AP Macroeconomics

Explain sticky vs. flexible wages and prices.

"sticky wages" prevents wages from falling. The government should increase spending to close the gap. For classical theory inflation means workers seek higher wages and production costs increase, but AS increases as workers accept lower wages and production costs fall. This assumes wages can fall.

Define and give examples of the shifters of aggregate demand

1. Change in Consumer Spending ex: taxes (decrease in income taces shifts to the right) 2. Change in Investment Spending ex: Productivity and Technology (new robots shifts to the right) 3. Changes in Government Spending ex: (cut defense spending moves to left) 4. Change in Net Exports (X-M) ex: imports decrease and AD increases

Define and give examples of the shifters of aggregate supply.

1. Change in Inflationary Expectations- if an increase in AD leads people to expect higher prices. This increases labor and resource costs and decreases AS. 2. Change in Resource Prices- prices of domestic and imported resources. Prices go up (right) Price goes down (left). 3. Change in Actions of the Government (regarding business) 4. Change in Productivity- machines or worker productivity

List and Explain the three causes of inflation.

1. The government prints TOO MUCH money, this can be explained using the Quantity Theory of Money Equation: MxV=PxY, so the more money does not affect the velocity of money thus causing inflation. 2. Demand-Pull INflation- demand pulls up prices, if we have low unemployment and high income then shortages drive prices up. 3. Cost-push inflation- higher production costs increase prices, a negative supply shock increases the costs of production and forces producers to increase prices.

The Three functions of Money

1. medium of exchange 2. unit of account 3. store of value

Explain the three shifters of money demand

1.Change in price level (when price level goes up, the demand curve shifts right) 2.Changes in Income/GDP (when income/GDP goes up, the demand curve shifts right) 3. Any Change in Transactions (if its easier for us to make purchases we demand more money.)

Allocative and Productive Efficiency

Allocative efficiency is that that the products beings produced are the ones most desired by society ex:if the population is younger they will desire education. Productive efficiency is any point on the PPC curve.

If China makes 400 shirts and 200 TVs, and India makes 120 shirts and 30 shirts: what country has an absolute advantage in producing shirts? TVs?

China has the absolute advantage in producing shirts and TVs. China has the greatest advantage in producing the most outputs using the least amount of inputs.

If China makes 400 shirts and 200 TVs, and India makes 120 shirts and 30 shirts: What is China's opportunity cost for producing one shirt?

China's per unit opportunity cost for producing one shirt is .5 a TV for one shirt.

Fiat vs Commodity Money

Commodity money is something that performs the function of money and has alternative uses; for example: gold and silver. Fiat Money is something that serves as money but has no true value or other important uses.

Consumer Goods and Capital Goods

Consumer goods are goods created for direct consumption whilst capital goods are goods used to make consumer goods (tools, machines, robots, buildings, etc).

Define the four components of GDP, and give an example of each.

Consumer-spending by households on goods and services spending. Investments-when business put money back into their own business. Purchases of goods that will be used in the future to produce more goods and services Includes capital, investors, construction, structures, etc. Government Spending on goods and services ex: tanks, public employees, parks, etc. Not transfer payments such as social security, welfare, etc. Xn or Net Exports- exports (x)- imports (m). Equals the purchases of domestically produced goods by foreigner (exports) minus the domestic purchases of foreign goods (imports).

What is the difference between discretionary and non-discretionary fiscal policy?

Discretionary fiscal policy- congress creates a new bill that is designed to change AD through government spending or taxation. Non-discretionary policy- immediate or automatic stabilizers. Permanent spending or taxation laws enacted to work counter cyclically to stabilize the economy (does not need congress).

What is the equation for the GDP deflator? Explain the purpose of the GDP deflator?

Equation for the GDP deflator: (Nominal GDP/ Real GDP) x 100. It measures the prices for all good produced, whereas the CPI measures prices of only the goods and services bought by consumers.

What does it mean to "finance" something?

Financing something is to fund something some with fixed rate and some with adjustable rate or interest only.

Define and give examples of the three types of unemployment discussed in class.

Frictional Unemployment (good) -temporarily unemployed or being between jobs, individuals or qualified workers with transferable skills but they aren't working, actively seeking work. Structural Unemployment (good but painful)- changes in the structure of the labor force make some skills obsolete, workers DO NOT have transferable skills and the so jobs will never come back, workers must learn new skills to get a job, the permanent loss of these jobs is called "creative destruction". Cyclical Unemployment (bad)-unemployment that results from economic downturns (recessions); as demand for goods and services fall, demand for labor falls and workers, are fired.

Time Value of Money (present and future value)

Future Value of Money: if a person invents or lends money to someone it will compound or grow according to the future value of money equation: FV= PV (1+ i)^t Present Value of Money: it is the amount of money I need to invest at the present moment to get a desired amount in the future. Found using the equation: PV= FV/(1+i)^t

Define GDP, identify what is not included.

GDP is the dollar value of all final goods and services produced within a country's borders in one year. GDP is measured in dollars. GDP does not include the value of intermediate goods and services. Intermediate goods are goods used in the production of final goods in services. A US owned factory in another country does not count . Not included in GDP: intermediate goods, non production transactions, non-market (illegal) activities

Explain why GDP per capita is a better reflection of a nation's wealth.

GDP per capita is a better reflect of a nation's wealth because GDP needs to be adjusted to reflect the size of the nation's population.

If the actual inflation is greater than the anticipated inflation, fully explain who would benefit and who would be hurt and explain why?

If the actual inflation is greater than the anticipated inflation then lenders who lend money at a fixed interest rate, because they are not gaining money, they are losing it as the value of the dollar decreases; however, borrowers are benefiting because the money the pay back has less value than when they borrowed it.

Is the combination efficient, allocatively efficient, or both if a society only makes one of two products on the PPC curve?

If you only make one product you can't make another product therefore it is not allocatively efficient (unless we know the society) however it is productively efficient because it is a point along the PPC curve.

Free-Market vs Centrally Planned Economies

In a centrally planned economy the government owns all the resources (the four factors of production) and answers the three economic questions ex: communism in Cuba, North Korea, former Soviet Union, and China. In a free market system there is little government involvement in the economy. ex: capitalism in America.

If China makes 400 shirts and 200 TVs, and India makes 120 shirts and 30 shirts: Identity which country has a comparative advantage in shirts? TV?

India has the comparative advantage in shirts, because they have a lower per unit opportunity cost for shirts. China has the comparative advantage in TVs, because they have a lower per unit opportunity cost for TVs.

If China makes 400 shirts and 200 TVs, and India makes 120 shirts and 30 shirts: What is India's opportunity cost for producing one TV?

India's opportunity cost for producing one TV is 4 shirts for one TV.

If there is a point inside the PPC curve, what does this mean?

It is inefficient because some of the resources are unemployed.

How does a PPC graph show opportunity costs, efficiency (both types), unemployment, the law of increasing opportunity costs,and economic growth?

It shows opportunity costs because the curve shows what you can give up bu picking any point (choices). Any point can be both productive efficiency (always) and allocative efficiency depending on the most desired by the society. Unemployment is shown at the point inside the PPC curve because it is showing that not all the resources ware being used (as of labor resources). The PPC shows the laws of increasing opportunity cost because the PPC is bowed out. It shows economic growth because it is bowed out which probably means the quality or quantity of goods has changed.

What can cause it to change?

It usually doesn't change, but it can change if: either structural or frictional unemployment change, unemployment benefits change, significant changes in the labor force (baby boomers).

Measures of Money Supply (levels of liquidity)

M1=coins, currency M2=money which takes longer to use, saving deposits M3=plus time deposits above $100 k

MPC vs. MPS

MPC is the marginal propensity is consume; how much people consume rather than save when there is a change in income, always expressed as a fraction or a decimal. MPC= (change in consumption/ change in income). However, MPS is the marginal prosperity to save; how much people save rather than consume when there is a change in income, always expressed as a fraction or a decimal. MPS= (change in savings/change in income)

Explain the difference between nominal GDP and real GDP.

Nominal GDP: what was bought x price (GDP measured in current princes. Does not account for inflation from year to year. The GDP is "inflated") Real GDP: GDP expressed in constant or unchanging dollars. Is calculated using a constant "base year". The GDP is deflated (adjusts for inflation).

Identify how to calculate nominal interest rates and real interest rates. Explain the difference between the two.

Nominal interest rates is the rate we get at the bank. The amount of interest that lenders must charge to make a return AND adjust for inflation. Real interest rate + expected inflation. Real interest rates is nominal interest rate- expected inflation.

Define "Per Unit Opportunity Costs".

Per unit opportunity cost is the opportunity cost per units gained, or the comparative advantage is the lowest per unit opportunity cost.

Normative vs Positive Economics

Positive economics is based on facts and avoids value judgments (what is) ex: taxes. Normative economics include value judgment (what ought to be) ex: higher prices makes the higher living standard of supplier

How does inflation affects people's incomes?

Real wages is when wages are adjusted for inflation. A better indicator of "purchasing power". So the real wages could fall if inflation happens but wages don't change, it would stay the same if wages went up at the same rate/amount as inflation, and increase if wages growth accelerates at a faster rate than inflation.

Explain three different scenarios in which inflation can cause your REAL income to fall, stay the same, and increase.

Real wages is when wages are adjusted for inflation. A better indicator of "purchasing power". So the real wages don't change, it would stay the same if wages went up at the same rate/amount as inflation, and increase if wages growth accelerate at a faster rate than inflation.

Explain the difference between the short run aggregate supply curve and the long run aggregate supply curve. Why are there two different curves?

Short-run aggregate supply wages and resource process will not increase as price levels increase however in long-run aggregate supply the prices will increase as price level increase. There are two different curves because only having one curve wouldn't show the movements enough.

What are some problems with the unemployment rate?

Some problems with the unemployment rate: it can misdiagnose the actual unemployment rate such that it doesn't factor in discouraged job seekers (some peple are no longer looking for a job because they have given up (not counted as unemployed)), part-time workers (someone who wants more shifts but can't get them is still considered employed) and under employed (someone who is overqualified for a job but will take it anyway just to get paid.)

The Multiplier Effect and Spending Multiplier

The multiplier effect is an initial change in spending which will set off a spending change that is magnified in the economy. Spending multiplier= (1/MPS)

If there is a point outside the PPC curve, what does this mean?

The point is impossible/unattainable given the current resources.

List and explain the problems with fiscal policy.

The problems with fiscal policy is deficit spending, if the government increases spending without increasing taxes they will increase. The annual deficit and the national debt; if the government cuts taxes without also cutting spending they will increase the annual deficit and the national debt.

Resource Markets vs Product Markets

The resource market is the "place" where resources are sold to business ex:land, labor, capital. The productive market is the "place" where goods and services are produced by business and are sold to households ex:grocery store.

If China makes 400 shirts and 200 TVs, and India makes 120 shirts and 30 shirts: Explain why these countries can benefit from trade. Identify a terms of trade that would benefit both countries?

They can benefit from trade because it is cheaper, more efficient, and a higher standard of living to do so. One shirt traded for 1/3 a TVs and one TV traded for 3 shirts.

Trade offs vs. Opportunity cost

Trade-offs are all the alternatives that we give up whenever we choose one course of action over others. However, opportunity cost is the most desirable alternative decision given.

Explain what the fundamentals of classical theory are and explain how the economy can "fix itself" in the long run.

Underlying assumption of classical theory is that wages are flexible (economy will fix itself with no government action needed). Shifts in AD or AS change the price level and output in the short run. In the long run inflation means workers seek higher wages and production costs increase (self correct). The aggerate supply curve will always self correct in the long-run due to the rising and falling of wages as a result in the surplus or shortage of labor.

Do we want zero unemployment?

We do not want 0% unemployment, we want 4-6%, it means there is the good unemployment but NO cyclical unemployment.

How does conducting open marker operations manipulate this interest rate?

When banks charge each other more then typically charge us more too.

Explain what the fundamentals are of Keynesian theory are and how they are different than classical theory.

a decrease in AD will lead to a persistent recession because prices of resources (wages) are not flexible (born out of the neo-classical movement. The theory assumes that we make decisions based on knowing all important information. Accordingly, our behavior reflects knowing all possible outcomes.) "Sticky Wages" prevents wages from falling. The government should increase spending to close the gap.

Explain what a liquidity trap is and why it can prevent monetary policy from becoming effective.

a multiplier is only effective if people loan out money however when people stash money it is ineffective: this is called a liquidity trap.

Explain and give examples of "automatic stabilizers"

automatic stabilizers arethe same as non-discretionary policy. ex: social welfare, food stamps, medicare (when there is high unemployment, unemployment benefits to citizens)increases consumer spending

Definition of financial assets: money, stocks, and bonds

bond= "I Owe You" and a loan (has no ownership) (like a fundraiser) (the FED gives out bonds) money= is anything accepted as payment for something you want, does not equate to wealth or income stock=stock is like a bond but when you buy a stock you get partial ownership of a company.

list and explain the supply shifters of loanable funds rate

changes in private savings behavior changes in foreign investment (when rich foreigners put money in our banks),and changes in expected profitability from financial investment.

Demand Deposits

consumer checking accounts, apart of M1, so high liquidity.

Explain the difference between expansionary and contractionary fiscal policies.

contractionary fiscal policy (the brake)- laws that reduce inflation, decrease GDP (close a inflationary GAP) decrease government spending, tax increases, or combinations of the two expansionary. Expansionary fiscal policies (the gas)- leaves that reduce unemployment and increase GDP (close a recessionary gap). Increase government spending, decrease taxes on consumers, or a combination of the two.)

explain how crowding out can raise real interest rates

crowding out when the government buys a lot of bonds, not leaving a lot of money for consumers. the real interest rates increase when crowding out occurs.

What constitutes the labor force?

employed (people with jobs) + unemployed (seeking people looking for jobs)

Explain the difference between Excess and Required Reserves

excess reserves, is the remainder of the total reserves after the required reserves which becomes loans, the required reserves is the certain % in the vault banks are required to keep.

Define and explain the federal funds rate.

federal funds rate is the interest rate banks charge other banks for one-day loans of reserves, The federal funds rate fluctuates due to market conditions bit its mainly influences when market conditions but is mainly influenced when the FED buys and sells bonds.

Crowding Out

government spending might cause unintended effects that weakent he input of the policy ex:we have a recessionary gap. government creates how public library (AD increases). Now consumers spend less on books (AD decrease)

Explain the difference between conducting open market operations with members of the banking system versus the non-banning public with regard to the effect on the money supply.

if the FED purchases bonds from a bank, the bank may loan out ALL new reserves, the only have to keep money is required reserves if it comes from a non-banking public.

In a recessionary gap, list and explain the steps the fed should take to fix it, and the effect on AD.

if there is a recession the FED should decrease the Reserve Ratio the banks will hold less money and have more excess, banks create more money, money supply increases, interest rates decrease, and due to this AD will go up due to interest-sensitive spending increases.

In an inflationary gap, list and explain the steps the fed should take to fix it, and the effect on AD

if there is an inflation, the FED should increase the Reserve Ratio; banks will hold more money and have less excess, banks create less money money supply decreases, interest rates rise, and because of all of this AD will go down due to interest-sensitive spending decreases.

Explain the discount rate

is the interest rate the FED charges commercial banks for short term loans, (like the federal funds rate for the FED)

Expansionary Monetary Policy

is when the FED increases the money supply to stimulate the economy causing the interest rates to decrease, interest-sensitive consumer spending and investments increase, and AD, GDP, Income, employment, and PL increases

What is the labor force participation rate?

labor force/ population

Define and identify how to calculate the CPI?

most commonly used measurement inflation for consumers is the CPI. CPI=(price of market basket/price of market basket in base year)x 100.

real interest rate

nominal interest rate-expected inflation. the intended return on an investment for lending (adjusted for inflation)

Explain what the open market operations are and what the FED should do to address inflationary or recessionary gaps.

open market operations is when the FED buys or sells government bonds. They should sell in an inflation, they should buy bonds in a recession.

Explain what the Philips curve is used for.

the Philips curve shows trade off between inflation and unemployment. In general, there is an inverse relationship between unemployment and inflation.

List and explain the shifters of loanable funds demand

the demand shifters are changes in percieves buisness opportunities and changes in government borrowing; since as, deficit spending, and budget cuts

Describe what the money multiplier is and explain how changing the reserve requirement can change the money supply.

the money multiplier is found with the equation: money multiplier= 1/reserve requirement (ratio). If the FED decreases the reserve ratio banks in turn holds less money and have more excess reserves, banks create more money by loaning out excess, money supply increases, interest rates fall, and AD goes up. And inversely if the FED increases the reserve ratio.

The Tax Multiplier

the multiplier effect also applies when the government cuts or increases taxes. or changes transfer payments. but changing taxes/transfers has less of an impact then government spending because the tax multiplier= spending multiplier- 1.

Reserve Requirement

the percent of money banks have to keep in the bank while the other percent is being loaned out by the bank

Price vs Cost

the price is the "out of pocket cost" or explicit costs of decision making. ex: tuition/room and board of college. Cost is how much that product was made for/manufactured for or the fact that I couldn't have money from getting a job instead.

nominal interest rate

the rate we get at the bank, the amount of interest that lenders must change to make a return and adjust for inflation.

What is the natural rate of unemployment?

unavoidable unemployment (frictional + structural), together they make up the natural rate of unemployment (NRU).

How is the unemployment rate calculated?

unemployment rate= (unemployed/labor force)

Define scarcity and explain how it is related to choices and trade-offs

unlimited wants but limited resources. since we are unable to have everything we desire, we must make choices on how e will use our resources. however every choice has a cost or a trade-off.

Contractionary Monetary Policy

when the FED decreases the money supply to slow down the economy causing the interest rates to increase,e consumer interest-sensitive spending and investment decreases, and AD, GDP, income, employment and PL decreases.