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8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Circular Flow Model
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Gross Domestic ProductValuation of economy
Value of production, not simply production
Final Goods
Second hand goods not included
Transfers not included
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
GDPGDP = AD (Aggregate Demand)
GDP = C + I + G + (X-M)
C = Personal Consumption I = Capital InvestmentsG = Government Expenditures No transfer payments
X-M = Net Exports = eXports - iMports
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
GDP vs GNPGross Domestic Product
What is produced within a country’s borders, regardless of who produces it.
Mercedes built in America count towards American GDP
Fords built in Germany count towards German GDP
Gross National Product
What is produced by the citizens of a country, regardless of where they produce it.
Mercedes built in America count towards German GNP
Fords built in Germany count towards American GNP
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Real vs Nominal GDPNominal
Value of current production in current prices
RealValue of current production in base year prices
GDPReal = (GDPNom)(Price Index)
%∆GDPReal = %∆GDPNom - %Δ Index
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
CPIConsumer Price Index
Measure inflationBase yearMarket Basket
What is the difference between the CPI and the GDP deflator?Both are price indices but they have different
market baskets. The CPI includes consumer goods whereas the GDP deflator contains all items that are produced domestically.
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Causes of Inflation2 types
Demand-pull inflation Aggregate demand > productive capacity
Causes include increases in money supply or credit.
Cost-push Prices increased by producers to cover higher costs of
production. Supply shocks such as changes in oil prices, crop failures & natural
disasters.
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
5 Major Effects of Inflation
Decreased purchasing powerDecreased value of real wagesIncreased interest ratesDecreased savings & investingIncreased production costs
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
UnemploymentUnemployed – must be looking for work to be part of labor force.
Unemployment rate is % of labor force that is unemployed.
Types of unemployment include: Frictional Seasonal Structural Cyclical
Full employment is economy at full steam. Since there is always frictional & structural unemployment, the Natural unemployment rate is the unemployment rate for full employment.
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Consumption Function
DI
CF
Consumption FunctionC = a + b (DI)a = autonomous spendingspending when income = 0B = consumption rate
Savings
Dissavings
Consumption
Disposable Income
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Marginal Propensity to Consume & Save
MPC = ΔC/ΔDI
MPS = ΔS/ΔDI
MPC + MPS = 1
C=Consumption, S=Savings, DI=Disposable Income
MPC= Consumption rate in consumption function
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
MultiplierMultiplier
= 1 / MPS = 1 / (1-MPC)
Examples MPC = .9, Multiplier = 1/.1 = 10 MPC = .8, Multipler = 1/.2 = 5 MPC = .5, Multiplier = 1/.5 = 2
NB Taxes have a smaller multiplier than direct government spending
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
AD – AS ModelPriceLevel
GDPR
LRAS SRAS
AD
YO
P
Aggregate Demand (AD)= C+I+G+(X-M)
Short-run Aggregate Supply (SRAS)
Long-run AggregateSupply (LRAS)
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
AD – AS Model - InflationPriceLevel
GDPR
LRAS SRAS
AD
YO
P
Y1
Economy producingBeyond L-R capacity
Inflationary Gap
Higher rates drivedown interest sensitiveexpenditures (AD )
AD2
P2
GDP beyond L-REquilibrium at Y1 & P
AD Shift causes Y to go to L-R YO, & P
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
AD – AS Model - InflationPriceLevel
GDPR
LRASSRAS
AD
YO
P
Y1
Economy producingunder L-R capacity
Recessionary Gap
Lack of demand drivesdown nominal wages ( SRAS )
SRAS2
P2
GDP below L-R Equilibrium at P & Y1
SRAS2 shift resultsin P & Y
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Shifts in AD
Changes in expectations Expectations – AD
Changes in wealth Wealth , - AD
Amount of physical capital Existing Capital – AD
Fiscal policy Government spending – AD
Monetary policy Money supply – AD
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Shifts in SRAS
Commodity pricesExample is oilPrices - AS
Nominal wagesWages - AS
ProductivityProductivity - AS
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
AD AS Model
Shifts of AD
Demand shock
Negative “Great Depression” ADN, EN, PN, YN
Positive WWII ADP, EP, PP, YP
AD
SRAS
ESRPE
YE
Real GDP
Ag. Pr.Level
EP
EN
PP
PN
YPYN
ADP
ADN
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
AD AS Model
Positive Demand Shock AD shifts to AD2
E1 up to E2
P1 up to P2
YP up to Y2
Inflationary Gap
Inflation causes L-R increase in wages SRAS shifts to SRAS2
E2 shifts to E3
P2 up again to P3
Y2 down to YP
AD
SRAS
E1P1
YP Real GDP
Ag. Pr.Level
LRAS
AD2
E3
E2
SRAS2
Y2
P3
P2
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
AD AS Model
Shifts of SRAS
Supply shock
Negative Oil Crisis SRASN, EN, PN, YN
Positive Internet SRASP, EP, PP, YP
AD
SRAS
ESRPE
YE
Real GDP
Ag. Pr.Level
EP
ENPN
PP
YPYN
SRASN
SRASP
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Continuum – Government Policies
Restrictive
Low GrowthLow Inflation
Expansionary
High GrowthHigh Inflation
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Fiscal PolicyExpansionary
Stimulates economy Decrease taxes and/or increase spending Increases disposable incomes/demand Inflationary & leads to debt
Restrictive Reduces Disposable income/demand. Lack of cash reduces investments. Reduction in government spending/programs
Restrictive Expansionary
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Monetary PolicyMonetary PolicyEasy Money
Increases growth (good) Increases inflation (bad)
Tight MoneyDecreases growth (bad)Decreases inflation (good)
Easy MoneyTight Money
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
How the Fed Can Change MSHow the Fed Can Change MS
Fed Tools
1. Open Market Operations
2. Fed Funds Rate & Discount Rate
3. Reserve Requirements for Banks
4. Moral suasion
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Expansionary PolicyExpansionary PolicyGDPR
up
Imports down
Price Level
up
Exports up Unemploy
-ment down
GDPN up
Exchange rates down
Invest-ments
up
AD up
InterestRatesdown
MoneySupply
up
Inflation up
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Phillips CurveInflation
Unemployment
LRPC
SRPC
NRU/NAIRU
%
S-R trade-off betweenInflation & unemployment
Trade-off does not Occur in the L-R
SRPC2
Shifts in SRPC the result of Δ expected inflation
%2
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Money SupplyInterestRate, i
GDPR
MS
MD
M
i
i = nominalinterest rates
Δ in MS controlledby the Fed Reserve
M * V = P * Q
MS*Velocity or multiplier= Price Level * Output
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Money Supply & Interest RatesMoney Supply & Interest RatesInterest rate
r1
r2
Mde1
Money supply
MD1
Quantityof money
MS2
AD1
GDPRY1 Y2
P1
Mde2
AD2
SRAS
P2
Increased MS leads to r
Lower r leads to C& I meaning AD
AD shifts right, leading to Price Level & GDPR P
rice
Leve
l
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Loanable FundsInterestRate, r
GDPR
SM
DM
YO
r
r = real interest rates
NB - With interest ratesi includes inflationwhile r is for real
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
TermsCrowding out
Government competes with or eliminates private enterprise. Providing a service otherwise supplied by a company Competing in the marketplace for loans to finance debt.
Rational Expectations TheoryBusinesses & consumers react to expected changes in
monetary & fiscal policy, thereby negating their impact.
Automatic Stabilizersadjust automatically, without government deliberation,
to offset economic conditions
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Crowding Out Effect – Change in Demand
Quantity ofLoanable Funds
Interest Rate, r S1
D1
D2
∆ in Demand:government debtcreates additional demand for funds.
r1
r2
Rightward shift of demand curve resultsin r & Q .
Q1 Q2
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Crowding Out Effect – Change in Supply
Quantity ofLoanable Funds
Interest Rate, r S1
D1
S2
∆ in Supply:Government is Most credit worthyBorrower, so FedDebt removes supply
r1
r2
Leftward shift of Supply curves resultsIn r & Q
Q2 Q1
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Automatic Stabilizers$
GDPR
Deficit – Economy in recession, causestaxes to drop below govt. expenditures
Taxes
Govt
Surplus – Economy booms, causes taxes to increase above govt spending
Automatic adjustments to economic conditions by increasing deficit during recessions & increasing surplus in boom periods (income taxes)
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Macroeconomic TheoriesClassical
Changes in MS only affect nominal rates, not realAutomatic stabilizers will correct market fluctuationsNo government action
KeynesianFiscal policy as a tool to correct cyclical fluctuationsGovt spending up to offset recessions
MonetaristsGovt often wrong or late, only make matters worseMS to grow at rate of GDP growth (no fiscal remedies)
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Foreign TradeRevisit Comparative & Absolute advantages from
Micro PP
Balance of PaymentsCurrent Account – Transactions w/o liabilitiesCapital Account – Transactions w/ liabilities
Exchange Rate ChangesConsumer tastesRelative incomesRelative inflationSpeculationMoney supply/ relative interest rates
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Exchange Rates$/€
Q
S
D
Qe
$
Demand for $ increases asother currencies trade for $
Demand Curve shifts to D2
causing $ & Q
D2
$2
Q2
Looking at exchange rate fromother side – euros/dollarHigh demand for $ means people want to trade euros in& this leads to excess supply
Supply curve shifts to S2, causing € & Q
S2
€2
€
€/$
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
International Trade & TaxesDollars/Euro
Q
SDom
D
10
$100
$80
8 12
Imports
Example: US Oil Market Equilibrium at $100 & 10MBarrels.
World price is $80. Effect onUS market is Demand at $80 Is 12M while Supply is 8M.Difference of 4M is imports.
Protective tariff of $10/Barrel added
$90
9 11
Deadweight Loss (DWL)
Effects of tariff include P $10, Q 1M barrels, & Imports 2M barrels
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Graph RelationshipsGraph RelationshipsI
Money Market
M
MD
MS
Investment Demandi
I
I
GDPR
i i
I
I
Y
MS
M M
i i
Y
I
I
Contraction of MS leads to higher i, which reduces I, causing GDP to fall
Graph reversed so GDP is falling
8 AM – May 17th, 2012AP Macroeconomics Test Review
RMCE/HWRHS
Graph Review – MS Money Supply Loanable Funds Investment Demand
ADAS ModelExchange RatesPhillips Curve
i
Q Q Q
Q
I/RI/R I/R
M
r r
Iq
P/L
P
Real GDPY
A/B
ER
qUnemployment
Infl
atio
n
%
M
i
q
rr
I
Y
P
ER
q
%
NRUU/R
MD
MS MS SS
DI/D
AD
AD
ASLRPC
SRPC
SS
D
Fed increases MS i MS leads to
shift right in S inloanable fundsr & q
r leads to I
I = AD AD = P & Y
P/L = X & M Supply of $ ER & q
AD = Inflation &Unemployment
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