1. AP Macro Economics Review
Peggy Pride, Presenter

3. Production Possibility Curve
Capital goods B D2 D A C F B D E W
Capital goods
Consumer goods
Consumer goods

4. Market Equilibrium P r i c e
Supply Pe
Demand Qe
Quantity

5. A change in Demand versus a change in the Quantity Demanded
√ Moves the curve
Income
Future Expectations
# of Buyers
Consumer Information
Taste and Preference
Substitues and Complements
Change in Quantity Demanded
√ Moves Along the SAME curve
• Caused only by Price change.

6. Price Change P QD $5 4 3 2 1 10 20 35 55 80 P D o Q Price of Corn $5 Q
Quantity of Corn

7. 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 Q
Quantity of Corn

8. A change in Supply versus a change in the Quantity Supplied
√ Moves the curve
Costs of Production
Future Expectations
# of Sellers
Taxes and Subsidies
Prices of goods using same resources
Time period of production
Change in Quantity Supplied
√ Moves Along the SAME curve
• Caused only by Price change.

9. Price Change P QD $5 4 3 2 1 10 20 35 55 80 P S o Q Price of Corn $5 Q
Quantity of Corn

10. 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 Q
Quantity of Corn

11. Verbal Clues Use a correctly labeled graph and show…
Analyze the effect…
Explain the mechanism…
Identify the area of…
Show the impact…
Calculate (number and process)…
Show price and output…
Compare before and after…
Two separate graphs correctly labeled graph
Side-by-side
What is the relationship…

12. Distinguish between: Price and price level AS and S AD and D ASlr ASsro
PL1
ASsr
ASlr
AD1 Qf
Price Level
Real domestic output

13. GROSS DOMESTIC PRODUCT
Defining…
Market Value of the total goods and services produced within the boundaries of the US whether by Americans or foreigners in one year.

14. + + + + + + + G D = P = GROSS DOMESTIC PRODUCT Consumption Wages
Expenditures Approach
Income Approach
Consumption
by Households
Wages + +
Rents G D P +
Investment
by Businesses = + =
Interest +
Government
Purchases
Profits + +
Expenditures
by Foreigners
Statistical
Adjustments

15. NOMINAL GDP vs. REAL GDP Nominal GDP
… reflects the current price level of goods and services and ignores the effect of inflation on the growth of GDP.
… this measure is called Current Dollar GDP.
Real GDP
… measures the value of goods and services adjusted for change in the price level. It will reflect the real change in output.
… This measure is called the Constant Dollar GDP.
… indicates what the GDP would be if the purchasing power of the dollar has not changed from what it was in a base year. The government currently uses 2000 as its base year for Real GDP measurement.

16. GDP Price Index x 100 = = Nominal GDP Real GDP Price Index
in a given
year =
Price of market basket
in specific year
Price of same market
basket in base year
x 100
Real GDP =
Nominal GDP
Price Index
(in hundredths)

17. Disposable Income = C + S
By subtracting from Personal Income, the dollars lost to taxes, we have the Disposable Income. This is the “bottom” line of national income accounting.
Disposable Income = C + S

18. Unemployment Rate = Unemployed Labor Force
Frictional – “temporary”, “transitional”, “short-term” (“between jobs” or “search” unemployment) (seasonal work)
Structural – “technological” or “long term”. basic changes in the “structure” of the labor force which make certain “skills obsolete”.
Cyclical – “economic downturns” in the business cycle.

19. The Full employment rate of unemployment or the Natural Rate of Unemployment (NRU) is present when the economy is producing its potential output.
The Natural Rate of Unemployment exists when the cyclical unemployment is zero.

20. CPI = x 100 Inflation A rising of the general level of prices
Price of the same market
basket in 2000
x 100
CPI
Price of the market basket in the particular year
Producer Price Index (PPI) Prices at the wholesale or production level which are early indicators of inflation.

21. Real and Nominal Income
Nominal income … is the number of dollars earned as rent, wages, interest or profit
Real income… measures the amount of goods and services nominal income can buy.
√ If nominal income rises faster than price level, real income will rise.
√ If the price level increases faster than nominal income, then real income will fall.
√ Your real income falls only when nominal income fails to keep up with inflation.

22. Qf is the amount of Real GDP at full employment.
Long Run Equilibrium
In the extended AD-AS model, equilibrium occurs at the intersection of AD and the ASlr and the ASsr.
Qf is the amount of Real GDP at full employment. o
PL1
ASsr
ASlr
AD1 Qf
Price Level
Real domestic output

23. DEMAND-PULL INFLATION But…PL rises even more to PL3!
and Self-Correction
Short Run—Increase in AD shows point b
Price Level
ASlr
AS2sr
ASsr
Long Run
Nominal Wages rise and AS2sr moves left. RGDP returns to previous level on Aslr
But…PL rises even more to PL3! c
PL3[7%] b
PL2[5%] a
PL1[2%]
AD2
AD1 o Qf Y2
Real domestic output

24. with government action
COST-PUSH INFLATION
with government action
If government stimulates AD to dotted line, an inflationary spiral will occur…PL3 at Qf. We have Full Employment but at a higher price level.
Price Level
ASlr
AS2sr
ASsr c
PL3[5%] b
PL2[3%] a
PL1[2%]
AD2
AD1 o Y2 Qf
Real domestic output

25. with NO government action
COST-PUSH INFLATION
with NO government action
ASlr
AS2sr
If government lets the recession take its course, nominal wages will fall in the long run and return to point a…PL1 at Qf.
Price Level
ASsr c
PL3[5%] a
PL1[2%]
AD1 o Qf
Real domestic output

26. Recession
This decline in the price level will eventually shift the AS1sr to AS2sr. Price level declines to PL3 at Qf . Shown at point c.
ASlr
AS1sr
Price Level
AS2sr a
PL1[5%]
PL2[3%] b
PL3[2%] c
AD1
AD2 o Qf Y2
Real domestic output

27. The Phillips Curve Concept7 6 5 4 3 2 1
As inflation declines...
Unemployment
increases
Annual rate of inflation PC
Unemployment rate (percent)

28. The Phillips Curve Summary
The short run Phillips Curve is downward sloping.
Aggregate Demand changes move along the same short run Phillips curve.
Aggregate Supply changes create new short run Phillips curves.
√ In the long run, there is not a stable relationship between unemployment and inflation.
√ The long-run Phillips curve is the vertical line at the natural rate of unemployment.

29. Expansionary Fiscal Policy Contractionary Fiscal Policy
Goal: To Reduce Unemployment and Effects of Recession…
√ Increase Government Spending
√ Decrease Tax Rates
…Or Combination of the Two
Contractionary Fiscal Policy
Goal: To Reduce Demand—Pull Inflation…
√ Decrease Government Spending
√ Increase Tax Rates
…Or Combination of the Two

30. EXPANSIONARY FISCAL POLICY
the multiplier at work...
$20 billion decrease in tax rates; $15 billion in new consumption spending AS
$60 billion
increase in
Aggregate
Demand
Price level P2 P1
AD1
AD2
MPS = .25
$490
$550
Real GDP (billions)

31. CONTRACTIONARY FISCAL POLICY
the multiplier at work...
$20 billion increase in tax rates; $15 billion lost in consumption spending AS
$60 billion
decrease in
Aggregate
Demand
Price level P2 P1
AD3
MPS = .25
AD4
$490
$550
Real GDP (billions)

32. Quantity of Loanable Funds
Crowding —Out Effect
Increased demand for loanable funds by government raises the interest rate. S i%
Real Interest Rate, (percent) i% D2 D
LF0
LF1
Quantity of Loanable Funds

33. + + M3 M2 MI Large time deposits Money market accounts
Savings deposits
Small time deposits M2 +
Checkable deposits
Travelers checks
Currency MI

34. The Money Market
Supply of money is a vertical line since monetary authorities (FED) and financial institutions have provided the economy with a certain stock of money. i%
$$ demanded Dm
i%1 Sm

35. √ The banking system creates a “multiplied” amount.
√ One bank can loan only its excess reserves and is limited by those reserves in creating money.
√ The banking system creates a “multiplied” amount.
The Money Multiplier
Money
Multiplier
Required reserve ratio 1 =
Maximum
Demand-
Deposit
creation =
Excess
reserves x
Money
Multiplier
Currency drain and no creditable customers will decrease the amount multiplied.

36. EASY MONEY Goal: Cheap, available credit; increase the money supply
MS i% In C AD PL RGDP
Easy money is reinforced by the Net Export Effect

37. Quantity of money demanded and supplied
Easy 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 AS
If the Money Supply
Increases to Stimulate
the Economy…
Interest Rate Decreases
PL3
Price level
Investment Increases
PL2
AD & GDP Increases
with slight inflation
PL1
AD3(I=$25)
AD2(I=$20)
Increasing money supply
continues the growth –
but, watch Price Level.
AD1(I=$15)
Real domestic output, GDP

38. Tight Money Goal: Restrict credit; decrease the money supply
MS i% In C AD PL RGDP
Tight money is reinforced by the Net Export Effect

39. Quantity of money demanded and supplied
Tight Monetary Policy And Equilibrium GDP
Sm3
Sm2
Sm1
Investment
Demand 10 8 6 10 8 6
Real rate of interest, i Dm
Quantity of money demanded and supplied
Amount of investment, i AS
If the Money Supply
Decreases to “cool”
the Economy…
Interest Rate Increases
PL1
Price level
Investment Decreases
PL2
AD & GDP Decreases
with lower PL
PL3
AD1(I=$25)
AD2(I=$20)
Decreasing money supply
continues the “cooling” –
as Price Level falls.
AD3(I=$15)
Real domestic output, GDP

40. Nominal Rate =
Real Interest rate + expected rate of inflation
Real Interest Rate =
Nominal rate—expected rate of inflation

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

42. Money Market Graph—Nominal Interest Rate
The supply of money is vertical no matter what the interest rate is on the vertical axis. The FED controls the supply of money. Sm i%
Q of $$ demanded Dm
The demand for money is composed of the transaction demand and asset demand.
i%e Qe

43. Loanable Funds Market—Real Interest Rate
Demand is:
• Business for investment
• Consumer for spending
• Government for Deficit spending r
SLF re
DLF
Supply is mostly from private savings Qe
Q of LF
Changes in the real interest rate caused by movements of demand (from borrowers) and supply (from savers).

44. Classical View:
√ AS is vertical and determines the output at Qf
√ AD is stable and determines the price level as long as money supply is stable.
√ If AD is unstable, prices and wages adjust. AS
Price Level P1 P2
AD1
AD2 Qf
Real Domestic Output
A shift to AD2 shows that the price level declines.

45. Keynesian View: AS √ AS is horizontal up to Qf then becomes vertical
√ Product prices and wages are downward inflexible
√ AS is horizontal up to Qf then becomes
vertical
√ If AD is unstable, changes in AD have no effect on PL but affect RGDP. AS
Price Level
Real Domestic Output P1
AD1
AD2 Q2 Qf
Movement from AD1 to AD2 reduces the Real GDP but the PL remains constant.

46. Self-Correction AS2 ASLR AS1 P3 P2 P1 AD2 AD1 Q1
NEW CLASSICAL VIEW OF SELF-CORRECTION
Self-Correction
AD increases moves economy from a to b.
Price level rises (P2) and then self-correction to c by shifting left to AS2 as Nominal Wages rise.
AS2
ASLR
AS1
Price Level P3 c P2 b P1 a
AD2
AD1 Q1
Real Domestic Output

47. Deficits, Surpluses and Debt
A budget deficit is the amount by which the government expenditure exceeds the government revenue in a particular year.
A budget surplus is the amount by which the government revenue exceeds the government expenditure in a particular year.
The National or Public Debt is the accumulated deficits and surpluses of the government over time.

48. √ Comparative Advantage …is the ability to produce an item at a lower opportunity cost. Resources are scarce, so that one can only produce more of one product by taking the resources away from another. It means that total world output will be greatest when each good is produced by the nation which has the lowest domestic opportunity cost.
√ As a result of trade, countries that trade products based on their own specialization will have more of BOTH products (produced and traded for).
√ Terms of Trade…the exchange ratio between goods traded. This ratio explains how the gains from international specialization and trade are divided among the trading nations; it depends on the world supply and demand for the two products.

49. The intersection will be the exchange rate.
Flexible exchange rates S
$ Price of
Foreign Currency
The intersection will be the exchange rate.
$fc D
Qfc
Quantity of Foreign Currency

50. A nation’s Balance of Payments records all the transactions that take place between its residents and the residents of a foreign nation.
Current Account
Mdse. Trade
Services Trade
Net Investment Income
Net Transfers
Capital Account
Real Investment
Financial Investments
Official Reserves Account
+ to balance a deficit
—to balance a surplus =

51. Determinants of exchange rates:
Changes in tastes
Changes in relative incomes
Changes in relative prices
Changes in relative interest rates
Speculation in currencies