ap macro review
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AP Macro Review
Aggregate Demand• Consumption, investment, govt. purchases and net exports
(exports – imports)• More income, more wealth = more spending• Investment – purchases of new capital by businesses; interest
rate rises – less investment; interest rate falls – more investment
• $ appreciates – U.S. goods more expensive; exports fall• $ depreciates – U.S. goods less expensive; exports rise• AD increases – shifts to right; P rises, GDP rises,
unemployment falls• AD decreases – shifts left; P falls, GDP falls, unemployment
rises
MPC and MPS• MPC = ∆ consumption resulting from a ∆ in income• MPS = ∆ savings resulting from a ∆ in income• MPC = 1 – MPS• If MPC = .80 then a $100 increase in income will cause us
to spend $80• Multiplier = 1/MPS• ∆ in GDP = multiplier x ∆ in spending• If multiplier is 5, consumption rises by $100, GDP rises by
$500.• If MPC = .8, multiplier is 5; income rises by $100,
consumption rises by $80, GDP rises by $400• Multiplier works for any increase in spending, whether to
consumption, investment, govt. purchases or net exports
Money Market
Sm1 Sm2Sm3 Dm
i1
i2
i3
i
Q
Vertical S curve –S set by FED; Includes S and D for all $ in the economy
i
Q
D
S
i1
Q1
Loanable Funds Market
Government deficit affects demand; Savings affects supply
Loanable funds market
• Increase in budget deficit increases D for loanable funds; interest rate increases
• Decrease in budget deficit decreases D for loanable funds; interest rate falls
• Increase in savings increases S for loanable funds; interest rate falls
• Decrease in savings decreases S for loanable funds; interest rate rises
AS
AD1
P
GDPGDP1
P1 AD2
P2
ExpansionaryFiscal Policy or Easy Money Policy
Qf
ASlr
Fiscal vs. Monetary policy
Expansionary Fiscal
• Implemented by govt.• Cut taxes• Increase govt. purchases• Increases budget deficit• Increases D for loanable
funds• Increases interest rate• $ appreciates
Easy money policy
• Implemented by FED• Buy bonds• Decrease required
reserve ratio• Decrease discount rate• Increases S of $ in
money mkt.• Interest rate falls• $ depreciates
AS
AD2
P
GDPQf GDP1
P1
P2ContractionaryFiscal Policy or Tight Money Policy
AD1
ASlr
Fiscal vs. Monetary policy
Contractionary Fiscal
• Implemented by govt.• Increase taxes• Decrease govt.
purchases• Decreases budget deficit• Decreases D for loanable
funds• Decreases interest rate• $ depreciates
Tight money policy
• Implemented by FED• sell bonds• increase required reserve
ratio• increase discount rate• decreases S of $ in
money mkt.• Interest rate rises• $ appreciates
Demand-Pull InflationP
GDP
ASSR1
AD1
ASLR
P1
Qf
AD2
Q2
ASSR2
P3
P2
Demand pull inflation if govt does not respond to the inflation• In the long run, prices and wages are flexible.• Increase in price level causes wages to rise.• Increase in wages shifts AS in short run to left –
more expensive to produce• As economy approaches long run equilibrium,
GDP returns to full employment GDP and unemployment returns to the natural rate of unemployment
RecessionP
GDP
ASSR1
AD1
ASLR
P1
Qf
AD2
Q2
ASSR2
P3
P2
Recession if govt does not respond w/ fiscal or monetary
policy• In the long run, prices and wages are flexible.• Wages fall when unemployment increases.• decrease in wages shifts AS in short run to right
– cheaper to produce• As economy approaches long run equilibrium,
GDP returns to full employment GDP and unemployment returns to the natural rate of unemployment
Inflationrate
Unemployment rate
SRPC1
SRPC2
AD
AS1
AS2P
GDP
P2
P1
GDP2 GDP1
P goes upUnemployment rises
Phillips Curve
Phillips Curve
• Short run – tradeoff between unemployment and inflation; as 1 goes up the other falls
• If AS shifts, short run PC shifts in opposite direction
• If AD shifts, movement along the PC.• Long run – no tradeoff between
unemployment and inflation• LRPC is a vertical line
Effect on ASCapitalgoods
Consumergoods
P
GDP
PPF1
PPF2
ASLR1 ASLR2
Qf1 Qf2
Economic Growth
• Rightward shift of PPF curve = rightward shift of long run AS
• Caused by increase in technology, # or quality of natural or human resources, increase in capital stock
• Economic growth influenced by interest rates – if interest rates rise, I (investment) falls, capital stock declines, less economic growth
Effect on ASP
GDP
Inflation
Unem.
ASLR1 ASLR2
Qf1 Qf2 NRU1NRU2
LRPC1LRPC2
Mkt. for Dollars Mkt. for Pounds
U.S. Exports – English buying American wheatP in pounds
Q
P in dollars
D1
D2S
D
S1
S2
P2
P1
Q1 Q2Q1 Q2
P1
P2
Exchange rates• If 1 currency appreciates, the one it’s being
compared to depreciates.• Interest rates and value of the currency move in
same direction.• If D for $ increases (b/c people want U.S. wheat
or higher interest rates in U.S.), $ appreciates.• The English must supply more pounds to get the
dollars they demand so the pound depreciates.
Mkt. for Dollars Mkt. for Pounds
U.S. Imports – Americans buying English teaP in pounds
Q
P in dollars
D1
D2
S
D
S1
S2
P2
P1
Q1 Q2Q1 Q2
P1
P2
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