Macro Notes All Units
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1 Unit 1: Basic Principles of Economics Standard 1: Scarce Resources, Krugman Module 1 What is the science of economics? What is the difference between macro and micro? Economics--The social science of decision-making under conditions of scarcity. The study of how people seek to satisfy their needs and wants by making choices. “Economics is the art of making the most out of life.” 2. Macro vs. Micro _______________—the study of a country’s economy or one sector—all consumers or all producers. _______________—the study of one business/consumer or all businesses within a market. Examples—Cause of the Great Depression: ____________, buying t-shirts at the Gap: ____________, effect of Pandora on MP3 sales: ________________, effect of tax increase on GDP: ________________, merger of American and Southwest: __________________ _____________Economics—what is, statements of fact* economist most interested in _____________ Economics—what should be, statements of opinion Examples: “The number of farms has decreased over the last 50 years.” P or N “The poor pay too much for housing.” P or N “If income decreases the demand for most goods will decrease.” P or N Ceteris Paribus-- a Latin phrase that means all variables other than the ones being studied are assumed to be constant. “All other things being ____________” What is scarcity? How is it related to the discipline of economics? What is the difference b/wn opportunity costs and tradeoffs? 1. Scarcity Forces us to make ____________________. A resource or good/service must meet ONE of the two definitions of scarcity: 1. Limited quantities of resources to meet unlimited demands 2. More than one valuable use Something is NOT scare if you give up nothing to obtain it—basically it is NOT scare if it is free. However, free does not just mean no monetary cost. Ex. Free lunch in the cafeteria, you are giving up eating a quality lunch. Is it scarce examples: trash:______, land: _____, pollution: ______, iPads: _________, unused textbooks:______, unused textbooks that can be recycled: ______, oil in Japan: _______, oil in Saudi Arabia: _______ 2. Opportunity Cost vs. Tradeoffs (p. 11) Trade-offs-- an exchange for one thing in return for another Opportunity cost—the value of the foregone alternative, i.e. the value of the next best thing you could have done. 1. Add both the explicit costs and the implicit costs—what you gave up to do the action. 2. For example—if a date costs you $70 those are your explicit costs of the date, but you also gave up going to working at Marina’s where you would have made $100, so the total opportunity cost is $170. Example: You have 5 alternatives for this Friday night—going on a date, hanging out with friends, studying for economics, working or going camping with your family. You decide to go on a date. All 5 alternatives are your _____________Working is your next best choice, it is your _______________. What’s the point? Your decisions carry with them implicit (hidden) costs far beyond explicit cost.
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Macro Notes
Transcript of Macro Notes All Units
1
Unit 1: Basic Principles of Economics
Standard 1: Scarce Resources, Krugman Module 1
What is the science of economics? What is the difference between macro and micro? Economics--The social science of decision-making under conditions of scarcity.
The study of how people seek to satisfy their needs and wants by making choices.
“Economics is the art of making the most out of life.”
2. Macro vs. Micro
_______________—the study of a country’s economy or one sector—all consumers or all producers.
_______________—the study of one business/consumer or all businesses within a market. Examples—Cause of the Great Depression: ____________, buying t-shirts at the Gap: ____________,
effect of Pandora on MP3 sales: ________________, effect of tax increase on GDP: ________________,
merger of American and Southwest: __________________
_____________Economics—what is, statements of fact* economist most interested in
_____________ Economics—what should be, statements of opinion
Examples: “The number of farms has decreased over the last 50 years.” P or N “The poor pay too much
for housing.” P or N “If income decreases the demand for most goods will decrease.” P or N
Ceteris Paribus-- a Latin phrase that means all variables other than the ones being studied are assumed
to be constant. “All other things being ____________”
What is scarcity? How is it related to the discipline of economics? What is the difference b/wn
opportunity costs and tradeoffs?
1. Scarcity
Forces us to make ____________________.
A resource or good/service must meet ONE of the two definitions of scarcity:
1. Limited quantities of resources to meet unlimited demands
2. More than one valuable use
Something is NOT scare if you give up nothing to obtain it—basically it is NOT scare if it is
free. However, free does not just mean no monetary cost. Ex. Free lunch in the cafeteria, you
are giving up eating a quality lunch.
Is it scarce examples: trash:______, land: _____, pollution: ______, iPads: _________,
unused textbooks:______, unused textbooks that can be recycled: ______, oil in Japan:
_______, oil in Saudi Arabia: _______
2. Opportunity Cost vs. Tradeoffs (p. 11)
Trade-offs-- an exchange for one thing in return for another
Opportunity cost—the value of the foregone alternative, i.e. the value of the next best thing
you could have done.
1. Add both the explicit costs and the implicit costs—what you gave up to do the action.
2. For example—if a date costs you $70 those are your explicit costs of the date, but you
also gave up going to working at Marina’s where you would have made $100, so the
total opportunity cost is $170.
Example: You have 5 alternatives for this Friday night—going on a date, hanging out with
friends, studying for economics, working or going camping with your family. You decide to
go on a date. All 5 alternatives are your _____________Working is your next best choice, it
is your _______________.
What’s the point? Your decisions carry with them implicit (hidden) costs far beyond explicit
cost.
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What are the four major factors of production, and how do they relate to income? Factors of production= a.k.a. resources—these are scarce.
1. Land—natural resources, Examples:
___________=income from land resources
2. Labor—paid human effort, Examples:
___________=income from labor resources
3. Capital
Physical capital—man-made resources that are used to produce other goods.
Examples:
Human capital—education for the job
Examples:
___________=income from capital resources
Investment in physical and human capital increase future ____________.
NOT ______________capital, stocks, bonds, money
4. Entrepreneurship—risk taker and combines the other resources to make a good or service,
Examples:
__________= income from entrepreneurship
How do different types of economic systems seek to answer the three basic economic questions? Organized way to produce and distribute g/s
Answers 3 Basic economic questions:
o ________ to produce?
o ________ to produce it?
o ________gets it?
Three Major Types
o Market—forces of ____________________answer the 3 basic Qs, self-interest ____________,
competition ____________
Examples:
The Good—flexible, freedom, variety of g/s, growth
The Bad—inequitable, market failures—ex. Pollution, public goods
o Command—government answers the 3 basic Qs
Examples:
The Good—can change drastically fast, may provide for basic necessities
The Bad—Lacks incentives for hard work, costly to plan, inflexible for small stuff
o Traditional—the past answers the 3 basic Qs
Examples:
The Good--Life is predictable, closer to family and community
The Bad—no growth, low standard of living, discourage new ideas
All economies are a mixture of the above--some more market, some more command. U.S. is the ____ most
market. N.Korea is the most command.
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Standard 2: PPC, Krugman Module 3
How does the production possibilities curve demonstrate opportunity cost, growth, and efficiency?
Squares 0 1 2 3 4 5
Triangles
Draw it above
PPC—shows the alternative ways of using resources to produce the maximum amount of goods and services.
Demonstrates ______________ costs. If you increase production of triangles, then you must give up some
production of squares.
What is the opportunity cost of producing one square? _____________ What is the opportunity cost of
producing one triangle? ______________
_________________ Opportunity Cost—graph above right, opportunity costs stay the same, the production
of each additional square costs two triangles, if opportunity costs are constant, then resources are easily
convertible—easy to make 2 triangles out of one square.
___________________ Opportunity Costs—graph on bottom, opportunity costs increase (for BOTH
goods) as you produce more of one good. For example, as you produce more pizzas it costs more robots. The
1st pizza only cost ____robot; when going from point D to point E, the 4th pizza costs_____ robots. This is
because the resources are not easily convertible. MOST COMMON,
Also shows efficiency/inefficiency, full employment/unemployment, growth, and unattainable points.
o All points along the curve are _______________ efficient—making the most goods/services possible.
_________________ efficiency—type of efficiency where the right mix of g/s is produced.
Shown on only one point on the graph. You will not know which point this is unless other
information is provided.
o Points _____________ the curve are attainable but inefficient. Resources are not fully utilized. Ex.
there is unemployment, discrimination (people discriminated against are not being fully utilized),
factories not operating at full capacity.
o Points _______________ the curve are unattainable with current resources unless the production
possibilities curve shifts outward.
Production Possibility Curve Shifts o Shifts ___________ if more resources or improved productivity
o Shifts ____________ if resources are lost—ex. global warming causes all coastal land to flood 10
miles into the US.
o If you produce more physical capital goods, then PPC will shift out more because physical capital
goods are a resource, more resources=more growth.
5.
6.
7.
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Standard 3: Comparative and Absolute Advantage, Krugman Module 4
How do you compute comparative advantage and terms of trade?
Theory that demonstrates the benefits of specialization and trade.
_____________ Advantage—the ability to make more stuff with the same amount of resources.
_____________ Advantage—the ability to make stuff with the least amount of opportunity cost.
Finding Comparative Advantage—Output Problems
o Output problems=number of goods/services produced
o Input problems=amount of time or other resources used to produce.
Always put the actors in
this column Dishwashing Sweeping
Betty 2 (3/2=1.5) 3 (2/3)
Bert 1 (1) 1 (1)
Step 1: Set up the problem correctly in the above table.
Step 2: Find the opportunity cost for each person and task.
For output problems ONLY—put the opposite number on top and reduce the fraction (if needed)
Put the opportunity cost in parentheses
Step 3: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task.
Who has the comparative advantage in dishwashing?
o Look at the dishwashing column
o See who has the lowest number as the opportunity cost.
o Do the same for the other good/service
o * If one person has the comparative advantage in one thing (Bert in dishwashing), then
the other person must have the comparative advantage in the other thing (Betty in
sweeping) but make to do the math to double check yourself.
The stuff can be shown on a graph or a table. Must be able to read both.
To read the table or graph the easiest approach is to look at the highest numbers. Mexico can
produce 60 avocados OR 15 soybeans, the US can produce 90 avocados OR 30 soybeans.
Who has the absolute advantage in avocados? ___________
Who has the absolute advantage in soybeans? ___________
If on a graph, whichever country’s PPC is on the right, it has the absolute advantage.
The comparative advantage must be computed.
Work the avocado/soybean problem in the box above.
1. Who has the comparative advantage in avocados? ___________
2. Who has the comparative advantage in soybeans? ___________
5 10 15 20 25 30
15
3
0 4
5 6
0 7
59
0
United S
tatesMexico
Soybeans
Avo
ca
do
s
5
Importing and exporting—Whoever is producing the product will be ____________ it. You
_____________a product if you allow another country to produce it for you.
____________ will be exporting and __________ will be importing avocados
____________ will be exporting and __________ will be importing soybeans
Terms of Trade
Sometimes problems will ask about what terms of trade (price per good) would be beneficial
to both nations.
For example—In order to be beneficial to both nations what should the terms of trade be for
1 avocado ?
The easiest thing to do is to look at the column for avocados and place the terms of trade as
in between the two opp cost. 1 avocado for more than ____of a soybean but less than
_____of a soybean.
REMEMBER—the seller always benefits from a ___________ price and the buyer benefits
from a ___________ lower price. Mexico is selling avocados. It would benefit as long as the
price is HIGHER than ¼ a soybean. The US can make 1 avocado for the cost of 1/3rd a
soybean, so they only benefit if the price is LESS than 1/3rd.
What terms of trade would be beneficial to both nations for 1 soybean? _________
Who would benefit if the terms of trade were 1 soybean for 5 avocados? _________
Input Problems
Not looking at how much the person (country) can produce, but how much resources it takes
to produce the same good.
Absolute advantage
o Who has the lower number?
o Why? Because it takes him/her less resources.
Comparative advantage
o Set up the same way
o EXCEPT switch the order to find the opp. cost—put the same number on top.
Joe can produce a salad OR a smoothie in only two minutes, but his new trainee Liz takes
much longer to produce salads—10 minutes. However, she has worked on her smoothie
skills and can turn one out in the same time as Joe.
Absolute advantage in salads? __________
Absolute advantage in smoothies? _______
Comparative advantage in salads? _______
Comparative advantage in smoothies? ____
Work the following problem.
Assume that: the US can produce a car in 16 minutes; Japan can produce one in 14 minutes; the US can
produce a computer in 12 minutes; Japan can produce one in 8 minutes.
Absolute advantage in cars? ________________
Absolute advantage in computers? ___________
Comparative advantage in cars? _____________
Comparative advantage in computers? __________
Salads (in minutes) Smoothies (in minutes)
Joe 2 (1) 2 (1)
Liz 10 (5) 2 (1/5)
(in minutes)
(in minutes)
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Terms of trade advantageous to both? ___________
Winners and Losers of Free Trade
o Who wins?
o Who loses?
Standard 4: Supply and Demand Krugman, Module 5-6
What is the difference between a change in demand and a change in quantity demanded? Be able to
graphically apply the determinants of demand.
What is a market? Any arrangement that brings buyers and sellers together.
The buyers create ____________.
The sellers create ____________.
Who sets the price in a competitive market? ___________________________
How does competition help consumers? ___________________________________________________
The market is ruled by the forces of SUPPLY and DEMAND.
Demand—1. _____________ to own 2. ability and willingness to __________
Law of Demand—as prices increase, quantity demanded decreases; as prices decrease quantity demand increases.
3 Reasons that explain the slope of the demand curve
Income Effect—when the price of a good goes down, your money will buy more; therefore, it has
the effect of increasing your real income
Substitution Effect—If prices go up, the quantity demanded will go down b/c you will begin to
buy substitutes.
Diminishing Marginal Utility—each additional (marginal) unit purchased will give you less
utility (satisfaction). Therefore, the only way I will buy more is if the producer lowers the price.
Tools to Show Demand
Demand Schedule—a ____________ that lists the various quantities demanders will purchase at various
prices.
Demand Curve—schedule in __________ form
Individual—one person’s demand for a product
Market—a group’s demand for a product
Difference between QUANTITY DEMAND and DEMAND
Quantity Demanded—ONE quantity at ONE price
Demand—List of quantities at different prices illustrated by a demand schedule and a demand curve.
Change in QUANTITY demanded
o ________________ along the demand curve
o Caused by a change in the _________ of the product
Change in DEMAND
o __________ of the entire curve
o Caused by one of the_______________ of demand
Price Quantity
$2.00 0
$1.50 1
$1.00 2
$0.50 3
.50
1.0
01.5
02.0
0
1 2 3 4
Price
Quantity
Demand for Pizza
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Changes in Demand
Shifts the curve LEFT or RIGHT, NOT up or down
If demand INCREASES, the demand curve shifts to the _____________
If demand DECREASES, the demand curve shifts to the ____________
What are the factors that will change demand?
Determinants of Demand
o T--taste and preferences—events, new technology, more information
Example:
o R—related goods
substitutes—if the price of a substitute goes up, then the demand for the original good will
______________, direct relationship
Example:
complements—if the price of a complementary good increases, then the demand for the
original good will _____________, an inverse relationship
Example:
o I—income
Normal goods—assume normal unless otherwise stated or unless it is a known inferior
good (ramen/off-brand names); if income ↑, then demand ↑, vice versa
Inferior goods—if income ↑, then demand ↓. o B—number of buyers—if the population that demands a particular product increases, then
demand increases
Example:
o E—expectations—if people expect a shortage, then buy today; if people expect a sale tomorrow,
then demand less today—Demand is always for the current time period (today) unless otherwise
stated.
Example:
.50
1.0
01
.50
2.0
0
1 2 3 4
Price
Quantity
Demand for Pizza
D1
D
INCREASE
in
DEMAND
.50
1.0
01
.50
2.0
0
1 2 3 4
Price
Quantity
Demand for Pizza
D1
D
DECREASE
in DEMAND
What happened to
the equilibrium
price? _________
What happened to
the equilibrium
quantity? _______
What happened to
the equilibrium
price? _________
What happened to
the equilibrium
quantity? _______
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What is the difference between a change in supply and a change in quantity supplied? Be able to
graphically apply the determinants of supply.
Supply—amount produced for sale.
Law of Supply—as prices increase, quantity supplied increases;
as prices decrease, quantity supplied decrease.
Individual and Market Supply Schedule and Curve
Change in quantity supplied—movement along the curve, caused
by a change in ______________
Change in supply—shifts the curve, brought about by determinants of
supply
o Shift to the right=______________
o Shift to the left=_______________
Determinants of Supply
R—resource costs—if the costs to make the good increases, then producers will not be able to
produce as much.
Example:
O—other goods—if the price of another good that the producer sells has gone up, then supply will
decrease for the other good.
Example:
T—Taxes (government) also deals with subsidies—helps businesses, if the government offers a tax
credit for businesses then supply increases, if they eliminate a tax credit for businesses then supply
decreases
Example:
T—Technology
Example:
E—Expectations—if supplier expects prices to rise in the future, then will cut back supply today.
Example:
N—number of sellers
Example:
.50
1.0
01.5
02.0
0
1 2 3 4
Price
Quantity(per slice, in hundreds)
Supply of Pizza
S
.50
1.0
01
.50
2.0
0
1 2 3 4
Price
Quantity
Market for Pizza
D
S S1
INCREASE IN SUPPLY
.50
1.0
01
.50
2.0
0
1 2 3 4
Price
Quantity
Market for Pizza
D
SS1
DECREASE IN SUPPLY
What happened to
the equilibrium
price? _________
What happened to
the equilibrium
quantity? _______
What happened to
the equilibrium
price? _________
What happened to
the equilibrium
quantity? _______
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Standard 5: How does price and quantity change when the equilibrium changes? What happens when
the market is in disequilbrium?
Equilibrium: Quantity Demand=Quantity Supplied, Happy Place!
Equilibrium changes when demand and/or supply shifts (see examples above)
What happens to EP and EQ when both demand and supply shift at the same time?????
Shift both curves by the same amount. Either price or quantity will always change, the other
will always be indeterminate, unless you know exactly how much each curve shifted by.
o In this case, I increased both supply and demand, which caused there to be an
increase in quantity and an indeterminate change in price.
.50
1.0
01.5
02.0
0
1 2 3 4
Price
Quantity(per slice, in hundreds)
Increasing Both D and S
Draw above a decrease in D and an increase in S. What
happened to EP? ________ What happened to EQ? _________
Disequilibrium
QS and QD do NOT equal
A competitive market will self-correct to get back to equilibrium
What are price ceilings and price floors, and what do they cause?
Shortage: quantity demanded > than quantity supplied
Seller will _________ the price until it reaches equilibrium
Surplus: quantity supplied > than quantity demanded
Seller will _________ the price until it reaches equilibrium
Sometimes the government sets prices above and below the market price for equity reasons.
__________—maximum price the seller can charge, Helps consumers, Causes a shortage, Ex.
rent control apartments
__________—minimum price that the seller can charge, Helps suppliers, Causes a surplus,
Ex. agricultural goods, minimum wage in the labor market
Calculate the shortage/surplus by finding the difference between the quantity demanded and quantity
supplied at the given price. At $1.75—the surplus is 2: 4 (QS) – 2 (QD)
.50
1.0
01.5
02.0
0
1 2 3 4
Price
Quantity(per slice, in hundreds)
Supply of Pizza
S
D
Price Ceiling=Shortage
Price Floor=Shortage
Surplus
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Unit 2: Macroeconomic Indicators Notes
Unit Overview—This is the first unit of macroeconomics. In it we will study the three major economic indicators (things
that tell us how the economy is doing)—GDP, unemployment, and inflation.
______________--measures production (How much goods/services were made.) Goal--2-4% each year
______________--measures how many people want a job but don’t have a job; Goal 4-5%
______________--measures changes in the price level –Goal 2-4% or keep pace with growth
Economic _________________—increase in productive capacities, sustained increase in GDP
Standard 6: Market Macroeconomic Models (Module 2 and Module 10)
What is the business cycle? How does it relate to the macroeconomic indicators (Module 2)
Natural phenomenon of market economies
Overall ____________ trend BUT
Cyclical periods of _________ and _________
Phases of the Business Cycle
o ____________________________—GDP is increasing, unemployment is declining, inflation may begin
o __________—GDP is at its highest in the business cycle
o ________________________—GDP is decreasing, unemployment is rising, deflation may begin
o Trough—GDP is at its lowest point in the business cycle
____________________ GDP falls for 6 consecutive months
____________________ a prolonged recession
How do you prevent the volatility?
o Focus of next two units, largest part of the AP Macro Exam
What is the circular flow model of the economy? Make sure that you understand each of the markets, sectors,
injections, and leakages. (Module 10 pgs. 102-106)
Simple Circular Flow
Two Sectors—________________ and _______________
Two Markets—_____________ (aka Resource) Market and the ______________ Market
Households earn ______________ in the factor market.
They take the money they’ve earned and ___________ it in the product market.
THUS—_______________ (the money households make) should = _______________ (how much they spend)
THIS is GDP—total of everything produced can be calculated 2 ways
o _________________ Approach-total everyone’s income in the factor market OR
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o _________________ Approach—total the value of all goods produced and sold in the product market. C
+I+G +NX.
Leakages and Injections
_________________—income leaves the economy.
o Savings, Taxes, and Imports
_________________—income that is added into the economy
o Investment, Government Spending, and Exports
______________________ Sector Added
LEAKAGES of __________--People do not spend all of their money. They may save some of it.
INJECTION of ___________________--Banks take the SAVINGS and loan out money to businesses that buy
_______________ goods (i.e. tractors, factories). With the purchase of INVESTMENT goods they INJECT money
back into the economy. Banks also take the savings to loan consumers money to make purchases they couldn’t
afford otherwise. This is also is an injection.
_________________ Sector Added
LEAKAGE of _______________--Some of the money you earn is taken by the government in the form of taxes
This is a LEAKAGE because it could otherwise be spent on consumer goods
But, the money is ___________________ back into the economy through government spending
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International Sector Added
Your purchase of _______________ decreases our GDP, thus it is a LEAKAGE.
But when other countries buy our _______________, it INJECTS money back into our economy.
If there are NO LEAKAGES and NO INJECTIONS OR if all LEAKAGES EQUAL all INJECTIONS
o then INCOME=EXPENDITURES
If more leakages than injections, then _______________ > than _______________
If more injections than leakages, then _______________> than ________________
Standard 7: GDP
What is included in the GDP? Differentiate between the income and expenditure approach. (Module 10 pg. 106-110)
Gross _________________ Product
US government’s official measure of output
Market Value of the ____________ goods and services produced within the ______________ of the US whether
by Americans or foreigners in one year.
Final goods vs. intermediate goods
_____________ goods not included—inputs used to produce products, like cotton for a shirt, wood for
a house, silicon chips in a computer
Weird EXCEPTION--_____________ goods like factory equipment are included as investment
GDP—produced within our borders, no matter the nationality of company
Nissan plant in Smyrna—____________ in GDP
Apple plant in China—______________ in GDP, products produced outside borders
Excluded from GDP
_____________________ Payments—ex. Social Security, Welfare, Veterans’ retirement benefits
Private Transfer Payments—ex. gifts
________________(financial capital) transactions—stocks/bonds (securities) BUT BROKER’S SERVICE IS
COUNTED!!!
Why are the above not counted?
Nothing has been produced. Just money being transferred from one person to another.
________________Sales—ex. used books purchased on Amazon. Why? Already been counted on the
original sale.
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Non-market transactions—ex. cleaning your own house, babysitting your own kids, _________________
economy—sale of illegal substances, income that is not reported (under the table), why—can’t really
count if no one knows about it.
Two approaches to measurement
_________________—measure aggregate (total) sales--what is sold plus unsold inventories
_________________—measure aggregate income, how much $$ people made.
Expenditures should equal income
Expenditure Approach
GDP aka Y
Y= C + G + I + NX (I-E)
C=__________________—majority of our spending, durable goods (things that last—houses, not
clothes), nondurable goods, and services *largest portion of GDP
G=___________________—federal and state spending—roads, schools/teachers, police (NOT TRANSFER
PAYMENTS—transfer payments=welfare, food stamps, social security, veteran’s benefit)
I= ______________________—capital goods (factories, tractors, business computers) also INVENTORIES
(excess goods not sold) Why include inventories? Measuring PRODUCTION for that year. Gross vs. Net;
Gross-- Do NOT subtract out for depreciation
NX=__________________—Our exports add to the GDP, our purchase of imports subtract from the
GDP
Income Approach
Y=Wages + Interest + Rent + Profit
____________ paid to labor resources * largest % of GDP
_____________ paid to capital resources
________________ paid to land resources (including rental of housing—why b/c renting a house is a
service)
____________—paid to entrepreneurs for combining the factors of production and risk taking
Calculate nominal and real GDP. (Module 11 and pgs. 145-146)
Two types of GDP
o ____________—total market value of g/s produced measured in current dollars. “Current quantities at
current prices”
If nominal GDP increases—it could be due to greater production OR just higher prices OR both
o _____—total market value of g/s produced measured in constant dollars “Current quantities at past
prices”
If real GDP increases—it MUST be because production has ____________________
How to calculate each?
o Nominal—use current _________ x current _____________
o Real GDP—use current quantities x _________ year prices
Base year=starting point, here nominal and real GDP will be the same
The AP Exam will tell you which is the base year
Year Price of Hotdogs
Quantity of
Hotdogs
Price of Hamburgers
Quantity of Hamburgers
Nominal GDP
Real GDP Calculate the nominal GDP and real
GDP for each year. Assume that
Year 1 is the base year.
What would be the RGDP for Year
1 if the base year changed to Year
2? ____ _______
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1 $2 5 $3 10
2 $2 10 $4 10
3 $3 15 $5 5
4 $2 15 $5 20
Other Ways to Find Real and Nominal GDP
o May not have a list of goods and prices
o It may give you two of the following three variables: the price index (to be discussed in detail later, now
just know that it is a measurement of inflation/deflation), real GDP, or nominal GDP. You must figure
out the missing variable.
o Real GDP= Nominal GDP/Price Index
Move the decimal for the price index
If the PI is 150, divide by 1.5
o MEMORIZE THIS FORMULA!!!!!
o Be able to manipulate it
Nominal GDP=Real GDP x the price index
Price Index=Nominal GDP/Real GDP
Don’t forget to change the PI!!
How to find real GDP growth (or any % change)
o Growth= (rGDP in current year – rGDP in previous year)/rGDP in previous year (new-old/old)
o If rGDP went from $10,000 in 2012 to $11,000 in 2013, by what percentage did real output grow?
Change a decimal into a percentage—move the decimal two places to the right--_____
How to find real or nominal GDP per _________(per person)
o Divide real or nominal by the population
o If rGDP for Country A is $500,000 and there are 5 people living in Country A, then the rGDP per capita is
$100,000
___________________
o Real GDP per capita increases are the best measure of a country’s increasing standard of living.
Discuss the limitations of GDP as a measure of economic performance. (Not in textbook)
GDP is used as a measure of our standard of living. High GDP per capita means that you can buy more stuff.
More stuff=cushier lifestyle. But GDP doesn’t consider many things that also contribute to a higher standard of
living.
Doesn’t consider household production. Ex. ____________________________
Leisure time—GDP only considers work time. Leisure time definitely increases standard of living, but it is not
included Ex. __________________________
Doesn’t consider damage to the environment. Ex. ___________________
Health and life expectancy—usually goes up with increased GDP, but not always.
Doesn’t consider social/economic justice—only considers the total GDP, not wealth ______________.
REAL
NOMIN
AL
Price
Index
15
Standard 8: Calculate the labor force participation rate and the unemployment rate. (Module 12)
The BLS surveys to find the following stats every month: 1. The ______________ population, 2. The
______________ participation rate. 3. The __________________ rate
_________________________ Population--Excludes: under the age of ___________, members of the
____________, people in __________ or ____________, and __________________
___________________ Participation Rate---Of the working age population, how many people are employed
(have a job working at least ____ hour) or are actively seeking work. If you are ____________ or choose to be
unemployed—you are NOT in the labor force.
o Labor force participation rate= __________________________________
o Of the 225.7 million people in working age population, 148.9 million people are employed or
unemployed and looking for work. Therefore, our labor force participation rate is
Unemployment Rate--Unemployment rate finds what percentage of the labor force is not currently working (at
least 1 hour) and is ___________ seeking employment.
o Unemployment Rate=______________________________
o 2005 figures—of the 148.9 million people in the US in the labor force, 7.3 million are unemployed and
seeking work. Therefore our unemployment rate in 2005 was:
Calculate. If the US population was 200 million and 50 million people were too young or were institutionalized
and 50 million people chose not to work (retired, independently wealthy, stay at home moms/dads) and 10
million people did not have a job but wanted one and were actively seeking one—
o What is the labor force participation rate? ______ What is the unemployment rate? _____
Flaws in the unemployment statistics
o Doesn’t consider ________________ people—those who want (need) to work more than part-time and
cannot find a full-time job
o Doesn’t considered ___________________—unemployed people who wanted to find a job but gave up
looking because they couldn’t find one after a prolonged search.
o July 2013--US official unemployment rate is 7.6%, accounting for discouraged workers and
underemployed—14.3%
Differentiate between the types of unemployment. (Module 13)
__________________l Unemployment—in-between jobs, arises from normal labor turnover from people
entering and leaving jobs.
o Businesses do not hire the first person who applies, unemployed do not take their first offer.
o Ex. Recent college graduate looking for a job
o Not a bad type-actually can be a good thing-get workers who are more suited to the job
_________________unemployment—Duh! Unemployment due to seasonal weather patterns/holidays
o Ex. Construction and farm workers during winter are sometimes seasonally unemployed, department
store Santa laid off after Dec. 25th
__________________ unemployment—unemployment b/c skills of workers do not match the jobs available
o Ex. Switch from manufacturing to service based economy
o Sometimes due to ___________________________
________________ unemployment—unemployment due to natural downturns in the business CYCLE
o Ex. Sales clerk is laid off due to decreased sales
o In a ___________, cyclical unemployment is high—During an expansion, cyclical unemployment is low
16
Standard 9: Inflation
Discuss the relationships among the following terms: full employment, natural rate of unemployment, actual RGDP,
and potential GDP. (Module 14)
Full employment=no _______________unemployment
o Could be a lot of seasonal, frictional, and structural unemployment
o Why? Other kinds of unemployment are natural and could even be good for the economy, cyclical is
always bad for the economy
___________________________ (NRU)—pretty much the same as full employment—the unemployment rate
when the economy is at full employment
o Usually around _________
_______________ RGDP—what the economy could produce if at full employment
o If the economy is at full employment—potential and actual RGDP are the ____________
o If the unemployment rate is greater than the NRU, then potential RGDP is _________than actual RGDP
o If the unemployment rate is less than the NRU, then actual RGDP is ___________ than potential RDGP
Define inflation. Explain the different methods of calculating inflation—GDP deflator, CPI, PPI. Calculate the CPI and
the rate of inflation. Who wins and who loses with unanticipated inflation? (Module 14 and 15)
_____________—general increase in prices (not an increase in the price of one or several goods/services)
_____________—general decrease in prices
_____________—prices rise rapidly ex. Germany after WWI
______________—really bad—prices __________, GDP _________, and unemployment _______
o Normally, when prices are high, GDP is __________, and unemployment ____________
______________—measures prices by using current year quantities and putting them in terms of previous (base
year) prices, already learned, GDP deflator=Nominal GDP/Real GDP
PPI—_________________________—measures prices of wholesale/input prices (not if prices go up at Wal-
mart, but the price Wal-mart pays for the products it sells)
CPI—__________________—a measure of the average price paid by urban consumers for fixed market basket
of consumption g/s
o Most used measure of inflation
o Base year was set from 1982-1984=CPI was 100 that year, May 2005—CPI was 194.4 which means that
prices were 94.4% higher than in 1984.
o How does the BLS calculate the CPI?
1st select a ____________________ of goods—tries to reflect the average budget of
consumers—housing takes up a large portion of consumers’ money, so it is weighted
more heavily, considers food, education, recreation, and others—about 80,000 goods in
the basket
2nd BLS finds the current prices of the ____________ goods
3rd they compare these prices with the base year and with the previous period
o Criticisms of the CPI
17
o To do the AP problems—you basically already did this in lesson 4 with hamburgers and hotdogs, except
the quantities don’t change. They will ask you to compute and will give you a base year.
o 1st find the market basket price by multiplying the price times the quantity on each item given.
Market Basket in 2000
Item Quantity Price
Oranges 10 $1
Haircuts 5 $8
Total cost of the basket
2nd Find the CPI. CPI=Cost of market basket of the year you are trying to find/Cost of the market
basket at base year x 100
If the base year is 2000
o CPI for 2000=100
o CPI for 2001 = 75/50=1.5 x 100=150
If the base year is 2001,
o CPI for 2001=100
o CPI for 2000= ___________________
Who wins and who loses with unanticipated inflation?***
o ____________ win with unanticipated inflation and ____________ lose with unanticipated inflation—
Why? When you take out a loan, the bank anticipates some inflation, so they build that into the loan.
For example, if you take out a loan for $100 and plan to pay it back next year and the bank anticipates
5% inflation that year, so they charge you $7 in interest—leaving them at least $2 in profit. BUT if
inflation is more than they anticipated (ex. 10%), then they have lost $3 b/c you will pay them back with
money that is worth less than when you took out the loan.
o Who loses with unanticipated DEFLATION? ________________________
o People living on a fixed income or people with fixed wages lose with unanticipated inflation
Calculate real and nominal wages and real and nominal interest rates. (Modules 14 and 15)
Like GDP, __________ wages and interest rates remove the effects of inflation and nominal wages and interest
rates include inflation
___________ wages are the wages that you make on your pay check
The nominal interest rate is interest rate that banks charge you when you take out a loan
Real wages and interest rates are adjusted for inflation.
So, if you experience a 5% raise from last year BUT inflation is 10%, your real wage has decreased by 5%.
If you experience a 15% raise and deflation of 2% occurs, then your real wage has increased by _____%
Same with interest rates—If the bank charged you 10% and inflation was 5%, then your real interest rate is
_____%.
Market Basket in 2001
Item Quantity Price
Oranges 10 $2
Haircuts 5 $11
Total cost of the basket
18
Standard 10—The AD/SRAS Model
What is the AD/AS model? Why is the AD curve downsloping, and what is the difference between a shift in AD and a movement
along the AD curve? What are the determinants of aggregate demand? Be able to apply the determinants to a graphical analysis.
(Module 17—Remediation all parts)
3 Reasons the Aggregate Demand Curve is Downsloping
_____________________ also called the real _____________ effect—a higher price level reduces savings account balances/purchasing
power/assets, therefore people spend less.
________________________—higher prices=higher demand for money, if people demand more money, then interest rates go ___, if
interest rates go ______ the consumption and investment spending _________
________________________—higher prices for US goods induces people to buy fewer US goods and more imports, imports subtract
from rGDP. (not in your text)
Difference between a movement along the curve and a shift in AD
Movement along the curve—only caused by a change in the __________________
Shift in AD—caused by one of _________________of AD
o To the right is an _______________
o To the left is a _________________
Shifts Affect on Inflation, Real GDP, and Unemployment
If AD increases—what happens to inflation? ____________ REAL GDP ____________? Unemployment ________________?
If AD decreases—what happens to DEflation? ___________ REAL GDP ____________? Unemployment ________________?
AD shifts to the right—called _______________ Inflation
Aggregate Demand—schedule or curve that shows the amounts of real _______________ (rGDP) that buyers collectively desire to purchase
at each possible price level. ___________ relationship
Aggregate Supply—schedule or curve that shows the amounts of real output (rGDP) that firms will ___________________ at each possible
price level. ____________ relationship
19
Determinants of Aggregate Demand
Real GDP= _____ +_____+ _____+ ______
Consumption Determinants
o ________________________—If people feel wealthier because their assets have increased in value, then they will spend more. Ex.
Stock market increases, home prices are on the rise.
o ________________________—what will happen in the future? (Ex. In the weeks before shutdown, gov. employees limit their
spending)
o ______________________—reduction in taxes=increase in AD, increase in taxes=decrease in AD***
o ______________________—if IR go up, less spending on cars and other interest sensitive consumer purchases will decrease
Investment determinants— (BUYING CAPITAL GOODS)
Government Spending/Taxes (Fiscal Policy) o More gov. spending ____________AD, less gov. spending _____________ AD
o More taxes ___________ AD, Less taxes ______________ AD
__________________________— (Social Security, welfare, veteran’s benefits) are technically not a part of GDP, but if gov.
spending on these go up, then AD will increase
Net Exports (Exports-Imports) (Last Unit)
o __________________________________—if foreigners have more money, then they will buy more of our exports. If other
countries are experiencing a recession, then our AD decreases
o _____________________—If our dollar depreciates and foreign currency appreciates, then it will be cheaper for foreigners to buy
US goods. Therefore, they will buy more US exports. At the same time, it becomes more expensive for Americans to buy foreign
goods, so they buy fewer imports. Therefore, our AD increases
All of these cause the ID curve AND the AD curve
to shift!!
o ____________________--if business expect to
make more money in the future by expanding,
then they’ll buy more capital goods; if the gov.
gives tax breaks to businesses, especial tax
incentives to buy more capital goods
o Size/Quality of Capital Stock—if businesses
have bought a ton of capital goods last year,
then they will decrease their investment today.
(cause for the business cycle). Also, if new
technologies come out, businesses may
purchase new capital goods.
Draw the Investment Demand Graph Draw the AD/AS Model
o Interest Rates—if IR go down, more
businesses will buy _____________goods
Changes in IR _____________
the investment curve but cause a
___________ in aggregate
demand
MONETARY POLICY
CHANGES INTEREST
RATES!!!!!
20
What are the different sections of the short-run AS curve? What are the determinants of short-run aggregate supply?
Be able to apply them to an AD/AS graph. How is the short-run curve different than the long-run aggregate supply
curve? (Module 18 and 19—Remediation all parts of both)
D Draw the 3 sections of the AS Curve
Shifts in Short-Run Aggregate Supply
Shifts are sometimes called ________________
o AS doesn’t shift as often as AD
o Adverse supply shock=shift to the left; Positive supply shock=shift to the right
Draw an increase in SRAS Draw a decrease in SRAS
If SRAS increases—what happens to inflation? ____________ REAL GDP ____________? Unemployment
________________?
If SRAS decreases—what happens to inflation? ___________ REAL GDP ____________? Unemployment
________________?
o When SRAS decreases it can be due to ______________ inflation—inflation due to businesses’ costs increasing
o When SRAS decreases it creates ________________—stagnant economy b/c real GDP is decreasing at the same
time there is inflation
Short-Run Aggregate Supply Curve’s 3 Sections o Qf=GDP at full employment
Full employment=no cyclical unemployment
o What happens to the PL and RGDP when AD shifts in each of the sections
o Horizontal aka Keynesian Range—
Low GDP
what happened to the price level when AD increased?
_________ What happened to rGDP? _______________
o Intermediate Range—
Medium GDP
Assume that this is the section, unless otherwise stated.
what happened to the price level when AD increased ?
____________ What happened to RGDP? _________________
o Classical Range—
Begins with GDP at full employment
What happened to the price level when AD increased? ______
What happened to RGDP? ________
21
Determinants of Short-Run Aggregate Supply
_____________________—the cost of resources. If the cost of resources (like oil or labor) decreases, then suppliers will have an
incentive to produce more. Thus, AS will increase. If the cost of resources increases (more than productivity increases), then AS will
decrease
____________________—
o Increased productivity means that it takes less inputs (resources) to make the same amount or more outputs (stuff);
o Productivity= total ____________/total __________
Example of productivity increase
If you have made 10 pens with $5 worth of resources (ink, plastic, machines to make the pens) Productivity=10/5=2
Then you can make 20 pens with $5 worth of resources; Productivity=20/5=4
o If workers are more productive, then profits will increase, so producers will have a greater incentive to produce more—AS will
increase; _______________________________ (technology) and __________________ (education) usually makes workers
more productive; ex. Secretary can do much more work using a computer than she/he did on a typewriter. She can also do
much more work if she has mastered computer skills.
o If the government spends money on __________________—public capital goods—roads, bridges, levees, internet connectivity
can make workers more productive
Government Business Taxes, Subsidies, and Regulation
o If governments tax businesses more, it will cut into their profits. Thus, aggregate supply will _____________. Tax businesses
less, AS will increase.
o If government ______________ (helps—usually gives money or a tax break) a business, AS will ___________; Ex. Ethanol; if the
government removes subsides, then AS will decrease
o _________________ cost money for businesses to implement, which cuts into profits; more regulations=AS decreases; less
regulations=AS increases
o When gov. attempts to increase AS by cutting taxes/regulations or increasing subsidies to business, it is called
____________________________
o Changing policies to help businesses produce more is call _________________ policy.
Inflationary Expectations—If business expect higher prices in the future, they will ____________supply today; if they expect lower prices
in the future, then they will sell more today. *
If both shift but you do not know by how much—just like regular demand/supply—shift both curves equally-the one that doesn’t change
is indeterminate
Standard 11: From Short-Run to Long-Run Draw the graph above (Economy in full employment equilibrium)
The economy above is in long-run equilibrium—meaning there is no cyclical unemployment, the actual unemployment
rate is equal to the NRU, and the real GDP is the same as the potential GDP
I. The Short Run
a. A period of time in which _____________wages (how much people get paid without subtracting out inflation effects) remain FIXED as the price level increases or decreases.
b. Wages are fixed for a time period b/c i. Workers are not immediately aware that inflation (or deflation) has made their _____________ wages
decrease (or increase). ii. Many workers (including your teacher) are under fixed wage ______________. Ex. I get paid only so much this
year. I cannot negotiate a pay increase until the following school year.
22
II. The Long Run a. Once nominal wage adjustment for inflation/deflation economy enters the long run b. The long run: a time period in which nominal wages are fully responsive/____________ to previous changes in the
price level.
III. Classical vs. Keynesian Economics
a. _____________________________ economist—focuses on the long run. They focus on how wages and resource
prices are flexible. They think that the government should not intervene in the economy because without intervention
the economy will return to equilibrium eventually.
b. _______________ Economist—focuses on the short run. They find that wages and prices are ______________
meaning that they will not change or that it will take way too long for them to change.
c. Which is correct? Depends upon who you ask.
IV. Recessionary Period
a. The economy below is experiencing a recessionary period because it is currently producing ________ RGDP than at full
employment. It is ___________its potential GDP. The unemployment rate is __________. The actual unemployment
rate is _______ than the NRU.
a. Draw a recessionary period b. Expansionary Fiscal or Monetary Policy c. Draw the self-correcting economy
b. If the gov. _____ taxes or _______ gov. spending, AD will increase. If the Federal Reserve ___________ interest rates,
AD will increase
c. Without government intervention—NO FISCAL OR MONETARY POLICY
After workers are laid off, they will accept lower (nominal) wages in order to gain employment. This pushes down the
price of labor. Therefore, SRAS will _____________ (shift ________) due to cheaper input prices. Therefore, in the long
run, RGDP has increased and inflation has decreased.
V. Inflationary Period
a. Draw an inflationary period b. Contractionary Fiscal or Monetary Policy c. Draw the self-correcting economy
23
a. The economy above is experiencing an _____________ period because it is currently producing __________ RGDP than
at full employment; it is ____________ its potential GDP and unemployment is __________ than the NRU
b. If the gov. _____ taxes or _______ gov. spending, AD will increase. If the Federal Reserve ___________ interest rates,
AD will increase
c. (Right) Without government intervention—NO FISCAL OR MONETARY POLICY. After workers notice that the inflation
has caused their ___________ wages to decline, they demand a pay raise (nominal). The producers grant the pay raise,
thereby causing their input (resource) prices to rise. We know that when input prices rise, SRAS must decrease, shift
_________. SRAS will shift left until in meets AD at the LRAS curve. Therefore, in the long run, RGDP has returned back
to the full-employment equilibrium and inflation has increased.
VI. Long-Run effects
a. In the LR, the government through fiscal or monetary policy CANNOT CHANGE OUTPUT, but the price level can increase
after fiscal or monetary policy.
b. In the LONG RUN, there is NO __________________ OFF BETWEEN INFLATION AND UNEMPLOYMENT
What happens to real/nominal wages when AD/SRAS shifts in the short-run? In the long-run?
Nominal=_________ + Inflation
Nominal wages must stay the same (sticky, not flexible) in the short-run, unless otherwise stated
If AD increases or SRAS decreases—
o Ask yourself—What happened to inflation?
o Nominal is constant= Real + Inflation____
o What MUST happen to Real?
o R= ____
If AD decreases or SRAS increases—
o Ask yourself—What happened to inflation?
o Nominal is constant=Real + inflation ___
o What MUST happen to Real?
o R=____
In the LR, REAL OUTPUT/WAGES are CONSTANT!!!! (unless LRAS shifts)
o Therefore, if inflation _____, then nominal ____
o If inflation ______, then nominal ______
Shifts in LRAS
What shifts LRAS?
a. Increase in Resources
i. Land—difficult to increase the actual land, but natural resources like cows, corn, and oil can be increased with
new technologies/efficiencies
ii. Labor—if the labor force increases NOT UNEMPLOYMENT DECREASING, or if the labor force is more
productive.
iii. Physical Capital Stock=NET INVESTMENT, not gross investment, amount of available technology, more
physical capital goods will increase when INTEREST RATES DECREASE, capital per worker will increase and
output per worker will increase.
24
iv. Human Capital—an increase in education that makes workers more productive
b. Increase in Productivity
Why is a shift in LRAS to the right so great? a. Causes an increase in RGDP without inflation.
b. Same as a shifting outward of the Production Possibilities Curve—you can make more of everything.
c. Shows an increase in a country’s standard of living—increases real GDP per capita LRAS
PL
SRAS
AD
PLe
RGDP
LRAS1
SRAS1
Yf Yf1
AD1
Co
nsu
me
r G
oo
ds
Capital Goods
Standard 12: Fiscal Policy
What is fiscal policy? How is it used to shift aggregate demand? What are automatic stabilizers? What is the
difference b/wn the deficit and the debt? How do the multipliers work (Be able to calculate)? What are the problems
with fiscal policy (Module 20-21, Module 16 pgs. 158-160, Crowding out—pg. 280—Remediation 20 and 21 all parts)
Fiscal Policy—gov. ______________and _________________policies to change the economy
Expansionary vs. Contractionary Fiscal Policy
Expansionary fiscal policy
o Implemented when the economy needs to expand
o During a _______________—unemployment is _______
o Gov SPENDS ________—roads, schools, tanks, also ___________ pay
o TAXES _______—cuts personal or corporate income taxes
o After implemented AD shifts to the __________
Contractionary fiscal policy
o Implemented when the economy needs to contract
o b/c of too much inflation
o Government SPENDS LESS
o TAXES MORE
o After implemented it shifts AD to the left
Discretionary vs. Automatic Fiscal Policy
__________________ fiscal policy—a fiscal policy that is implemented when Congress (and the President) passes a law.
o Ex. If Congress increases/decreases tax rates
o If Congress votes for “Race to the Top” giving more money to states for education
Automatic ________________--a fiscal policy that is implemented automatically
o ___________________ income tax
the more $ you make, the higher the % you pay in taxes; Highest tax bracket pays around 30%, lowest tax bracket
pays about 0% (although they pay SS taxes)
P
L
RGD
P
AD
SRA
S
P
L
RGD
P
AD
AS
25
When the economy is doing poorly, more people will have _______ income, so the tax automatically adjusts to tax
________
When the economy is doing well, then tax revenue will _____________ automatically
o Food stamps/welfare/Medicaid (poor)/unemployment insurance
These are all ___________________ programs
Entitlement means if you meet the requirements, then you get the benefit
For example, if you make less than $10,000 a year with a family of four, then you get $300 worth of food stamps each
month. If the economy begins to downturn, then more people will meet this requirement. Congress does not have
to take any action.
MEDICARE=health care for the elderly is an entitlement program (if you meet the requirement—65 years old) BUT
NOT an automatic stabilizer
Deficit, Surplus, Debt
____________________—tax revenue=government spending for a given year
_____________—government spending>tax revenue for a given year
____________—tax revenue > government spending for a given year
__________—accumulation of past deficits minus any past surpluses
_________________ Policy—(increased gov. spending and/or lower taxes) ______________ deficits and the debt
_________________ Policy—(decreased gov. spending and/or higher taxes)______________deficits and the debt
Fiscal Policy and the Multipliers
When the government changes spending and taxing in an economy the total affect is __________ than the original change.
For example, if the government spends $1 million dollars on a school, the total change to real GDP is more than 1 million
dollars. It could potentially change GDP by $10 million dollars.
The MPC and MPS
Before calculating the multiplier, we must figure out the MPC and the MPS
Marginal Propensity to ___________ (MPC)—the amount a person spends of any additional disposable income they receive
o _____________ always means additional
o Consume=spend
o If Sally was making $50,000 and she receives a raise to now make $60,000, then her marginal disposable income is
$10,000
o If Sally spends $9,000 of the $10,000, then she has spent 90% of her additional income. Therefore, her MPC is .___
Marginal Propensity to Save (MPS)—the amount a person saves of any additional disposable income they receive
o Sally—saves 1,000 of the $10,000 extra income she received. Therefore, her MPS is .______
MPC formula= change in __________/change in ___________
MPS formula=change in _________/change in ____________
MPC + MPS ALWAYS EQUALS ______
o A high MPC implies a small MPS
Savings can be negative
o How? __________________
If savings are negative, then the _____ is greater than 1
The Multipliers
Investment/Government Spending/Exports Multiplier
o If businesses increase investment spending (physical capital goods) OR government changes its spending, then the
total affect is larger than the original increase/decrease
o Investment/Spending multiplier=1/MPS
o Sally’s MPS was .1. Therefore, in her country, the spending multiplier would be 10
1/.1=10
If the MPC is .8 and government increases spending by $5 billion dollars, what is the total increase/decrease in GDP?
o 1/.2=5
o 5 x 5
26
o $25 billion
If the MPS is .33 and the government decreases spending by $20 billion dollars, what is the total increase/decrease in GDP?
________
o 1/.33=3
o 3 x 20
o $60
If the government increases spending by $500 and that produces a $2,000 change in GDP, then what was the MPC?
o For this example you must work backwards
o Multiplier must be 4
o 2,000/500=4
o If the multiplier is 4, then the MPS must have been .25
1/x=4
X=1/4
X=.25
If the MPS is .25, then the MPC must have been .75
If the government decreases spending by $1,000 and that decreases GDP by $10,000, then what was the MPS?
The Tax Multiplier
o –______/MPS
o The tax multiplier is always 1 smaller than the spending multiplier
Why?
The tax multiplier is smaller because there is no initial injection of spending
For example, if the government increases spending by 1,000, if the MPC is .75, then the total
increase to GDP will be 4,000—1,000 for the injection of government spending and 3,000 of
multiplying affect.
o It is always ________________
Because there is an inverse relationship between taxes and GDP
If taxes increase, then RGDP ___________________
Why? B/C when taxes increase, this taxes money out of people’s pockets that they would have
otherwise spent
If taxes decrease, then RGDP _________________
If the government increases taxes by $10 billion dollars and the MPC is .75, then what is the total affect on GDP?
o GDP will decrease by $30 billion
o –MPC/MPS
o -.75/.25=3
o -3 x 10= -30
If the government decreases taxes by $10 billion dollars and the MPS is .2, then what is the total affect on GDP?
The Balanced Budget Multiplier
It is always 1
Why? The spending multiplier plus the tax multiplier
always equals 1
“Consumers do no reduce their spending by the full
amount of the tax increase.”
Ex. If the MPC is .75
Spending multiplier: 1/MPS= 1/.25=____
Tax multiplier: -MPC/MPS -.75/.25=___
_____ + ____=1
If the government increases spending by $500 billion
MPC MPS Injection
Multiplier
Tax-
Leakage
Multiplier
.9 .1 10 -9
.8 .2 5 -4
.75 .25 4 -3
.67 .33 3 -2
.5 .5 2 -1
27
and also increases taxes by $500 billion to cover the
cost of the increase in spending, then the economy
will still increase by $500 billion.
Standard 13: What are the disadvantages/criticisms of fiscal policy?
_______________ policy lags
o Lag—time it takes to agree and implement the policy; Economy could worse or get better before the policy
changes anything.
o _________________lags--Takes time to agree on anything.
o _________________ lags—takes time to implement. Particularly spending policies—takes time to build
roads/tanks/schools or hire teachers. Tax cuts are a more immediate stimulus.
___________________ theory
o -“the idea that businesses, consumers, and workers expect changes in policies to have certain effects on the
economy and, in pursuing their own ______________________, take actions to make sure those changes affect
them as little as possible.”
o Ex. During a recession, the gov. gives a tax cut to all Americans. Instead of spending the extra income, people ________ it b/c
they realize that the gov. is cutting taxes b/c we are headed toward a recession. Knowing that a recession is imminent, people
save their money b/c it is in their best interest, just in case they lose their jobs.
o Multiplier only works if people spend at least some of the change in income.
______________________***important AP topic
o Expansionary and contractionary fiscal policy has a counteracting effect.
o _______________ policy=interest rates can increase
o Interest rates increasing=less investment spending (physical capital goods) and less consumer spending on big
items (cars, appliances)
o Interest rates increasing also decreases net exports (discussed later)
o Ex. If the economy is in a recession, the gov. conducts expansionary fiscal policy—tax less and spend more. This
creates a budget _____________. How does the government finance a deficit? By taking out loans. This can increase
interest rates for one of two reasons. 1. If the gov. increases DEMAND for loans, then the IR increases. AND/OR the SUPPLY of
private loans will DECREASE b/c now people are not lending as much privately, they will be lending the government more
money. If interest rates increase, investment (capital goods) spending and consumer spending decrease, shifting AD to the left.
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Draw the crowding out effect on the AD/AS graph below. Show the economy in a recessionary period. A) Draw the
expansionary fiscal policy—cutting taxes/increasing gov. spening. B) Draw what happens after crowding out.
The opposite also happens. Contractionary fiscal policy (meant to decrease GDP and the PL) will lower interest rates, thereby increasing interest-sensitive expenditures (houses, cars, capital goods).
Unit 4: Money and Monetary Policy Standard 14: What are the functions of money? What makes up the money supply? What are the determinants of the
demand and supply of money? Be able to graph the demand and supply of money on the money market graph. Calculate the
time value of money.
I. Characteristics of Money—Portable, durable, divisible, limited supply, accepted, uniform
II. Functions of Money a. ____________________—used for buying and selling goods, facilitates exchange, eliminates barter, decreases
________________ cost
i. Characteristics—
b. _________________—yardstick for measuring the relative worth of a g/s, prices
i. Characteristics—
c. _________________—allows you to save, in order to spend later
i. Characteristics—
III. The Money Market Graph—shows the demand and supply of money (below)
IV. The Supply of Money a. _______—currency—cash and coins, ________________ (money in your checking account)*
i. Types of currency
1. ________________—can be used to trade and have value by itself—salt, wheat, pearls
2. ____________ money—can be used to trade and can be exchange for gold/silver—Gold Standard:
each $ was worth so much in gold—so you could cash it in
3. _________ Money—has value b/c gov. says it has value and people accept it.
1. Draw the Public (Total) Loanable Funds
Market Below
2. Draw the Private Loanable Funds Market Below
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ii. Checkable deposits—_____________ component in the MS
b. M2—not as _____________(easy to exchange quickly)
i. Everything in M1 plus ___________ accounts, Money Market Mutual Funds, CDs of less than $100,000
c. M3—less liquid than M2
i. Everything in M1 and M2 + CDs of $100,000 or more
d. _____________________ ARE NOT MONEY e. The Supply of Money—____________ b/c it is independent of the interest rate. Why? The supply of money
is set by the _____________________. The Fed increases or decreases the supply of money to change interest
rates in order to affect AD. Determinants of supply—the Fed
V. The Demand for Money a. ___________________ Demand—money held to make purchases (medium of exchange)
i. Affected by NGDP, higher NGDP=greater transaction demand for $, determinant of demand—increase in
nominal GDP=increase in demand for money
ii. ___________ of interest rates
b. ___________ Demand—money held as a store of value
i. Advantages of holding $ instead of investing—more liquid and less _______
ii. Disadvantages—no _______________
iii. As interest rates increase, the asset demand decreases b/c if high ir, then people take their $ and put it in an
interest bearing account
iv. Aside—If interest rates increase—bond prices decrease—why? Decreased demand
Standard 15: What is the structure and function of the Federal Reserve? How is money created
in a fractional banking system? Be able to calculate, given data, the size of the money
multiplier and a change in the money supply. How does the Fed influence the supply of
money? How does open market operations affect the interest rate and the price of bonds?
What is the structure and function of the Federal Reserve? a. What is it?
i. The banks’ bank.
ii. Quasi-private institution, quasi-public--It is a private business just like First Tennessee bank, but
the government appoints its highest officials
b. Created in 1913 due to a volatile money supply
i. Main purpose of the bank is to regulate the money supply. Hyperinflation—really, really high
inflation is due to a mismanagement of the money supply. Think: Germany after WWI—printed a
bunch of money to repay war debts—backfired and Zimbabwe in the 20th century.
c. The Structure
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i. The Board of Governors is made up of 7 presidential appointees (confirmed by the
Senate). 14 year terms, President selects chairman and vice chairman. Recent ones—
Greenspan, Bernake, Yellen
ii. Federal Open Market Committee—12 members, all of the BOG plus 5 presidents of the
12 district banks (rotating members but NY president is always present). They meet to
discuss open market operations--buying and selling bonds, which is their major tool for
regulating the money supply.
iii. 12 Federal Reserve Banks—Think 12 regional branches, ours is in Atlanta
II. Functions
i. Bank’s Bank—banks can deposit money with the Fed, they can also take out loans
ii. Check clearing house—When I write a check for $100 on my First Tennessee account
and give it to my babysitter who banks with Wilson Co. Bank and Trust, how do the
funds get from my account to her account? The Fed debts First Tennessee $100 and
credits Wilson Co. Bank and Trust $100.
iii. Government’s Bank—like I have an account with First Tennessee, the gov. has an
account with the Fed
iv. Regulating and Supervising banks—monitor banks to ensure compliance with banking
laws, recently ran a test to make sure that all banks could weather another severe
recession—most major banks passed, several failed
v. MAJOR FUNCTION—REGULATE THE MONEY SUPPLY
What is the fractional banking system? How does it create and destroy money?
I. The Fractional Reserve Banking System—only a % of the total money supply is held as currency
a. Assume that I have $1,000 in my savings account, the bank does not actually hold my $1,000 to wait on
me to withdraw it. If they did, they wouldn’t make any profit. They lend out my money to others.
b. ______--The Fed sets the minimum percentage that the bank must hold to ensure that people who want
their money can access it at any time. The Required Reserve Ratio—expressed as a decimal and not a
percent—So, if the RRR is .1, banks must hold _______% of their demand deposits (money in
checking/savings accounts) in cash.
c. A bank’s balance sheet—aka T-account, called a balance sheet b/c both sides must equal
i. Assets—any deposit is an asset b/c the bank can take it and lend the $ out,
1. Lots of things can be assets for banks—_______, ___________ (required and excess) ,
and property,
ii. Liability—any deposit is also a liability b/c the person who deposited it can at any time ask for
the money back, sometimes you’ll see owner’s equity as a liability
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iii. Things you need to look at—demand deposits, reserves (total, required, excess) and loans
iv. _________Reserves—sometimes this is listed as total reserves, sometimes as just “reserves”.
This means the total amount the bank has on hand.
v. ____________ Reserves—the amount that the bank MUST keep on hand, sometimes just listed
as “reserves” particularly when the balance sheet also lists excess reserves.
vi. ___________ reserves—amount that the bank has on hand but could lend out if they wanted to
II. Money Creation
a. Money is created through the lending process.
Mrs. Powell deposits $100 in to the Bank of . The required reserve is .20. R=reserves; L=Loans; D=Deposit
Bank of Bank of Bank of Assets Liabilities Assets Liabilities Assets Liabilities
$20 R $100 D $16 R $80 deposit $12.80 R $ 64 D
$80 L $64 L $51.20L
b. Money creation works because banks create more money through the lending process.
_________________bank created $80, the entire banking process would create $400. Just by looking at
the three banks nearly $200 was created--$80 by the first bank, $64, by the second, $51.20 by the 3rd
c. Process goes on and on until there is no more money to lend and all $100 ends up in the reserves on the
various banks. We don’t have to add all of these up.
d. Money Creation formula—
i. Excess reserves x money multiplier
ii. Money multiplier=
iii. In the above, the initial deposit is $100, of the initial deposit (assuming a RRR of .2), the bank
must keep $20, so $80 is the excess reserves.
1. $80 x 1/.2
2. 1/.2=5
3. 5 x 80=$400
iv. Another way to figure, (Amount of the original deposit x money multiplier)-original deposit
1. $100 x 5=500
2. 500-100=$400
v. Why do you subtract out the original $100? Because we are trying to figure out how much was
created, and the banking process does not create the $100 that I deposited.
e. Money Created vs. Total Money Supply i. If the question states that my $100 is the only money in the money supply along with anything
else created, then the total money supply is $500.
ABC Bank
Assets Liabilities
Reserves--$20 Demand deposits--$100
Excess Reserves--$30 Fed loan--$100
Loans--$100 Owners Equity--$50
Other--?
1. Suppose that all the reserves at “All Banks” are required
reserves. What is the RRR? _________
2. Since ABC bank lists reserves and excess reserves, we can
assume that “reserves” are _________ reserves.
3. What must be the amount in other? _________
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How does the Fed influence the money supply? I. Three tools: 1. Set the RRR 2. Open-market operations (buying and selling of bonds) 3. Discount rate
II. Expansionary/Contractionary Monetary Policy
a. __________________ (Easy) Monetary Policy—use during bad economy, increase the money supply to
decrease interest rates to stimulate AD in order to decrease unemployment
ii. Decrease the RRR, Buy bonds, Decrease the discount rate
b. __________________ (Tight) Monetary Policy—use during inflation, decrease the money supply to
increase interest rates to decrease AD in order to decrease inflation
iii. Increase the RRR, Sell Bonds, increase the Discount Rate
III. RRR—raise or lower rrr to change the MS
i. If the RRR is .1—then, money multiplies by _______, if the RRR is .2, then, money only
multiplies by _____
ii. Increase RRR—more banks must keep on reserve=less they can lend=MS decreases
iii. Decrease RRR—less banks must keep on reserve=more they can lend=MS increases
IV. Open Market Operations
i. Buying and Selling of Bonds
ii. If Fed wants to increase the MS—they __________ U.S. savings bonds—puts money back into
the economy
1. How do they induce people to sell their bonds? Fed offers a ___________ price for the
bond.
iii. If the Fed wants to decrease the MS—they _______ U.S. savings bonds—takes money out of the
economy
1. How do they induce people to buy their bonds? The Fed offers a ________ price.
iv. The buying and selling of bonds affects the Federal Funds Rate.
v. _______________________ Rate—interest rate banks charge other banks.
1. Banks must have the legal minimum amount of reserves at the end of the night. If they
are short, they must take out a loan from another bank or from the Fed. Most banks want
to borrow from other banks instead of from the fed.
2. Banks are the ones who usually buy and sell bonds to and from the Fed. If the banks buy
the cheap bonds, the bank will have less money to lend out to the public and to other
banks, forcing interest rates up.
3. If banks are selling their bonds to the Fed, then they will have excess money to lend out.
Thus the interest rate they charge other banks will be lower.
V. ______________ Rate—interest rate the Fed charges member banks
i. Follows the federal funds rate. Fed doesn’t really use this to change the MS
ii. Expansionary—set low
iii. Contractionary—set high
Standard 16: How do changes in the money supply affect AD? What are the advantages and
disadvantages of using monetary policy?
Expansionary/Contractionary Monetary Policy affect on AD on your card.
What are the advantages and disadvantages of using monetary policy? a. Advantages—
i. less __________________than discretionary fiscal policy
ii. No offsetting effect like with fiscal policy—“no crowding out effect”
iii. IF YOU WANT TO STIMULATE YOUR ECONOMY (INCREASE AD) AND YOU WANT
LONG-RUN GROWTH THEN, YOU NEED TO DO EXPANSIONARY MONTARY POLICY
INSTEAD OF EXPANSIONARY FISCAL POLICY.
1. Why? Expansionary fiscal policy will increase interest rates. If interest rates increase
fewer businesses will buy capital goods. Capital goods are necessary for long-run
growth.
b. Disadvantages—
i. Like the fiscal policy multipliers—it multiplier is RARELY in full effect.
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1. People withdraw money from their accounts. It only multiplies while it is in the bank.
2. It assumes that banks will always lend all of its excess reserves. Lately—they haven’t been
doing this.
ii. By itself (w/o fiscal policy), it may not cure a major recession.
1. Why? Because in a deep recession it doesn’t matter how low the interest rate is. Consumers and
businesses will not take out more loans.
See last unit’s notes about advantages/disadvantages of fiscal policy
What are the competing macroeconomic theories? I. Keynes—
a. Assumes that wages are sticky(rigid) especially downward (wages might adjust upward—meaning that
ppl may ask for raises if prices are high, but denies that wages will adjust downward—if Mrs. Powell gets
laid off, she will not go flip burgers at McDonalds—she’ll wait a year or two to find another teaching job.
b. Says that gov. should intervene to increase/decrease AD through fiscal policy (also is ok with using
monetary policy)
II. Advocates of monetary policy
a. No fancy name—just think that the Fed should use monetary policy to influence the economy. The
current and two past Fed chairman used monetary policy quite a bit.
III. Classicals—
a. Do nothing. The economy will correct itself because wages and resource prices are flexible and will
adjust to economic conditions to return the economy to full employment equilibrium.
IV. Neo-classicals
a. Rational expectations theory—people are rational and use available info, may do the opposite thing (save
in recession, buy more during a peak)
b. Monetarists—should only grow the money supply to keep up with RGDP growth. Otherwise, only
inflation in the long-run. So, if RGDP is increasing 2% each year, the MS should also increase 2% each
year. Focus on the equation of exchange
MV=PQ
M is ______________ * V—___________ of money is the number of times it is exchanged=
Price level * Q—quantity of goods/services (remember p * q=Nominal GDP)
Therefore, if you increase M, if V is stable=you must increase P or Q.
If Nominal GDP is $8 trillion, and the MS is $4 trillion, what must the velocity be?
Monetarists say that in the LR only P (inflation) will increase, if you increase the MS. They think that Q
(RGDP is stable in the LR at full-employment)
Standard 17: How do changes in AD, SRAS, and LRAS reflect changes in the Phillips Curve?
The Phillips Curve
Model first conceived in the 1960s by A.W. Phillips
Demonstrates trade-offs between _______________ and ____________________
o When inflation is high, unemployment is ________
o When inflation is __________, unemployment is high
o Shifts in aggregate _____________
Adapted to show changes in SRAS and LRAS
Shifts in Aggregate Demand and Movements along the Short-Run Phillips Curve
Anytime there is a shift in AD or SRAS, it can be shown on the Phillips Curve
If AD increases (assuming an upward sloping AS curve), inflation increases,
RGDP increases, causing unemployment to decrease.
This is shown with a movement up the Phillips curve.
If AD decreases, inflation decreases, RGDP decreases, causing unemployment to increase.
This is shown with a movement down the Phillips curve.
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Shifts in Aggregate Supply and Shifts in the Phillips Curve
Shifts in SRAS can also be shown on the PC model.
If SRAS decreases, then inflation increases and unemployment increases
—STAGFLATION. This is shown in a shift right of the Phillips Curve.
If SRAS increases, then inflation decreases and unemployment decreases.
This is shown with a shift left of the Phillips Curve.
The Long-Run Phillips Curve
Like LRAS, the LRPC is ___________________, showing that in the long-run there is no trade-off
between inflation and unemployment.
LRAS is set at ______—RGDP at full employment, GDP when there is no
________________unemployment,
Corresponds to the NRU—________________ Rate of Unemployment—rate of unemployment when
there is no cyclical unemployment
Unit 5: International Economics
Standard 18: What are the benefits to free trade? How do countries attempt to prohibit free trade? How do the balance of
payments accounts work?
Benefits to Free Trade
More ____________—those with the least opportunity cost will produce the good
Allows _____________ beyond PPC
Decreases ______________
Disadvantage--Does hurt some ___________ producers
Trade Barriers
Attempts to restrict _________
Tariffs—______ placed on imported goods
Import _________—only a set number of goods can be imported
___________—complete trade restriction with a country
o Ex. Cuba
Results—overall ___________ prices, _____________ domestic production, helps domestic producers of the particular
item, _________ efficient, tariffs generate tax revenue for gov.
Result of the Smoot-Hawley Tariff Act of 1930—international trade tariff war, international trade declined by 66%--prices
increased, made the depression MUCH worse
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Balance of Payments
BOP is a summary record of a country’s international economic transactions
Two (Three) main accounts—Current and Financial (formally called capital)
_______________ Account—records a nation’s exports and imports mostly, also interest payments and net transfers
(foreign aid, money immigrants send to family abroad).
o Trade _________—more imports than exports
o Trade _________—more exports than imports
o Ex. US purchase of Italian sports cars will add to our trade deficit
Financial Account (formerly called capital account)—records the flow of money from the purchase of real and financial
assets
o _______assets—physical capital, like buildings, and land
o __________ assets—stocks and bonds
Capital ___________=money is flowing into a country because foreigners are: Buying US real estate,
buying American companies’ stocks, and/or purchasing government bonds
Capital ___________=money is flowing out of a country because foreigners are: Selling US real estate,
selling American companies’ stocks, and/or selling government bonds OR Americans are buying these
things in foreign countries.
Current and Financial Account must balance (or equal ___________)
o If there is a deficit in one account, then there must be a ___________ in the other account***
3rd Account—Official Transactions Account
o Called all kinds of things—statistical discrepancy account, reserve account, official settlements accounts
o But really a part of the ______________ account
o Makes sure that the balance of payments accounts actually balance to zero
If US consumers buy more imports and less exports, what happens to the trade balance? What happens to GDP?
Standard 19: How are exchange rates determined?
Foreign Exchange Rate—the price at which one currency exchanges for another
o With flexible exchange rates--determined by the forces of supply and demand in the foreign exchange
market
o Fixed exchange rates—determined by the government (ex. China has done this in the past. They have
held down the value of their currency, thereby making their exports cheaper. We’ve been mad at them
for doing this.)
Foreign Exchange Market Foreign Exchange Market for Dinar for U.S. Dollars
Both of the above graphs show that the US dollar has depreciated—the fall in the value of one currency in terms
of another currency.
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Both of the above graphs show that the Iraqi dinar has appreciated—the rise in the value of one currency in
terms of another currency.
Determinants of Exchange Rates
o Hint—Think of what happens to the demand for one country’s currency. The supply must go the same
way in the other country’s exchange rate graph
o Change in Relative Income—If income increases in a county (more than income increases in other
countries), then their currency will depreciate. Weird, huh? Ex. If the French experience a booming
economy relative to Mexico, then they will buy more of their own goods but they will also buy more
Mexican goods. This causes an increase in demand for Mexican pesos. Also, if Mexico is experiencing a
recession, then they will purchase less French exports, thereby decreasing their demand for Euros.
o Change in Relative Price-Level Changes—If more inflation in one country than another, the country with
inflation will experience depreciation. If America is experiencing more inflation than Germany, then
Americans will begin to buy cheaper German goods, and Germans will stop buying expensive American
goods.
o Change in Relative Interest Rates—When interest rates increase relative to other countries, then the
country with the higher interest rates will experience appreciation. Because citizens in other countries
will want to invest in the country that has higher interest rates, they will demand more of the currency
with the higher interest rates.
Change in Tastes—If
consumers in one country
demand foreign products,
then the demand for that
currency will increase. Ex.
Japanese video games
become popular with U.S.
children
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o Speculation—If currency speculators think that the value of a currency will appreciate in the future, then
they will buy more of that currency today. Becomes a self-fulfilling prophecy b/c when they buy the
currency, the currency appreciates. Ex. Iraqi dinar
Effects of Appreciation/Depreciation on Net Exports/Aggregate Demand
If appreciation of US currency
o Our RGDP and AD will decrease
o Exports (add to GDP) decrease and imports (takes away from GDP) increase
o Other countries goods are cheaper so we buy more of their imports and our goods are now more
expensive to them, so they buy less of our exports.
If depreciation of US currency
o Our RGDP and AD will increase b/c we will buy LESS imports (b/c they are more expensive), and
foreigners will buy more of our goods because they will become less expensive for them.
Standard 20: How does fiscal and monetary policy affect exchange rates and net exports? See card. No new
notes just connecting concepts.
