AP Macroeconomics

AP Macroeconomics

Unit 1

I. Basic Economic Concepts Scarcity: wants > resources Economics – study of how people satisfy wants

with scarce resources Economics is the study of choices. Microeconomics deals with specific economic

units such as individuals, households, & businesses.

Macroeconomics: Deals either with the economy as a whole or basic subdivisions such as government, households, or business sectors.

I. Basic Economic Concepts

relation v. causation: Just because something happens when something else happens does not mean one caused the other. It may just be that they are correlated.

positive statement-the way things are normative statement-the way things ought to be CETERIS PARIBUS: If all other things stay the same. The economy resembles a complex machine or a living organism.

To better determine how it works (or what’s wrong with it), simple models are used that assume ceteris paribus. In this way, we

seek to determine how one part of the machine affects another.


Utility=satisfaction Marginal utility is the satisfaction of getting one

more. The law of diminishing marginal utility: utility declines

with each additional unit. By dividing MU by P, one can see how much bang

they’re getting for their buck. By comparing MU/P for a variety of goods, one

makes rational purchasing decisions.

I. Basic Economic Concepts The Factors of Production Categories of resources needed to produce goods/services They are: Land – all natural resources (landforms, oil, animal life,

minerals, climate, etc.) Capital – stuff we make to make other stuff (tools,

machinery, human capital, etc.) Labor – workers applying efforts, abilities, & skills Entrepreneurship – when risk-takers combine the FOP into

new products

II. Opportunity Cost

The O.C. of an item is what you give up to get that item.

The O.C. of an item is the best alternative foregone.

Consumer Goods vs. Capital Goods Consumer Goods vs. Military Spending “There is no such thing as a free lunch.”

II. Opportunity Cost The Production Possibilities

Curve is a chart that illustrates the limits of what can be produced by an economy.

Assumes: Fixed resources & technology 2 products Efficiency and/or Full Employment


2 types of efficiency:productive-full use of all resourcesallocative-who gets what

The PPC represents productive efficiency. Allocative efficiency depends on what you

consider to be “fair”.


Operating inside the PPC is inefficient.

Operating outside the PPC for a long period of time is impossible.

II. Opportunity Cost Why is the PPC

curved/concave? The Law of

Increasing Opportunity Costs:Not all resources

are easily converted to producing the other good/ service.

II. Opportunity Cost What happens if: -additional resources

become available? -technological

advances increase productivity of labor and/or capital?

Which is better, A or B?

How can we reach D?

XI. Economic Systems Traditional: 3 Qs answered by custom. Resources allocated by

inheritance. Subsistence farmers,

cattle herders, hunter/gathers, etc.

African Mbuti, Aborigines, Inuits.

XI. Economic Systems

Disadvantages: New ideas discouraged. Low standard of living. Persecution/land encroachment.

XI. Economic Systems Command: Central authority answers

3 Qs. There are no “pure”

command economies. North Korea, Cuba, &

Vietnam are usually considered command economies.

XI. Economic Systems Market: Producers & consumers

answer 3 Qs. Producers provide the

goods/services consumers want to buy.

U.S., Canada, Japan, South Korea - are close


NNYY?NYMarket

YYNN?YNCommand

Employ-ment***

Price Stability

EfficiencyGrowthEquitySecurityFreedom

***Employment is sometimes included under the goal of Security

XII. Competition & Free Enterprise Capitalism: citizens own FOP Free enterprise: limited gov’t

interference; competition encouraged Voluntary exchange: buyers & sellers

benefit (GDP)

XII. Competition & Free Enterprise Private property rights motivate

people to work, save & invest Profit motive encourages

entrepreneurship & drives growth Competition helps lower prices

II. Opportunity Cost What is Crusoe’s O.C. of four

fish? What is Crusoe’s O.C. of each

fish? What is Crusoe’s O.C. of eight

coconuts? What is Crusoe’s O.C. of one

coconut? Per-unit opportunity cost can

be determined by making the

ends of the PPC into a ratio & setting 1 side equal to one.


What is the opportunity cost of 90 guns?

What is the opportunity cost of 50 butter?

XI. Economic Systems Traditional: 3 Qs answered by custom,

ritual, and habit. Resources allocated by

inheritance. Subsistence farmers, cattle

herders, hunter/gathers, etc.



Advantages: Life is stable, predictable, and continuous. Low income inequality. Disadvantages: New ideas discouraged. Low standard of living. Persecution/land encroachment.





Command Advantages: If circumstances require

a quick change in resource allocation it can meet this need rapidly.

Disadvantages: Little incentive to work

hard. Large bureaucracies

slow day 2 day decisionshigh cost





Market

Advantages: markets can adjust over time when producers answer 3 q’s, it is more

efficient individual decisions direct the use of scarce

resources larger variety of goods

Market

Disadvantages: the way FOR WHOM is answered without government regulations, without

enforced rules of the game, adequate competition may not occur or may fade away

only rewards production, so those who don’t produce suffer (young, old, sick)


NNYY?NYMarket

YYNN?YNCommand

Employ-ment***

Price Stability



I. Capitalism FOP privately owned

individuals must have control of property (Corp. clip)

intellectual, artistic, etc. property ownership. Freedom of enterprise and choice

owners must be able to use property any way they see fit

workers must have access to any occupation they see fit

consumers must have access to all goods and services

I. Capitalism Prices set by market (goes hand-in-hand

with market system)market: mechanism or arrangement

bringing buyers and sellers together through price, the market decides what is to

be produced, for whom, and how. Role of self-interest: all parties must be

free to try to get the most out of the system.Buyer tries to get a low P. seller tries to get

a high P

I. Capitalism

Competition: Large # buyers/sellers, each free to enter/exit the marketLarge # of buyers/sellers ensures that no

individual buyer or seller can influence the price.

Under such competition, what would happen if one seller decided to increase the price of their goods?

Limited government interaction. The market must be self-regulating.

I. Capitalism Advantages: efficiency, freedom,

individual satisfactionconsumer sovereignty: to make profits,

producers must make things consumers will buy, so the consumer indirectly answers the WHAT question

Disadvantages: underproduction of public goods, only produces for those with $$, unstable

II. Socialism

Gov’t owns/runs some basic resources, distributes some output for social goals

Elected officials make many economic decisions.

Pros: everyone gets certain benefits Cons: lower efficiency, higher taxes, special

interests get “entrenched” Sweden, Norway, Venezuela, China

III. Communism Needs of individual less important than

needs of society. Gov’t owns FOP Gov’t officials answer 3 Q’s No prices Pros: stability, spirit of sharing, no

unemployment Cons: low freedom, low incentive to

work hard, lack flexibility for day2day changes, inefficiency of centralized planning

Vietnam, Cuba, North Korea

III. Absolute Advantage

8 4

Old

Guy

10 10

Young

Guy

FishCoco-nuts

Max they can produce of each

When 1 person/ business/country, etc. can produce a good or service more efficiently than another person/business/country, etc.

Young guy has absolute advantage in coconuts & fish.


8 4

Old

Guy

(B)

10 10

Young

Guy

(A)

FishCoco-nuts

Max they can produce of each good


Some problems ask you to consider inputs rather than outputs to determine O.C. and/or absolute advantage.

Output problems state that you get a certain amount of product out of a given input.

Input problems state that it takes a certain amount of input to get a given product.


Input = Hours to build 1: Car Tank Company X: 2 2 Company Z: 3 1

Who has the absolute advantage in Cars? Tanks?

IV. Comparative Advantage

Specialization: doing one thing. Benefits of?

Costs of?

IV. Comparative Advantage Lower opportunity cost

= comparative advantage.

To get B’s O.C. Coconuts:

4C 8F 4 4 B’s O.C. Coconuts = 2 Fish

IV. Comparative Advantage B’s O.C. Fish: 4C 8F 8 8 B’s O.C. Fish = 4/8 or 1/2 Coconuts A’s O.C. Fish = 1 Coconut Who has lower O.C.

of Fish?


EVEN IF a country has an absolute advantage in all goods, trade can still be beneficial.

All countries benefit by making what they have a comparative advantage in, & trading.


4 2

Old

Guy

4 6

Young

Guy

FishCoco-nuts

Amounts they consume before trade

TOTALS


8 0

Old

Guy

(B)

0 10

Young

Guy

(A)

FishCoco-nuts

Amounts they produce with

trade


4 2

Old

Guy

4 6

Young

Guy

FishCoco-nuts


8 0

Old

Guy

0 10

Young

Guy

FishCoco-nuts

Amounts they produce with

trade

Totals: 8 8 10 8


4 2

Old

Guy

(B)

4 6

Young

Guy

(A)

FishCoco-nuts


Totals: 8 8 10 8

4 3

Old

Guy

(B)

4 7

Young

Guy

(A)

FishCoco-nuts

Amounts they consume after trade


4 3

Old

Guy

(B)

4 7

Young

Guy

(A)

FishCoco-nuts

Amounts they consume after trade


Product per hour Corn Wheat Mike 8 6 John 2 4

Corn Wheat

Mike’s O.C.: 6/8 8/6

John’s O.C.: 4/2 2/4

Who should make what?


Input Method Apples needed to

make one: Pie Juice Jeff 5 3 Judy 6 3

Convert to outputs Units per apple: Pie Juice Jeff 1/5 1/3 Judy 1/6 1/3

Jeff’s OC 5/3 3/5 Judy’s OC 6/3 3/6

Who should make what?


Absolute/Comparative Advantage; Input/Output Worksheet

IV. Comparative Advantage Terms of Trade: the rate by which one unit

of one good will be traded for another good.

Determine each country’s O.C. of each good.

Nebraska

IV. Comparative Advantage Nebraska-Wheat; Florida-Pears Now, Nebraska is willing to give up up to 4

wheat per pear, & Florida wants at least 3 wheat per pear.

Terms of Trade: 1 Pear will be traded for between 3 & 4 Wheat

Nebraska


Other benefits of specialization: More efficient use of resources. Increased production without increase in

resources. Effects of specialization on PPC? Practice Time (Problems in Class Notes)


3 Basic Questions: What should we

produce? How should we produce

it? For whom should we

produce?

The “Spruce Goose”-

-Largest airplane ever built.

-319 ft wingspan

-Could carry 750 soldiers or one Sherman Tank

-Made of wood

VI. Productivity The amount of goods/services

produces by each unit of labor input.

Drives economic growth. Affected by interdependence. Increase Productivity: Specialization- doing what you

have an advantage in Division of labor- splitting big jobs

up Investing in human capital. More

education = more income.

VII. Demand

A market is an arrangement that allows buyers and sellers to exchange things.

Demand is the desire, ability, & willingness to buy a product at a range of prices.

Quantity demanded is the amount that would be purchased at a certain price.

VII. Demand

Joe Schmoe’s demand schedule for hamburgers per week:

Price Quantity Demanded $5 1 $3 4 $1 8

VII. Demand

The demand curve shows how quantity (Q) demanded varies depending on price (P) of good/service; it is just a visual representation of the demand schedule.

P is on vertical axis, Q is on horizontal Demand curve slopes down.

VII. Demand

Price

VII. Demand

Price

Quantity

VII. Demand

Price

Quantity

$5

$4

$3

$2

$1

VII. Demand

Price

Quantity

$5

$4

$3

$2

$1

1 2 3 4 5 6 7 8 9 10

VII. Demand

Price

Quantity

$5

$4

$3

$2

$1

1 2 3 4 5 6 7 8 9 10

.

.

.

VII. Demand

Price

Quantity

5

4

3

2

1

1 2 3 4 5 6 7 8 9 10

.

.

. D

VII. Demand

Price

Quantity

5

4

3

2

1

1 2 3 4 5 6 7 8 9 10

.

.

. D

Changes in QUANTITY DEMANDED

VII. Demand

Price

Quantity

5

4

3

2

1

1 2 3 4 5 6 7 8 9 10

.

.

. D

An increase in price causes a decrease in quantity demanded.

Q’ Q

P’

P

VII. Demand

Price

Quantity

5

4

3

2

1

1 2 3 4 5 6 7 8 9 10

.

.

. D

A decrease in price causes an increase in quantity demanded.

Q Q’

P

P’

Mr. Cook’s Demand For Video Games

0

10

20

30

40

50

60

70

80

90

1 2 3 4 5 6 7 8 9

Quantity

Price

Line 1

8$11

7$12

6$15

5$18

9$9

4$20

3$35

2$55

1$80

Quantity Demanded

Price

VII. Demand

The Law of Demand: As P goes up, Q demanded falls, & vice

versa. The demand curve slopes downward

because of the: income effectsubstitution effect

VII. Demand A change in demand is

caused by a change in: Income (normal/inferior

goods) Consumer Tastes Price change in

substitute/complement Consumer expectations

about prices & income # of buyers

Complementary Goods

What effect does a fall in the price of potatoes have on the market for sour cream?

Potato Market

Complementary Goods

A decrease in the price of potatoes causes… an increase in the demand for sour cream.

Potato MarketSour Cream Market

Substitute Goods

What effect does an increase in the price of margarine have on the market for butter?

Margarine

Substitute Goods

An increase in the price of margarine causes an increase in the demand for butter.

Margarine

Market

Butter Market

VII. Demand Elasticity measures sensitivity to price changes. Elasticity coefficient = Q/[(Q2+Q1)/2]

. P/[(P2+P1)/2]

Demand is: Elastic if small P causes big Q. [more sensitive]

Elasticity coef.>1 Inelastic if big P causes small Q. [less sensitive]

Elasticity coef.<1 Unit or unitary Elastic if % P = % Q; E=1

VII. Demand

Note: Elasticity does not necessarily equal the slope of the demand curve.

VII. Demand

Determinants of Demand Elasticity

Can purchase be delayed? Are substitutes available? Does purchase use large portion of

income? If “yes’s” outnumber “no’s” then demand is

elastic.

The Total Expenditures Test Price times quantity demanded equals

expenditures (P * Q = Ex). Demand curve is: -Elastic if P and Ex move in opposite

directions. -Inelastic if P & Ex move in the same

direction. -Unit elastic if there is no change in Ex. Understanding the relationship b/w

elasticity & profits can help producers effectively price their products.

VIII. Supply Supply = Q seller(s) are willing & able to sell at various prices.

The Law of Supply = Suppliers will offer more at higher P & less at lower P.

Supply curve is always upward sloping.

VIII. Supply

VIII. Supply

VIII. Supply A decrease in price leads to a decrease in

Quantity Supplied. A increase in price leads to a increase in

Quantity Supplied.

VIII. Supply A change in supply occurs when suppliers offer

different Q for sale at all prices. Can cause a change in supply: Input costs Productivity Technology Taxes/Subsidies Seller Expectations Regulations # Sellers

VIII. Supply Supply is: elastic when a small P change causes a big

change in Q supplied. inelastic when P changes have little effect

on Q. Remember: Flatter is Elastic!

VIII. Supply Determinants of supply elasticity: If adjustments to production can be made

quickly, supply is elastic. If not, supply is inelastic.

Elastic Supply Inelastic Supply

IX. Equilibrium Price and Quantity Together, demand & supply make a

complete picture of the market. Price changes allow supply & demand to

be = Surpluses: when supply > demand Shortages: when demand > supply Equilibrium price where supply meets

demand

IX. Equilibrium Price and Quantity

IX. Equilibrium Price and Quantity

How do prices adjust to equilibrium?

Explaining & Predicting Prices If Supply increases, P __ & Q __ If Supply decreases, P __ & Q __ If Demand increases, P __ & Q __ If Demand decreases, P __ & Q __ If Supply & Demand increase, P __ & Q __ If Supply & Demand decrease, P __ & Q __ Supply incrse/Demand decrse, P __ & Q __ Supply decrse/Demand incrse, P __ & Q __ The more elastic a curve is, the less P will change if that

curve shifts.

The Lemonade Market

The Oil Market

X. Distorting Market Outcomes

Can occur when pursuing equity & security.

Example: setting a “socially desirable” P


Price Ceilings create shortages (rent control in Manhattan)


Price Floors create surpluses (minimum wage)

XI. Economic Systems Traditional: 3 Qs answered by custom. Resources allocated by

inheritance. Subsistence farmers,

cattle herders, hunter/gathers, etc.



Disadvantages: New ideas discouraged. Low standard of living. Persecution/land encroachment.










NNYY?NYMarket

YYNN?YNCommand

Employ-ment***

Price Stability



XII. Competition & Free Enterprise Capitalism: citizens own FOP Free enterprise: limited gov’t

interference; competition encouraged Voluntary exchange: buyers & sellers

benefit (GDP)

XII. Competition & Free Enterprise Private property rights motivate

people to work, save & invest Profit motive encourages

entrepreneurship & drives growth Competition helps lower prices

XIII. Role of Government Protector: pass/enforce laws to protect

consumers/workers Both a provider & a consumer A regulator by working to preserve

competition (anti-trust, property rights) Promote national goals Gov’t intervention makes the U.S. a

*mixed economy* or *modified free enterprise economy*.

XIV. Business & Market Structures

Corporation-limited liability, double taxation Sole P. & Partnerships-unlimited liability Monopoly-1 seller Oligopoly-Few sellers, price leadership,

interdependence Perfect-Many, Identical, Independent, No

barriers Monopolistic-Like perfect but not identical

Documents

AP Macroeconomics