AP Macro Exam Cumulative Review and Common Mistakes Students Make

1. AP Macro Exam Cumulative Review and Common Mistakes Students Make

2. General Stuff- MC’s To Guess Or Not To Guess On MC’s: The general rule of thumb: choose your best answer, and don’t skip the question if you can confidently rule out at least one of the multiple choice answers as not being the correct answer. • Guessing if one can eliminate at least one answer as not correct provides a statistical, but not guaranteed, advantage in the students favor as the 1 point awarded for the correct answer has a larger payoff than the smaller 1/4 point deduction for selecting the wrong answer. • However, there are other factors to consider; be especially careful on the earlier multiple choice questions since usually these questions are often somewhat easier than those questions towards the end of the multiple choice section (maximize your overall score by omitting "stupid mistakes" or mistakes due to rushing).

3. General Stuff- MC’s Cont’d • The first half of the MC portion of the test is a bit easier than the second half.  If you have extra time (finish early) on the multiple choice, go back and look over your first 3 or four answers (many students screw up in the very beginning of most tests). Only change an answer if it is obvious that a mistake was made. • Warm-up- do some simple S and D problems before the exam starts out of your PR book to get the brain going.

4. General Stuff- FRQ’s • Bring two blue pens, two black pens and two (or more) or more sharpened pencils) • Three questions, no pick and choose as in US History, do them all, one is the 'long' essay' worth the value of the other two put together.  Spend half your time there.  You get 60 minutes (10 review/50 write). • Read the question.  See what it is about.  Then read it again now that you know what it is about and its direction.  Then read and sketch an answer.  If you can see where nine or ten questions are buried in the long question, try to nail one more than half.  Don't waste time trying to figure out an extra point until you have attempts at all three.  • On the short-essays, see if you can identify four, five or six points in the format of the question.  Once again, nail down one more than half on each of the shorties.  Anything over that and it is pure gravy. • The vast majority of Q's on AP econ FRQ situations ask for ONE and  ONLY ONE shift.  If you feel compelled to shift two things you’re probably overanalyzing the question.  • Unless there are TWO SEPARATE actions, you should not look for two separate reactions or effects. 

5. General Stuff- FRQ’s Cont’d • Remember, pure declarative answers generally get you nothing.  An answer of "increases" just doesn't win a point.  It is your defense of why increases is correct.  And remember that one point is not a lot of heavy lifting.  If you’re going on-and-on for one point, then you probably don't know the answer. • No calculators, no cheat sheets, no copying.  Essays do not have to use complete sentences.  Many of the best essays use very few words.  And abbreviations are fine right from the get go.  NI is National Income, GDP is..well you know.  An arrow pointing up is read as increases or increasing or increased as grammar befits.

6. General Stuff- FRQ’s Cont’d • Write big and neat--If I can’t read it, it’s wrong. • Write clearly, skipping lines between responses. • Make bigger graphs. • Use the symbols and abbreviations we’ve used in class; don’t invent your own on the spot. • DO NOT put an LRAS line on a loanable funds market graph…

7. One thing only moves you along a demand or supply curve: PRICE The things that shift a demand curve: “Demand Shifters” [TIMER] 1. Taste [direct] 2. Income [normal-direct] [inferior-inverse] 3. Market Size [number of consumers-direct] 4. Expectations [of consumers about future *price-direct, about future availability-inverse, or about future income–direct. 5. Related Good *Prices [substitutes-direct] [complements-inverse] The things that shift a supply curve: • “Supply Shifters” [RATNEST] • Resource Cost • Alternative Output Prices [INVERSE] • 3. Technology [DIRECT] • 4. Number of Suppliers [DIRECT] • 5. Expectations [about future price] [INVERSE] • 6. Subsidies [DIRECT] • 7. Taxes [INVERSE]

8. One thing only moves you along an AD or AS curve: PRICE LEVEL The things that shift an AD curve: “AD Shifters” [CIGX] 1. Consumption 2. Investment 3. Government Spending 4. Net Exports The things that shift an AS curve: • AS shifters [REP] • Resource Cost • 2. Environment- business/legal • 3. Productivity

9. Big Mistake #1: Mislabeling or NOT labeling graphs correctly

10. EQUILIBRIUM: REAL OUTPUT AND THE PRICE LEVEL P AS Equilibrium in the Intermediate Range Price Level Pe P1 AD Q Q1 Qe Q2 Real Domestic Output, GDP

11. GROWTH IN THE AD-AS MODEL ASLR1 ASLR2 C A Price Level Capital Goods Q1 Q2 B D Real GDP Consumer Goods

12. ECONOMIC GROWTH IN THE EXTENDED AD – AS MODEL ASLR1 ASLR2 AS2 AS1 Price Level P2 P1 AD2 AD1 o Q1 Q2 Real GDP

13. THE MONEY MARKET Sm1 Sm 10 7.5 5 2.5 0 A temporaryshortage of money will require the sale of some assets to meet the need. ie Rate of interest, i (percent) Dm 0 50 100 150 200 250 300 Amount of money demanded (billions of dollars)

14. Net effects of Monetary Policy and/or Fiscal Policy onInterest Rates (Ir%)

15. FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION AS Fiscal Policy And Inflation Price level P1 AD1 AD2 $495 $505 $515 Real GDP (billions)

16. Expansionary Fiscal Policy >> Interest Rate INCREASE • Draw Money Market • Increase Spending (AD)>>Increase Demand for Money>>Increase Interest Rate • Higher Price Level>>Increase Demand for Money>>Increase Interest Rate

17. Expansionary Monetary Policy>> Interest Rate DECREASE

18. If the money supply increases to stimulate the economy... MONETARY POLICY AND EQUILIBRIUM GDP Sm1 Sm2 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 Money Supply Increases Interest Rate Decreases Price level Investment Increases P2 P1 AD & GDP Increases with slight inflation AD2 AD1 Real domestic output, GDP

19. If the money supply increases again… 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 More Money Supply P3 Lower Interest Rates Price level More Investment P2 P1 Still higher AD & GDP with significant inflation AD2 AD1 AD3 Real domestic output, GDP

20. MULTIPLIER(S) CONFUSION

21. Income (Spending) Multiplier • Spending Multiplier = Me = 1/ MPS • Tax Multiplier = Mt = MPC/MPS (or Me-1) • BB Multiplier = Mbb = 1 • Initial Change in Spending X MULTIPLIER = Change in Output

22. MONEY MULTIPLIER • 1 / Required Reserve Ratio • Maximum Multiple $$$ Money Expansion

23. Amount bank can lend - New money created Acquired reserves and deposits Required reserves Excess reserves Bank $80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57 A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 21.97 $20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40 $80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57 MULTIPLE DEPOSIT EXPANSION PROCESS $400.00 Total amount of money created by the banking system

24. Remembering the difference between the Amount of Money Created and theChange in the Money Supplywhen dealing with the Money Multiplier andMoney Creation

25. FEDERAL RESERVE PURCHASE OF BONDS New reserves $200 Required reserves Purchase of a $1000 bond from a bank... $800 Excess Reserves $1000 Initial Deposit $4000 Bank System Lending Total Increase in Money Supply ($5000)

26. Confusing Comparative AdvantageCalculationsInput—IOUOutput- OOO

27. Comparative and AbsoluteAdvantage[Comparative Advantagecan produce at a lower productive opportunitycost] Haiti’s DCCCuba’s DCC 1B = __ C 1B = __ C __ B = 1C __ B = 1C Haiti Cuba 90 100 6 4 1/4 1/6 80 Terms of Trade 1 bread = __coffees “A prisoner of my own PPC.” “I can consume only on my PPC.” 5 Coffee Coffee World CC 1Bread=__ Coffees __ Bread=1 Coffee 5 1/5 0 o Bread 18 20 15 Bread “Trade is the free lunch of economics.” 1. (Haiti/Cuba) has anabsolute advantage in coffeeand (Haiti/Cuba) has an absolute advantage in bread. 2.Haitiwill export(bread/coffee)[comparative advantage]andimport(bread/coffee). [comparative disadvantage] &Cubawillexport(bread/coffee) &import(bread/coffee). 3. Mutuallyadvantageous tradecan occur between Haiti & Cuba when1 breadis exchanged for (3/5/7)tons of coffee. Production in both is subject to (increasing/constant) opportunity costs. “Export”what it can produceat a lower relative priceand“import”goods it can buy at a lower relative price. Absolute Advantage- more efficient, can produce more with the same number of inputs [who can do the most in absolute numbers] “Do whatyou do best & trade for the rest.”

28. Remembering the difference between Real andNominal

29. Nominal:with InflationReal:without Inflation

30. 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 GDP

31. 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 INCOME

32. 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 INTEREST RATE (I%)

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

34. NOMINAL WAGES: amount of money received by a worker per unit of time (hour, day, etc.); Money Wage REAL WAGES: amount of goods and sevices a worker can purchase with their NOMINAL WAGE; purchasing power of the nominal wage. (Real = Nominal – Inflation rate) WAGES

35. Demand-Pull Inflationvs.Cost-Push Inflation

36. DEMAND-PULL INFLATION ASLR AS2 AS1 c P3 Price Level b P2 a P1 AD2 AD1 o Q1 Real domestic output

37. COST-PUSH INFLATION Occurs when short-run AS shifts left ASLR AS2 AS1 Price Level b P2 a P1 AD1 o Q2 Q1 Real domestic output

38. Phillips Curvevs.Laffer Curve

39. THE PHILLIPS CURVE CONCEPT 7 6 5 4 3 2 1 0 As inflation declines... Unemployment increases Annual rate of inflation (percent) 1 2 3 4 5 6 7 Unemployment rate (percent)

40. The most important things to know about the short-term PC: • Changes in AD move you along the curve. • A shift left in AS (supply shock or stagflation) shifts the PC to the right. • A shift right in AS (productivity gains, lower resource costs) shifts the PC to the left. • Think of it this way: the SRPC is a horizontally flipped version of SRAS, so what moves SRAS one way moves SRPC the other way.  • Note: The SRPC will also shift in tandem with the LRPC--anything which raises the natural rate of unemployment in other words (ie., factors such as stronger labor unions and higher unemployment compensation).

41. THE LAFFER CURVE 100 Tax rate (percent) l 0 Tax revenue (dollars)

42. THE LAFFER CURVE 100 Tax rate (percent) m l 0 Tax revenue (dollars)

43. THE LAFFER CURVE 100 n Tax rate (percent) m l 0 Tax revenue (dollars)

44. THE LAFFER CURVE 100 n Tax rate (percent) m m Maximum Tax Revenue l 0 Tax revenue (dollars)

45. Appreciation of the Dollar Increase in taste for U.S. goods Increase in U.S. Interest Rates Decrease in U.S. Growth Rate Decrease in U.S. Price Level FOREIGN EXCHANGE MARKET The Market for Dollars Exchange Rate: $1 = ¥100 Decrease in U.S. Currency Price D1$ S$ D2 P $’slooking for Y Y looking for$’s Y150 E2 D Yen Price of Dollar Yen depreciates Y100 E1 A Yen appreciates Y50 E3 D3 Depreciation of $ Decrease in Taste Decrease in In. Rates Increase Growth Rate Increase Price Level 0 QE D A Quantity of Dollars Increase in Currency Price

46. APPRECIATION of a Currency 1. Increase in taste [more demand for a country’s products or assets] 2. Increase in interest rates [Overseas investors increase their investments there.] 3. Decrease in price level [overseas buyers want to buy our cheaper goods.] 4. Decrease in growth rate [A country’s declining economy results in them buying less from other countries; decreasing demand for their currency and thus appreciating the declining economy’s currency] 5. Decrease in the price of a currency relative to the other

47. Appreciation/ Depreciation Quiz • If Japan buys 2 million more American cars • the dollar would (appreciate/depreciate) and our • imports from Japan would (increase/decrease). • 2. If U.S. interest rates are increasing faster than • Japan’s, the dollarwould (appreciate/depreciate) & • and our exports would (increase/decrease). • 3. If prices are dropping more in Japan than in • the U.S., the yen will (appreciate/depreciate) and • Japan’s imports will (increase/decrease). • 4. If the U.S. growth rate is faster than that of Japan, • the dollar will (appreciate/depreciate) and U.S. • imports from Japan will (increase/decrease). • 5. If the dollar price of the yen decreases, the • dollar has (appreciated/depreciated) and our our • imports from Japan will (increase/decrease).

48. Balance of Payments – sum of all the transactions that take place between U.S. residents and the residents of all foreign nations. There are three components: the Current Account, the Capital/ Financial Account, and the Official Reserves. The Current Account includes four things: 1. Goods [balance on goods (merchandise)] 2. Services [balance on goods and services] 3. Net investment income [interest, dividend, & profit income] 4. Net transfers [foreign aid, pensions, money sent back home, etc.] The Capital and Financial Account includes three items: 1. Balance on capital account [net “debt forgiveness”] 2. Foreign purchases of U.S. assets [real or financial] in the U.S. 3. U.S. purchases of foreign assets [real or financial] abroad. The difference between these two accounts is the“balance of payments.” They should balance. If not, official reserves will be used to balance them. [a + here means we will export a stock of foreign money ($’s will enterthe U.S.)] [a – here means we will import a stock of foreign money ($’s will exit the U.S.)]

49. Remember about the Current/Capital Accounts: • The balance in the current account will always offset the balance in the capital account. • The reason is that when a country pays for imports with its own currency, it cannot be used in the foreign country, so the foreigners must either buy our exports (balanced current account) or invest it, via the capital account, into financial assets or real assets.  • The bottom line is "trade is always balanced" between the current account and capital account. 

50. Current or Capital/Financial Account Current Account - something is physically transferred to another country. Capital/Financial Acct – nothing is physically transferred but ownership of the real [land/factory] or financial asset [stocks/bonds]. _____ 1. Joe buys $30,000 worth of stock from Korea’s Hyundai. _____ 2. France buys bombers and machine guns manufactured in N. Carolina. _____ 3. Toyota builds a Tundra manufacturing plant in San Antonio, TX. _____ 4. An American purchases a Japanese made Toyota Prius. _____ 5. Boeing sells a new 787 to France. _____ 6. An ARAMCO employee working in Saudi Arabia sends most of his pay to his family in Plano, TX. _____ 7. Americans donate $100 million in earthquake relief to Chinese relief organizations. _____ 8. The U.S. exports 50 tons of chocolate to Ireland. _____ 9. Ford buys three manufacturing plants in Taiwan. _____ 10. Japanese banks purchase U.S. Treasury Bonds. Cap/Finan. Cur.Acct Cap/Finan. Cur.Acct Cur.Acct Cur.Acct Cur.Acct Cur.Acct Cap/Finan. Cap/Finan.