Andrew Geib Basic Economic Concepts 1)

AP Macroeconomics Review

5/12/2011

a) Scarcity is limited resources with unlimited wants. b) Opportunity costs is what a person loses any time they make a decision, whatever they have not chosen is considered opportunity cost 2) Production Possibilities Curve compares two products and the opportunity cost associated when producing a combination of those two products 3) a) Comparative advantage deals with opportunity cost of producing two products when comparing two producers. b) Absolute advantage deals with the total output when comparing two producers. c) Specialization is when a producer has a comparative advantage at producing a good or service so they should specialize in the production of that good or service. d) Exchange is when two producers recognize that they each specialize at different goods/services and that they would benefit from trading with each other. 4) a) Demand represents what a consumer is willing and able to pay for a given quantity of goods/service. b) Supply represents the quantity of goods/ services producers/sellers are willing and able to sell their good for. c) Market equilibrium is the point at which supply and demand intersect. This is the desirable quantity and price of a good or service that the market has established in order to be bought and sold. 5) a) Business cycle is comprised of troughs, recovery s, peaks, and recessions; typically a sinusoidal motion. b) Unemployment is figured by dividing the amount of people unemployed by the quantity of the labor force; comprised of cyclical, structural, frictional, and seasonal. c) Inflation is the general rise in the price level of goods or services. Measurements of Economic Performance 1) National income accounts is a system used to calculate the economic activity in a country 2) Circular Flow represents the flow on money in the economy using two markets and two consumers with government in the middle of the circular diagram. 3) Gross domestic product is the total amount of products produced in one country s boarders in a given year. 4) GDP= Consumer spending + Government spending + Investment spending + Net exports 5) Real GDP is the country s GDP that has been deflated in order to compare with previous years in order to measure the countries true growth. Nominal GDP is the country s GDP without Inflating or deflating it

Andrew Geib

AP Macroeconomics Review

5/12/2011

6) Inflation measurement and adjustment is applied in order to calculate the true growth of an economy. 7) Price indices is the average price of the top 200 goods bought by consumers, updated every 2 years and is used to compare the general increase in price level in the country. 8) Normal values are values taken for face values while real values have been deflated or inflated in order to be compared with previous years. 9) Costs of inflation is the loss of the value of money 10) Unemployment is when a person is laid off or fired from their job; therefore they are not contributing to the economy and the country s GDP. 11) Unemployment is the failure to use all available economic resources to produce desired goods and services. It s calculated by taking the number of people unemployed divided by the number of people in the labor force, then multiplied by 100. 12) Types of unemployment a) Seasonal unemployed during periods between agricultural seasons, tourist s seasons, and school breaks, etc. b) Frictional- unemployment as people who move between hobs or into the labor market c) Structural workers laid off by declining industries or in declining regions, or by job obsolescence d) Cyclical- unemployment due to general economic recession. 13) Natural rate of unemployment is the natural rate of unemployment in an economy. Can never be 0 and is typically 4-6% National income and price determination

1) Aggregate demand is the sum of all demand in an economy 2) Determinants of Aggregate demand are Changes in: Consumer, Investment, Government or Net Export spending. 3) Multiplier effect states that when money is spent in the economy, it doesn t affect the GDP directly. Money is spent but affects the GDP much more than what was actually spent on the good or service. Since there is a marginal propensity to save a portion of one s income, the multiplier is defined by 1/MPS. This allows us to calculate how much a person s income, for example, is going to affect the GDP of the nation. 4) Crowding out may increase the interest rate by decreasing the money supply and could decrease Investment spending because the government spending takes up possible Investment spending options. 5) Aggregate supply is the sum of all supply curves in an economy 6) a) Short run aggregate supply shows how much goods and services a country is able to produce at certain price levels. b) Long run aggregate supply shows the supply of goods and services in the long run for an economy. Perfectly inelastic because a country is limited in the long run by its resources.

Andrew Geib 7)

AP Macroeconomics Review

5/12/2011

a) Sticky prices and wages are reluctant to increase or decrease (menu effect) b) Flexible prices and wages are easily increased or decreased. 8) Determinants of aggregate supply are Changes in: Input prices, productivity, legal-institutional environment( business taxes and regulations) 9) a) Real output the amount of output produced b) Real price level is the price level after it has been inflated or deflated. 10) In the short run, the macroeconomic equilibrium is derived by the intersection of aggregate supply and aggregate demand. In the long run, the intersection of short run aggregate supply and aggregate demand will overlap with the long run aggregate supply. 11) Actual output is the amount of output actually being produced; full-employment output is the amount of actual output being produced if a full-employment of all available resources is efficiently employed. 12) Economic fluctuations- the general fluctuation of the economy, recession and expansion.

Financial Sector 1) a) Money an item that is generally acceptable to sellers in exchange for goods and services. b) Stocks ownership share in a corporations c) Bonds a financial device through which a borrower is obligated to pay the principal and interest on a loan at a specific date in the future. Time is money, now and in the future The amount of money in the money supply is measured by the Federal Reserve Bank. The Federal Reserve Bank controls the amount of money in the money supply. This limits the amount of money banks are able to lend out because they must keep a reserve requirement in their vaults at all time. Money Demand is the Demand for money at the banks. When individuals wish to borrow money, they demand money from the banks Money market is the market for money. This is the market in which The Fed controls the money supply, the demand is downward sloping while the supply is perfectly inelastic because the fed cant instantaneously change the money supply. Only in the long run can it change. Loanable funds market is where individuals and the fed contribute money into the supply for loanable funds and where individuals wish to borrow money from the supply of loanable funds; this affects the real interest rate. The federal bank can adjust the money supply by adjusting the reserve ratio, the discount rate, or buy and sell bonds. The quantity theory of money states that the money supply has a direct, proportional relationship with the price level.

2) 3) 4)

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8) 9) 10)

Andrew Geib

AP Macroeconomics Review

5/12/2011

a) Real interest rates are calculated by subtracting nominal interest rate from the inflation premium, or anticipated inflation. b) Nominal inflation is calculated by adding real interest rate with expected inflation rate. This is the interest rate at which people expect to pay when they loan out money. Inflation, Unemployment, and Stabilization Policies 1) a) Fiscal Policy is used by the Government to aid the economy. They can either change their spending to increase aggregate demand or they can change taxes in order to encourage consumer spending. b) Monetary policy is used by the Fed to control the money supply. They can either: buy and sell bonds, change the discount rate and the reserve ratio in order to expand or contract the money supply. By doing this, they will change the interest rates which will later affect the aggregate demand. 2) Demand-side effects economic growth can only be achieved by lowering barriers for consumers to consume. 3) Supply side effects economic growth can only be achieved by lowering the barriers for people to produce goods and services such as lowering taxes 4) Policy mix- a mix of policy s employed by either the fed or the government in order to achieve a certain economic goal. 5) a) Government deficit is when they have spent money and collected taxes, but that the end of the day, they were too stupid to increase taxes, and came up short in their accounting books. Not yet a debt. b) Government debt is money owed by the government 6) a) Inflation is the general rise in the price level of the economy b) Unemployment is the failure to use all available economic resources to produce desired goods and services; the failure of the economy to fully employ its labor force. 7) Types of Inflation a) Cost-push inflation is when a sudden increase in the price of input prices causes supply to decrease. b) Demand pull inflation is when there is too much demand for a good or service for a country to provide. 8) Philips curve a) Short run- is a mirror image of the short run aggregate supply on the AD/AS model. This represents the short run relationship between % inflation and %unemployment. b) Long run represents the long run relationship between % inflation and % unemployment. It s perfectly inelastic because it must be consistent with the natural rate of unemployment. 9) Role of expectations if people predict a change in prices in the future, they will adjust their spending and saving accordingly in order to prepare for the future.

Andrew Geib

AP Macroeconomics Review

5/12/2011

Economic Growth and Productivity 1) Investment in human capital means to hire new workers to increase productivity. This investment in workers allows a firm to increase productivity and the unemployment rate to decrease. 2) Investment in physical capital means to invest in new technology in order to improve the productivity. This investment in physical capital is what leads a nation to increase their GDP in the long run. 3) Research and development allows for advances in the country to develop new technologies and improvements in technology allows for an increase in short run aggregate supply 4) Growth policy is the policies set by the Fed and the Government in order to ensure the general growth of the economy. Open Economy: International Trade and Finance 1) Balance of trade is the difference between its exports and its imports of goods 2) Current account is the sum of net exports on goods and services plus the net transfers in financial investment spending. 3) Capital account is a net account that mainly measures debt forgiveness. ( foreign countries forgive $4M but we forgive $5M = -$1M capital account ) 4) Foreign exchange market is a market in which the money of one nation can be used to purchase the money of another nation; currency market. 5) When one country wants to buy more products in another country with a different currency, they must supply more of their currency and demand more of the other country s currency in order to make the exchange. 6) Exchange rate determination is determined by the demand for that countries currency and the supply of a nation s currency. As well as the inflation or deflation from within the country. 7) a) Currency appreciation is when the dollar can buy more of the currency of another nation. When this happens, we are able to buy more of the other nation s goods. b) Currency depreciation is when the dollar can buy less of the currency of another nation, when this happens; we are able to buy less of the other nation s goods. 8) a) Net exports = exports imports (part of aggregate Demand) b) Capital Flow is the movement of money that is intended to be used for investment, trade or business production. 9) a) International trade allows for people from other countries to trade in our financial market. This increases the demand for these financials and therefore raises the price. b) International trade allows for people from other countries to buy and sell goods from around the world, increasing competition for businesses.