AP Macro Review

1. AP Macro Review

2. Aggregate Demand • Consumption, investment, govt. purchases and net exports (exports – imports) • More income, more wealth = more spending • Investment – purchases of new capital by businesses; interest rate rises – less investment; interest rate falls – more investment • $ appreciates – U.S. goods more expensive; exports fall • $ depreciates – U.S. goods less expensive; exports rise • AD increases – shifts to right; P rises, GDP rises, unemployment falls • AD decreases – shifts left; P falls, GDP falls, unemployment rises

3. MPC and MPS • MPC = ∆ consumption resulting from a ∆ in income • MPS = ∆ savings resulting from a ∆ in income • MPC = 1 – MPS • If MPC = .80 then a $100 increase in income will cause us to spend $80 • Multiplier = 1/MPS • ∆ in GDP = multiplier x ∆ in spending • If multiplier is 5, consumption rises by $100, GDP rises by $500. • If MPC = .8, multiplier is 5; income rises by $100, consumption rises by $80, GDP rises by $400 • Multiplier works for any increase in spending, whether to consumption, investment, govt. purchases or net exports

4. Money Market i Vertical S curve – S set by FED; Includes S and D for all $ in the economy i3 i1 i2 Sm3 Dm Sm1 Sm2 Q

5. Loanable Funds Market i S Government deficit affects demand; Savings affects supply i1 D Q Q1

6. Loanable funds market • Increase in budget deficit increases D for loanable funds; interest rate increases • Decrease in budget deficit decreases D for loanable funds; interest rate falls • Increase in savings increases S for loanable funds; interest rate falls • Decrease in savings decreases S for loanable funds; interest rate rises

7. ASlr P AS Expansionary Fiscal Policy or Easy Money Policy P2 P1 AD2 AD1 GDP GDP1 Qf

8. Fiscal vs. Monetary policy Expansionary Fiscal Easy money policy Implemented by FED Buy bonds Decrease required reserve ratio Decrease discount rate Increases S of $ in money mkt. Interest rate falls $ depreciates • Implemented by govt. • Cut taxes • Increase govt. purchases • Increases budget deficit • Increases D for loanable funds • Increases interest rate • $ appreciates

9. ASlr AS P P1 AD1 P2 Contractionary Fiscal Policy or Tight Money Policy AD2 Qf GDP1 GDP

10. Fiscal vs. Monetary policy Contractionary Fiscal Tight money policy Implemented by FED sell bonds increase required reserve ratio increase discount rate decreases S of $ in money mkt. Interest rate rises $ appreciates • Implemented by govt. • Increase taxes • Decrease govt. purchases • Decreases budget deficit • Decreases D for loanable funds • Decreases interest rate • $ depreciates

11. Demand-Pull Inflation ASLR ASSR2 ASSR1 P P3 P2 AD2 P1 AD1 Qf GDP Q2

12. Demand pull inflation if govt does not respond to the inflation • In the long run, prices and wages are flexible. • Increase in price level causes wages to rise. • Increase in wages shifts AS in short run to left – more expensive to produce • As economy approaches long run equilibrium, GDP returns to full employment GDP and unemployment returns to the natural rate of unemployment

13. Recession ASLR ASSR1 ASSR2 P P1 P2 AD1 P3 AD2 Qf GDP Q2

14. Recession if govt does not respond w/ fiscal or monetary policy • In the long run, prices and wages are flexible. • Wages fall when unemployment increases. • decrease in wages shifts AS in short run to right – cheaper to produce • As economy approaches long run equilibrium, GDP returns to full employment GDP and unemployment returns to the natural rate of unemployment

15. Inflation rate P Phillips Curve AS2 AS1 P2 P1 SRPC2 AD SRPC1 GDP2 GDP1 GDP Unemployment rate P goes up Unemployment rises

16. Phillips Curve • Short run – tradeoff between unemployment and inflation; as 1 goes up the other falls • If AS shifts, short run PC shifts in opposite direction • If AD shifts, movement along the PC. • Long run – no tradeoff between unemployment and inflation • LRPC is a vertical line

17. Effect on AS Capital goods P ASLR1 ASLR2 PPF1 PPF2 Consumer goods Qf1 Qf2 GDP

18. Economic Growth • Rightward shift of PPF curve = rightward shift of long run AS • Caused by increase in technology, # or quality of natural or human resources, increase in capital stock • Economic growth influenced by interest rates – if interest rates rise, I (investment) falls, capital stock declines, less economic growth

19. Effect on AS P Inflation ASLR1 LRPC1 LRPC2 ASLR2 NRU2 Unem. Qf1 Qf2 NRU1 GDP

20. U.S. Exports – English buying American wheat P in pounds P in dollars D2 S1 S S2 P2 P1 P1 P2 D D1 Q1 Q2 Q1 Q Q2 Mkt. for Dollars Mkt. for Pounds

21. Exchange rates • If 1 currency appreciates, the one it’s being compared to depreciates. • Interest rates and value of the currency move in same direction. • If D for $ increases (b/c people want U.S. wheat or higher interest rates in U.S.), $ appreciates. • The English must supply more pounds to get the dollars they demand so the pound depreciates.

22. U.S. Imports – Americans buying English tea P in pounds P in dollars S1 S S2 P2 P1 D2 P1 P2 D1 D Q1 Q2 Q1 Q Q2 Mkt. for Dollars Mkt. for Pounds