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AP Macro Economics Review

AP Macro Economics Review. Peggy Pride, Presenter. Production Possibility Curve. A. Capital goods. B. C. W. F. D. E. Consumer goods. B 2. Capital goods. B. D 2. D. Consumer goods. Market Equilibrium. P r i c e. Supply. P e. Demand. Q e. Quantity.

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AP Macro Economics Review

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  1. AP Macro Economics Review Peggy Pride, Presenter

  2. Production Possibility Curve A Capital goods B C W F D E Consumer goods B2 Capital goods B D2 D Consumer goods

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

  4. A change in Demand versus a change in the Quantity Demanded • Change in Demand • √ 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.

  5. P QD Price Change Price of Corn P $5 4 3 2 1 CORN 10 20 35 55 80 $5 4 3 2 1 D o Q 10 20 30 40 50 60 70 80 Quantity of Corn

  6. P QD GRAPHING DEMAND Price of Corn Increase in Quantity Demanded P $5 4 3 2 1 CORN 30 40 60 80 + 10 20 35 55 80 $5 4 3 2 1 Increase in Demand D’ D o Q 10 20 30 40 50 60 70 80 Quantity of Corn

  7. A change in Supply versus a change in the Quantity Supplied • Change in Supply • √ 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.

  8. P QD Price Change Price of Corn P S $5 4 3 2 1 CORN 10 20 35 55 80 $5 4 3 2 1 o Q 10 20 30 40 50 60 70 80 Quantity of Corn

  9. P QS GRAPHING SUPPLY Price of Corn Increase in Supply P S’ S $5 4 3 2 1 CORN 80 70 60 45 30 $5 4 3 2 1 60 50 35 20 5 Increase in Quantity Supplied o Q 10 20 30 40 50 60 70 80 Quantity of Corn

  10. 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…

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

  12. 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.

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

  14. 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.

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

  16. Disposable Income 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

  17. Unemployment Rate = UnemployedLabor 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.

  18. 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.

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

  20. 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.

  21. ASlr ASsr Price Level PL1 AD1 o Qf Real domestic output 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.

  22. DEMAND-PULL INFLATION 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

  23. 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 Qf Y2 Real domestic output

  24. 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

  25. 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 c PL3[2%] AD1 AD2 o Qf Y2 Real domestic output

  26. The Phillips Curve Concept 7 6 5 4 3 2 1 0 As inflation declines... Unemployment increases Annual rate of inflation PC 1 2 3 4 5 6 7 Unemployment rate (percent)

  27. 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.

  28. Expansionary 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

  29. 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 AD2 AD1 MPS = .25 $490 $550 Real GDP (billions)

  30. 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)

  31. 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

  32. M E A S U R E S • Large time deposits M3 + M O N E Y • Money market accounts • Savings deposits • Small time deposits M2 + • Checkable deposits • Travelers checks • Currency MI

  33. i% i%1 Dm $$ demanded 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. Sm

  34. 1 = Money Multiplier Required reserve ratio Maximum Demand- Deposit creation Excess reserves Money Multiplier x = √ 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 Currency drain and no creditable customers will decrease the amount multiplied.

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

  36. Easy Monetary Policy And Equilibrium GDP Sm1 Sm2 Sm3 Investment Demand 10 8 6 0 10 8 6 0 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 AD3(I=$25) PL1 AD2(I=$20) • Increasing money supply • continues the growth – • but, watch Price Level. AD1(I=$15) Real domestic output, GDP

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

  38. Tight Monetary Policy And Equilibrium GDP Sm3 Sm2 Sm1 Investment Demand 10 8 6 0 10 8 6 0 Real rate of interest, i Dm Quantity of money demanded and supplied Amount of investment, i If the Money Supply Decreases to “cool” the Economy… AS • Interest Rate Increases PL1 • Investment Decreases Price level PL2 • AD & GDP Decreases • with lower PL AD1(I=$25) PL3 AD2(I=$20) • Decreasing money supply • continues the “cooling” – • as Price Level falls. AD3(I=$15) Real domestic output, GDP

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

  40. 6% 11% 5% ANTICIPATED INFLATION = + Inflation Premium Nominal Interest Rate Real Interest Rate

  41. Sm i% Dm Q of $$ demanded 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. The demand for money is composed of the transaction demand and asset demand. i%e Qe

  42. 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).

  43. 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.

  44. Price Level Real Domestic Output Keynesian View: √ 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 P1 AD1 AD2 Q2 Qf Movement from AD1 to AD2 reduces the Real GDP but the PL remains constant.

  45. 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 b P2 P1 AD2 a AD1 Q1 Real Domestic Output

  46. 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.

  47. √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.

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

  49. 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 =

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