1. AP Economics Final Exam Review

2. Major Players Adam Smith – wrote “Wealth of Nations” (1776), promoter of laissez-faire, market driven economics Adam Smith – wrote “Wealth of Nations” (1776), promoter of laissez-faire, market driven economics David Ricardo – Comparative Advantage David Ricardo – Comparative Advantage Karl Marx – Communist Manifesto (1848) Karl Marx – Communist Manifesto (1848) John Maynard Keynes – Father of Modern Macroeconomics, asserts that government intervention is sometimes necessary to stabilizing the economy John Maynard Keynes – Father of Modern Macroeconomics, asserts that government intervention is sometimes necessary to stabilizing the economy

3. The Basics Marginal Analysis – Marginal Cost vs. Marginal Benefit Marginal Analysis – Marginal Cost vs. Marginal Benefit Opportunity Cost – What is lost when we make certain economic decisions. Opportunity Cost – What is lost when we make certain economic decisions. Theoretical Economics – systematically arranging facts, interpret them, and then generalize from them Theoretical Economics – systematically arranging facts, interpret them, and then generalize from them Rational Behavior – We assume that humans will act rationally when it comes to making economic decisions Rational Behavior – We assume that humans will act rationally when it comes to making economic decisions

4. Economic Goals Economic Growth Economic Growth Full Employment Full Employment Economic Efficiency Economic Efficiency Price-Level Stability Price-Level Stability Economic Freedom Economic Freedom Equitable Distribution of Income Equitable Distribution of Income Economic Security Economic Security Balance of Trade Balance of Trade

5. Basics Continued Positive Economics – Fact based statements Positive Economics – Fact based statements Normative Economics – Opinion based statements Normative Economics – Opinion based statements Post Hoc Fallacy – We cannot assume that certain effects are the result of specific behavior in some cases Post Hoc Fallacy – We cannot assume that certain effects are the result of specific behavior in some cases

6. The Economizing Problem Scarcity of Resources – We must develop a system that allocates effectively the limited amount of resources available for consumption Scarcity of Resources – We must develop a system that allocates effectively the limited amount of resources available for consumption 4 Factors of Production - Land, Labor, Capital, Entrepreneurship 4 Factors of Production - Land, Labor, Capital, Entrepreneurship Full Employment – Understand what is meant, desired goal is 4-6% unemployment Full Employment – Understand what is meant, desired goal is 4-6% unemployment

7. Production Possibilities Understand what a table, a graph, and a curve could all look like and how they depict opportunity cost as it relates to the production of two different goods Understand what a table, a graph, and a curve could all look like and how they depict opportunity cost as it relates to the production of two different goods

8. Supply & Demand Law of Demand – The lower the price, the higher the quantity demanded (Downward sloping in Expenditure Model) Law of Demand – The lower the price, the higher the quantity demanded (Downward sloping in Expenditure Model) Law of Supply – Firms will produce more of a product the higher the price for that product (Upward sloping in Expenditure Model) Law of Supply – Firms will produce more of a product the higher the price for that product (Upward sloping in Expenditure Model)

9. Supply & Demand Cont’d Law of Diminishing Marginal Utility – As a product is consumed in greater quantities, the satisfaction level for that product will decrease Law of Diminishing Marginal Utility – As a product is consumed in greater quantities, the satisfaction level for that product will decrease Demand Determinants – Consumer tastes, number of consumers, income levels, price level, expectations Demand Determinants – Consumer tastes, number of consumers, income levels, price level, expectations Supply Determinants – Resource prices, technology, taxes & subsidies, competition, Supply Determinants – Resource prices, technology, taxes & subsidies, competition, Substitute Goods vs. Complementary Goods Substitute Goods vs. Complementary Goods

10. The Market System Command Economies vs. Market Economies Command Economies vs. Market Economies Importance of private property rights Importance of private property rights Specialization as it relates to the division of labor Specialization as it relates to the division of labor The “Invisible Hand” The “Invisible Hand” The How, What, & Who question The How, What, & Who question

11. General View of U.S Economy Sole Proprietorship – Single ownership Sole Proprietorship – Single ownership Partnership – Two or more owners Partnership – Two or more owners Corporations – Legally formed organization, funds raised through sale of stock, double taxation Corporations – Legally formed organization, funds raised through sale of stock, double taxation LLC – Limited Liability Company LLC – Limited Liability Company Government intervenes in the form of transfer payments, restricting monopolies, & promoting stability Government intervenes in the form of transfer payments, restricting monopolies, & promoting stability

12. The Global Economy Comparative Advantage & Specialization Comparative Advantage & Specialization Foreign Exchange Market – Currencies are traded or exchanged so that each country may receive its desired monetary unit when purchasing goods and services Foreign Exchange Market – Currencies are traded or exchanged so that each country may receive its desired monetary unit when purchasing goods and services Exchange Rate - Rate at which one currency is exchanged for another Exchange Rate - Rate at which one currency is exchanged for another Tariffs and their effect on the global economy Tariffs and their effect on the global economy

13. Measuring Domestic Output GDP – Measure of the total amount of goods & services produced in a given year within the borders of the U.S.A. GDP – Measure of the total amount of goods & services produced in a given year within the borders of the U.S.A. Only final goods are counted as multiple counting must be avoided to maintain accuracy Only final goods are counted as multiple counting must be avoided to maintain accuracy Transfer Payments and stock purchases are NOT counted as a way to figure GDP Transfer Payments and stock purchases are NOT counted as a way to figure GDP

14. Measuring Domestic Output Expenditures Approach - C+Ig+Xn+G=GDP Expenditures Approach - C+Ig+Xn+G=GDP Income Approach – Rents + Interest + Proprietor Income + Corporate Profits + Wages - This = National Income - You also must add Indirect Business Taxes + Depreciation + Net Foreign Factor Income Income Approach – Rents + Interest + Proprietor Income + Corporate Profits + Wages - This = National Income - You also must add Indirect Business Taxes + Depreciation + Net Foreign Factor Income

15. Measuring Domestic Output Nominal (w/ out inflation )GDP vs. Real (w/ inflationary adjustments) GDP Nominal (w/ out inflation )GDP vs. Real (w/ inflationary adjustments) GDP Price Index = Nominal / Real OR Price Index = Nominal / Real OR Real = Nominal / Price Index (in hundredths) Real = Nominal / Price Index (in hundredths)

16. Unemployment & Inflation Structural Unemployment – Structure of the market changes due to changes in demand Structural Unemployment – Structure of the market changes due to changes in demand Frictional Unemployment – The “Natural” unemployment, job seekers continue seeking work Frictional Unemployment – The “Natural” unemployment, job seekers continue seeking work Cyclical Unemployment – Determined by fluctuations in the business cycle Cyclical Unemployment – Determined by fluctuations in the business cycle

17. Unemployment & Inflation Okun’s Law – For every 1 % that the unemployment rate exceeds that natural rate, GDP will decrease by 2% from the previous year Okun’s Law – For every 1 % that the unemployment rate exceeds that natural rate, GDP will decrease by 2% from the previous year Demand-Pull Inflation – Higher streams of income cause demand to increase which results in an increase in the prices of goods and services Demand-Pull Inflation – Higher streams of income cause demand to increase which results in an increase in the prices of goods and services Cost-Push Inflation – usually during recessionary periods, the per unit cost of goods increases and results in firms having to raise prices in order to maintain previous profit levels Cost-Push Inflation – usually during recessionary periods, the per unit cost of goods increases and results in firms having to raise prices in order to maintain previous profit levels

18. Aggregate Expenditures The Multiplier (Real GDP / Change in Spending) – In short, a change in investment spending will have an exponential effect on GDP The Multiplier (Real GDP / Change in Spending) – In short, a change in investment spending will have an exponential effect on GDP Injection – Injecting $ into the economy Injection – Injecting $ into the economy Leakage - $ that falls out of the spending stream Leakage - $ that falls out of the spending stream

19. AD/ AS Models Be able to express this model graphically Be able to express this model graphically Downward sloping AD due to Real Balances Effect (Higher price Level reduces purchasing power or demand), Interest Rate Effect (Higher price means higher interest rates which reduces demand), and Foreign Purchases Effect (High price level increases imports which reduces output) Downward sloping AD due to Real Balances Effect (Higher price Level reduces purchasing power or demand), Interest Rate Effect (Higher price means higher interest rates which reduces demand), and Foreign Purchases Effect (High price level increases imports which reduces output)

20. AD/ AS Models Three phases of AS curve: Three phases of AS curve: Horizontal – Recessionary Horizontal – Recessionary Intermediate – Price Level and Output both increasing, full employment not reached Intermediate – Price Level and Output both increasing, full employment not reached Vertical – Full employment and full production have been achieved Vertical – Full employment and full production have been achieved

21. Fiscal Policy Expansionary Policy – Expanding the role of the government, the money supply, etc. Expansionary Policy – Expanding the role of the government, the money supply, etc. Contractionary Policy – Limiting the role of the government, the money supply, etc. Contractionary Policy – Limiting the role of the government, the money supply, etc. Built-in Stabilizers – Economic features that maintain economic stability throughout the business cycle without requiring specific action from policy makers Built-in Stabilizers – Economic features that maintain economic stability throughout the business cycle without requiring specific action from policy makers

22. Fiscal Policy Continued Recognition Lag – Time involved in actually recognizing the problem in an economy Recognition Lag – Time involved in actually recognizing the problem in an economy Administrative lag – Time involved in between the recognition and then when the corrective action takes place Administrative lag – Time involved in between the recognition and then when the corrective action takes place Operational Lag – Time involved in between in the corrective action and then when actual results can be seen Operational Lag – Time involved in between in the corrective action and then when actual results can be seen

23. Money & Banking Money has 3 basic functions – medium of exchange, unit of account, store of value Money has 3 basic functions – medium of exchange, unit of account, store of value M1 = Currency in circulation M1 = Currency in circulation M2 = Savings deposits, including money markets, and money markets M2 = Savings deposits, including money markets, and money markets Understand that the demand for money has an indirect relationship with interest rates Understand that the demand for money has an indirect relationship with interest rates

24. How Banks & Thrifts Create Money Fractional Reserve Banking – Principle that allows banks to lend out more money than what they actually have as reserves Fractional Reserve Banking – Principle that allows banks to lend out more money than what they actually have as reserves Reserve Ratio = Excess Reserves / Required Reserves Reserve Ratio = Excess Reserves / Required Reserves Banks are unable to loan out required reserves Banks are unable to loan out required reserves

25. How Banks Create Money Federal Funds Rate – Rate at which banks may make overnight loans to each other Federal Funds Rate – Rate at which banks may make overnight loans to each other Monetary multiplier – Similar to the investment spending multiplier, equals 1 / Reserve Ratio. The new multiplier then allows to determine how much money is available for loan in a multi-bank system Monetary multiplier – Similar to the investment spending multiplier, equals 1 / Reserve Ratio. The new multiplier then allows to determine how much money is available for loan in a multi-bank system

26. Monetary Policy 3 Tools used by the Fed to manipulate money supply: 3 Tools used by the Fed to manipulate money supply: Open Market Operations – Selling Bonds Open Market Operations – Selling Bonds Changing the Reserve Ration (rarely done) Changing the Reserve Ration (rarely done) The Discount Rate (Interest Rate) The Discount Rate (Interest Rate)

27. Monetary Policy Continued Easy Money Policy – Actions which usually increase the money supply Easy Money Policy – Actions which usually increase the money supply Tight Money Policy – Actions which usually decrease the money supply Tight Money Policy – Actions which usually decrease the money supply

28. Extending Aggregate Supply Long run aggregate supply is shown with a vertical line that intersect the AD/AS Model at the equilibrium point. Long run aggregate supply is shown with a vertical line that intersect the AD/AS Model at the equilibrium point. Phillips Curve – Depicts relationship between unemployment and inflation (indirect) Phillips Curve – Depicts relationship between unemployment and inflation (indirect) Laffer Curve – Depicts relationship between tax rates and tax revenues. Direct until optimal point is reached. Curve then retracts and is an indirect relationship Laffer Curve – Depicts relationship between tax rates and tax revenues. Direct until optimal point is reached. Curve then retracts and is an indirect relationship Long Run vs Short Run Long Run vs Short Run