AP MACRO MID-TERM REVIEW

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AP MACROMID-TERM REVIEW

• MODULES 1-23
• Mr. Lipman

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UNIT 1 THE BASICS Economics- The study of
scarcity and choice. Macroeconomics- A focus on
the overall ups and downs in the economy
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The Four Factors of Production

• Producing goods and services requires the use of
  resources.
• ALL resources can be classified as one of the
  following four factors of production

Land
Labor
Capital
Entrepreneurship
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• ALL decisions involve trade-offs.

Trade-offs are all the alternatives that we give
up whenever we choose one course of action over
others. (Examples going to the movies or going
to a game)
The most desirable alternative given up as a
result of a decision is known as opportunity cost.

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Key Economic Assumptions

1. Wants are unlimited, resources are limited
   (scarcity).
2. Due to scarcity, choices must be made. Every
   choice has a cost (a trade-off).
3. Everyone acts rationally by comparing the
   marginal costs and marginal benefits of every
   choice
4. Ceteris paribus other things being equal

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In economics the term marginal additional
Thinking on the margin, or MARGINAL ANALYSIS
involves making decisions based on the difference
of additional benefit vs. the additional cost.
Everyone will continue to do the same thing
until the marginal cost outweighs the marginal
benefit being gained and then they will stop
doing it.
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The Various Business Cycles

• Depression
• Recession
• Expansion or growth (which leads to inflation)
• Graph demonstrates changes happening over time as
  cycles change

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When using a PPC always remember that if a point
is inside or on the curve it is feasible but if
it lies outside the curve then it is not
feasible. Being on the curve is most efficient
(aka no missed opportunities)
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• An individual has a comparative advantage in
  producing a good or service if the opportunity
  cost of producing the good is lower for that
  individual than for other people.
• An individual has an absolute advantage in an
  activity if he or she can do it better than other
  people. Having an absolute advantage is not the
  same thing as having a comparative advantage.

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5 KEY ELEMENTS TO SUPPLY DEMAND

• THE DEMAND CURVE
• THE SUPPLY CURVE
• FACTORS THAT CAUSE CURVES TO SHIFT
• MARKET EQUILIBRIUM
• HOW MARKET EQUILIBRIUM CHANGES WHEN SUPPLY OR
  DEMAND CURVE SHIFTS

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Demand is the different quantities of goods
that consumers are willing and able to buy at
different prices. The law of demand
states there is an INVERSE relationship between
price and quantity demanded AS PRICE GOES UP
THE QUANTITY DEMANDED WILL DROP AS PRICE DROPS
DEMAND RISES
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• The law of demand has 3 parts
• 1.The Substitution effect as price of good
  goes up consumers will purchase a substitute good
• 2. The Income effect as price drops the
  purchasing power increases
• 3. Law of Diminishing Marginal Utility
• the more you buy of ANY GOOD the less
  satisfaction you get from each new unit of that
  good.

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Keys to Graphing Supply Demand

• 1. The slope of the curve is always down and to
  the right
• 2. A change in demand at the same price requires
  a SHIFT but a change in demand due to a change in
  price is show as MOVEMENT along the curve

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Demand Will Shift because of

• 1. Market Size
• 2. Expectations
• 3. Related Prices (compliments/substitutes)
• 4. Income (normal inferior)
• 5. Tastes

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Key Terms

• Substitute good is one whose demand goes up when
  the price of another good goes up (coffee and
  tea are examples of this)
• Compliment goods are ones usually used together
  and thus if demand for one falls then demand for
  the other will also fall (cars and gasoline are
  examples of this)
• Most goods are normal (demand increases as
  income rises) but some are inferior (demand
  drops as income risesfor example busesas income
  rises people tend to then take taxis)

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Unit 3 Measuring Economic Performance

• GROSS DOMESTIC PRODUCTION (GDP)
• UNEMPLOYMENT
• INFLATION

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• The most important measure of growth is GDP.
• Gross Domestic Product (GDP) is the dollar value
  of all final goods and services produced within a
  countrys borders in one year.
• Dollar value- GDP is measured in dollars.
• Final Goods-GDP does not include the value of
  intermediate goods. Intermediate goods are goods
  used in the production of final goods and
  services.
• One Year-GDP measures annual economic performance.

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What is NOT included in GDP?

• Intermediate Goods
• No Multiple Counting, Only Final Goods
• EX Price of finished car, not the radio, tire,
  etc.

• 2. Nonproduction Transactions
• Financial Transactions (nothing produced)
• Ex Stocks, bonds, Real estate
• Used Goods
• Ex Old cars, used clothes

• 3. Non-Market (Illegal) Activities
• Ex Illegal drugs, unpaid work

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Circular Flow Diagram Inflow of money into each
market or sector must equal the outflow of money
coming from that market or sector
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How can you measure growth from year to year?
X 100
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• Expenditures Approach-Add up all the spending on
  final goods and services produced in a given
  year.
• GDP C I G Xn (exports-imports)
• C IS CONSUMER SPENDING
• I IS INVESTMENT SPENDING
• G IS GOVERNMENT PURCHASES OF GOODS AND SERVICES
• Xn IS EXPORTS - IMPORTS

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For each situation, identify if it is included in
GDP the identify the category C, I, G, or Xn
AND WHAT IS TOTAL GDP

1. 10.00 for movie tickets
2. 5M Increase in defense expenditures
3. 45 for used economics textbook
4. Ford makes new 2M factory
5. 20K Toyota made in Mexico
6. 10K Profit from selling stocks
7. 15K car made in US, sold in Canada
8. 10K Tuition to attend college
9. 120 Social Security payment to Bob
10. Farmer purchases new 100K tractor

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Included or not Included in GDP?
GDP7,125,010

• 10.00 for movie tickets
• 5M Increase in defense expenditures
• X 45 for used economics textbook
• Ford makes new 2M factory
• X 20K Toyota made in Mexico
• X 10K Profit from selling stocks
• 15K car made in US, sold in Canada
• 10K Tuition to attend college
• X 120 Social Security payment to Bob
• Farmer purchases new 100K tractor

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Real vs. Nominal GDP

• Nominal GDP is GDP measured in current prices.
  It does not account for inflation from year to
  year.

• Real GDP is GDP expressed in constant, or
  unchanging, dollars.
• Real GDP adjusts for inflation.
• REAL GDP IS THE BEST MEASURE OF ECONOMIC GROWTH!

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3 Types of Unemployment
1. Frictional Unemployment

• Temporarily unemployed or being between jobs.
• Individuals with transferable skills
• Seasonal Unemployment
• Examples College Grads, Santa Claus Workers

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2. Structural Unemployment

• Workers DO NOT have transferable skills and these
  jobs will never come back.
• Technological Unemployment
• Workers must learn new skills to get a job.
• Examples
• VCR repairmen
• Carriage makers
• Automobile Workers replaced by robots

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3 Cyclical Unemployment

• Unemployment that results from economic downturns
  (recessions).
• As demand for goods and services falls, demand
  for labor falls and workers are fired.
• Examples
• Steel workers laid off during recessions.
• Restaurant owners fire waiters after months of
  poor sales due to recession.

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The Natural Rate of Unemployment

• 2 of 3 types of unemployment are unavoidable
• Frictional unemployment
• Structural unemployment
• They are natural rate of unemployment (NRU).
• We are at full employment if we have only the
  natural rate of unemployment.
• This is the normal amount of unemployment that we
  SHOULD have.
• The number of jobs seekers equals the number of
  jobs vacancies.

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Three Causes of Inflation 1. Printing
too much Money 2.Demand-Pull Inflation 3.
Cost-Push Inflation
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Measuring Inflation

• Inflation Rate Percentage s
• Price Yr 2 - Price Yr 1 x 100
• Price Yr 1
• The process of bringing the inflation rate down
  is known as Disinflation and it is difficult to
  do because you must temporarily slow growth or
  even depress the economy.

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Key Inflation Terms

• Shoe-leather costs
• Increased transaction costs of shopping around
• Menu Costs
• it costs to change prices
• Unit of Accounts Costs
• inflation makes less reliable as a unit of
  measurement

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Hurt by Inflation Helped by Inflation

• Borrowers-People who borrow money
• A business where the price of the product
  increases faster than the price of resources

• Lenders-People who lend money (at fixed interest
  rates)
• People with fixed incomes
• Savers

Cost-of-Living-Adjustment (COLA) Some works have
salaries that mirror inflation. They negotiated
wages that rise with inflation
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• The most commonly used method to determine
  inflation for consumers is the Consumer Price
  Index
• Here is how it works
• The base year is given an index of 100
• To compare, each year is given an index as well

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Problems with using CPI as a Measurement

• Substitution Bias- As prices increase for the
  fixed market basket, consumers buy less of these
  products and more substitutes that may not be
  part of the market basket. (Result CPI may be
  higher than what consumers are really paying)
• New Products- The CPI market basket may not
  include the newest consumer products. (Result
  CPI measures prices but not the increase in
  choices)
• Product Quality- The CPI ignores both
  improvements and decline in product quality.
  (Result CPI may suggest that prices stay the
  same though economic well being has improved
  significantly)

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CPI vs. GDP Deflator
The GDP deflator measures the price of all goods
produced, whereas the CPI measures prices of only
the goods and services bought by consumers. An
increase in the price of goods bought by firms or
the government will show up in the GDP deflator
but not in the CPI. The GDP deflator includes
only those goods and services produced
domestically.
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Calculating GDP Deflator
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UNIT 4 How is Spending Multiplied?

• Assume the MPC is .5 for everyone
• Assume that when the Super Bowl comes to town
  there is an increase of 100 in Ashleys
  restaurant.
• Ashley now has 100 more income.
• She saves 50 and spends 50 at Carls Salon
• Carl now has 50 more income
• He saves 25 and spends 25 at Dans fruit stand
• Dan now has 25 more income.
• This continues until every penny is spent or saved

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Marginal Propensity to Consume (MPC)

• How much people consume rather than save when
  there is an change in income.
• It is always expressed as a fraction (decimal).

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Marginal Propensity to Save (MPS)

• How much people save rather than consume when
  there is an change in income.
• It is always expressed as a fraction (decimal)

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MPS 1 - MPC
Why is this true? Because people can either save
or consume
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Two factors can change Aggregate Consumption
Function

• 1. Changes in expected future disposable
  income
• (higher expected future income tends to lead to
  lower savings todaythis is known as the
  permanent income hypothesis)
• 2. Changes in aggregate wealth
• (wealth has an effect on consumer spending and
  consumers generally plan their spending over
  their lifetime and not just based on current
  disposable incomethe life-cycle hypothesis).

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Aggregate Demand Curve
AD is the demand by consumers, businesses,
government, and foreign countries
Price Level
Changes in price level cause a move along the
curve not a shift of the curve
AD
C I G Xn
Real domestic output (GDPR)
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Shifters of Aggregate Demand---------------------
----------------------An increase in Aggregate
Demand means a shift of the curve to the
rightand may include the following factors
1. Changes in expectations2. Changes in
wealth 3. Size of firm capacity 4.
Government Policies
GDP C I G Xn
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Aggregate Supply

• The amount of goods and services (real GDP) that
  firms produce in an economy at different price
  levels.
• Aggregate Supply differentiates between short run
  and long-run and has two different curves.
• Short-run Aggregate Supply
• Wages and Resource Prices will not increase as
  price levels increase.
• Long-run Aggregate Supply
• Wages and Resource Prices will increase as price
  levels increase.

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Shifters of Aggregate Demand
AD C I G X
Change in Consumer Spending
Change in Government Spending
Change in Investment Spending
Net EXport Spending
Shifters of Aggregate Supply
AS I R A P
Change in Inflationary Expectations
Change in Resource Prices
Change in Actions of the Government
Change in Productivity (Investment)
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Assume the government increases spending. What
happens to PL and Output?
LRAS
Price Level
AS
PL and Q will Increase
PL1
PLe
AD1
AD
QY
Q1
GDPR
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How the Government Stabilizes the Economy
The Government has two different tool boxes it
can use 1. Fiscal Policy- Actions by Congress
the President OR 2. Monetary Policy-Actions by
the Federal Reserve Bank (aka Central Bank
actions)
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Two Types of Fiscal Policy

• Discretionary Fiscal Policy-
• Congress creates a law designed to change AD
  through government spending or taxation.
• Problem is time lags due to bureaucracy.
• Takes time for Congress to act.
• Ex In a recession, Congress increases spending.
• Non-Discretionary Fiscal Policy
• AKA Automatic Stabilizers
• Permanent spending or tax laws enacted to counter
  cyclical problem to stabilize the economy
• Ex Welfare, Unemployment, Min. Wage, etc.
• When there is high unemployment, unemployment
  benefits to citizens increase consumer spending.

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Contractionary Fiscal Policy (The BRAKE)

• Laws that reduce inflation, decrease GDP
• Either Decrease Government Spending or Enact Tax
  Increases
• Combinations of the Two

Expansionary Fiscal Policy (The GAS)

• Laws that reduce unemployment and increase GDP
• Increase Government Spending or Decrease Taxes on
  consumers
• Combinations of the Two

How much should the Government Spend?
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KEY TERMS TO KNOW unit 5

• Budget Surplus
• Budget Deficit and Budget Debt
• Budget Balance
• National Savings v. Private Savings
• Capital inflow

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Money is anything that is generally accepted in
payment for goods and services

• Commodity Money- Something that performs the
  function of money and has alternative uses.
• Examples Gold, silver, cigarettes, etc.

• Fiat Money- Something that serves as money but
  has no other important uses.
• Examples Paper Money, Coins

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3 Functions of Money

• 1. A Medium of Exchange
• Money can easily be used to buy goods and
  services with no complications of barter system.
• 2. A Unit of Account
• Money measures the value of all goods and
  services. Money acts as a measurement of value.
• 1 goat 50 5 chickens OR 1 chicken 10
• 3. A Store of Value
• Money allows you to store purchasing power for
  the future.
• Money doesnt die or spoil.

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Types of Money
Liquidity- ease with which an asset can be
accessed and converted into cash (liquidized)
M1 (High Liquidity) - Cash, Travelers Checks
and Checkable Deposits. In general, this is known
as the MONEY SUPPLY
M2 (Medium Liquidity) - M1 plus other near
money such as savings accounts (CDs) and mutual
funds
M3 (Low Liquidity) No longer used
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To Protect Against Bank Runs the Following
Regulations are in effect

• FDIC Insured to 250K
• Capital Requirements Owners must hold more
  assets then the value of the deposits (usually at
  least 7 more)
• Reserve Requirements Reserve ratio is presently
  10 of all checkable deposits
• Discount Window Ability to borrow from the Fed
  to avoid having to sell assets at below market
  prices

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• The Federal Reserve uses three primary tools in
  the pursuit of monetary policy
• Reserve Requirements
• The Discount Rate
• Open Market Operations

These tools are used to increase or decrease the
money supply.