DY2 P2
DY1
D$1 Q1 Q2 Q1 Q2
Quantity of Yen
Quantity of U.S. Dollars

60. Part 2: The Graphs
You must be able to draw/label/manipulate these graphs

61. Production Possibilities Curve

62. AD/AS

63. AD/AS: Recessionary Gap OR “Below full employment”

64. AD/AS: Inflationary Gap OR “beyond/above full employment”

65. Money Market

66. Loanable Funds Market

67. Phillips Curve: Part I

68. Phillips Curve: Part II

69. Economic Growth Causes of Economic Growth
Increased investment in physical capital
Equipment and machinery
Increased investment in human capital
Education and training
New Technology
Increase in quality/quantity of resources