Transcript COMMON MISTAKES ON THE AP MACRO EXAM

COMMON MISTAKES
ON THE AP MACRO
EXAM
Compiled by:
John Ostick
Malvern Prep
Malvern, PA 19355
The difference between a
change in demand and the
resultant movement along
a demand curve
vs.
Shifting of the demand
curve
GRAPHING
DEMAND
Price of Corn
P
CORN
P
$5
4
3
2
1
QD
10
20
35
55
80
$5
4
3
2
What if
Demand
Increases?
1
o
D
10 20 30 40 50 60 70 80
Quantity of Corn
Q
GRAPHING
DEMAND
Price of Corn
Increase
in Quantity
Demanded
P
CORN
P
$5
4
3
2
1
QD
10 30
20 40
35 60
55 80
80 +
$5
4
3
2
1
o
Increase
in
Demand
10 20 30 40 50 60 70 80
Quantity of Corn
D’
D
Q
The difference between a
change in supply and the
resultant movement along
a supply curve
vs.
Shifting of the supply
curve
GRAPHING
SUPPLY
Price of Corn
P
$5
4
3
2
S
What if
Supply
Increases?
1
o
10 20 30 40 50 60 70 80
Quantity of Corn
CORN
P QS
$5
4
3
2
1
Q
60
50
35
20
5
GRAPHING
SUPPLY
Price of Corn
P
$5
4
3
2
1
Increase
in
Supply
S
S’
CORN
P QS
$5
4
3
Increase 2
in Quantity 1
Supplied
o
10 20 30 40 50 60 70 80
Quantity of Corn
Q
60 80
50 70
35 60
20 45
5 30
Mislabeling or NOT
labeling graphs correctly
EQUILIBRIUM: REAL OUTPUT
AND THE PRICE LEVEL
Price Level
P
AS
Equilibrium in the
Intermediate Range
Pe
P1
AD
Q1
Qe Q2
Real Domestic Output, GDP
Q
GROWTH IN THE AD-AS MODEL
ASLR1 ASLR2
C
Price Level
Capital Goods
A
B
D
Consumer Goods
Q1 Q2
Real GDP
ECONOMIC GROWTH IN THE
EXTENDED AD – AS MODEL
ASLR1
ASLR2
AS2
Price Level
AS1
P2
P1
AD2
AD1
o
Q1
Real GDP
Q2
Rate of interest, i (percent)
THE MONEY MARKET
Sm1
Sm
10
7.5
ie
5
Dm
2.5
0
A temporary shortage
of money will require
the sale of some assets
to meet the need.
0
50
100
150
200 250 300
Amount of money demanded
(billions of dollars)
Net effects of Monetary
Policy and/or Fiscal Policy
on
Interest Rate (I%)
FISCAL POLICY, AGGREGATE
SUPPLY AND INFLATION
Price level
AS
Fiscal Policy
And Inflation
P1
AD1
AD2
$495 $505 $515
Real GDP (billions)
Expansionary Fiscal
Policy >> Interest Rate
INCREASE
Draw Money Market
Increase Spending (AD)>>Increase
Demand for Money>>Increase Interest
Rate
Higher Price Level>>Increase Demand
for Money>>Increase Interest Rate
Expansionary Monetary
Policy>> Interest Rate
DECREASE
MONETARY POLICY AND EQUILIBRIUM GDP
Real rate of interest, i
Sm1 S
m2
10
10
8
8
6
6
Investment
Demand
Dm
0
Quantity of money demanded and supplied
Price level
AS
P2
P1
0
Amount of investment, i
Money Supply Increases
If the money
supply increases
Investment
Increases
to stimulate
the
economy...
AD &
GDP Increases
Interest Rate Decreases
AD1
AD2
Real domestic output, GDP
with slight inflation
MONETARY POLICY AND EQUILIBRIUM GDP
Real rate of interest, i
Sm1 S S
m2
m3
10
10
8
8
6
6
Dm
0
Quantity of money demanded and supplied
AS
Price level
Investment
Demand
P3
P2
P1
0
Amount of investment, i
More Money Supply
If theInterest
moneyRates
Lower
supply increases
More Investment
again…
AD1
AD2 AD3
Real domestic output, GDP
Still higher AD & GDP
with significant inflation
MULTIPLIER(S)
CONFUSION
Income (Spending)
Multiplier
Multiplier = 1/
1 – MPC or 1/ MPS
Initial Change in Spending X
MULTIPLIER = Change in Output
MONEY MULTIPLIER
1/
Required Reserve Ratio
Maximum Multiple $$$ Money
Expansion
MULTIPLE DEPOSIT EXPANSION PROCESS
Bank
Acquired reserves Required
and deposits
reserves
Excess
reserves
Amount bank
can lend - New
money created
$80.00
64.00
51.20
40.96
32.77
26.22
20.98
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.57
Total amount of money created by the banking system $400.00
A
$100.00
B
80.00
C
64.00
D
51.20
E
40.96
F
32.77
G
26.22
H
20.98
I
16.78
J
13.42
K
10.74
L
8.59
M
6.87
N
5.50
Other banks 21.97
$20.00
16.00
12.80
10.24
8.19
6.55
5.24
4.20
3.36
2.68
2.15
1.72
1.37
1.10
4.40
$80.00
64.00
51.20
40.96
32.77
26.22
20.98
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.57
Balanced Budget
Multiplier
=1
(Net Result on GDP)
Remembering the
difference between the
Amount of Money Created
and the
Change in the Money
Supply
when dealing with the
Money Multiplier and
Money Creation
FEDERAL RESERVE
PURCHASE OF BONDS
Purchase of a
$1000 bond
from a bank...
New reserves
$800
Excess
Reserves
$4000
Bank System Lending
$200
Required
reserves
$1000
Initial
Deposit
Total Increase in Money Supply ($5000)
Confusing
Comparative Advantage
Calculations
Remembering the
difference between
Real
and
Nominal
Nominal:
with Inflation
Real:
without Inflation
GDP
Nominal GDP:
GDP measured in
terms of current
Price Level at the
time of
measurement.
(Unadjusted for
inflation)
Real GDP: GDP
adjusted for
inflation; GDP in a
year divided by a
GDP deflator (Price
Index) for that year
INCOME
NOMINAL INCOME:
number of dollars
received by an
individual or group
for its resources
during some period
of time
REAL INCOME:
amount of goods
and services which
can be purchased
with nominal income
during some period
of time; nominal
income adjusted for
inflation
INTEREST RATE (I%)
NOMINAL I%:
interest rate
expressed in terms
of annual amounts
currently charged for
interest; not
adjusted for inflation
REAL I%: interest
rate expressed in
dollars of constant
value (adjusted for
Inflation) and equal
to the NOMINAL I%
minus the
EXPECTED RATE
OF INFLATION
ANTICIPATED INFLATION
11%
=
+
5%
Nominal
Interest
Rate
Real
Interest
Rate
6%
Inflation
Premium
WAGES
NOMINAL WAGES:
amount of money
received by a
worker per unit of
time (hour, day,
etc.);
Money Wage
REAL WAGES:
amount of goods
and sevices a
worker can
purchase with their
NOMINAL WAGE;
purchasing power of
the nominal wage.
(Real = Nominal –
Inflation rate)
NOMINAL/REAL TIPs
If nominal rates INCREASE and Price
Level INCREASE, the CHANGE in Real
is “indeterminable.”
If nominal Wage rates do NOT change
and Price Level fall. REAL WAGES
increase.
NOMINAL RATES “PIGGY-BACK”
REAL RATES & NOT VICE VERSA.
Confusing calculations
using
MPC / MPS
to determine changes
necessary to correct
Recessionary and
Inflationary Gaps
FULL-EMPLOYMENT GDP
Aggregate Expenditures (billions of dollars)
Recessionary Gap
AE0
AE1
530
510
Recessionary Gap
= $5 Billion
490
Full Employment
o
45
o
490
510
530
Real domestic product, GDP (billions of dollars)
FULL-EMPLOYMENT GDP
Aggregate Expenditures (billions of dollars)
Inflationary Gap
530
AE2
AE0
Inflationary Gap
= $5 Billion
510
490
Full Employment
o
45
o
490
510
530
Real domestic product, GDP (billions of dollars)
Demand-Pull Inflation
vs.
Cost-Push Inflation
DEMAND-PULL INFLATION
ASLR
AS2
Price Level
AS1
c
P3
b
P2
a
P1
AD2
AD1
o
Q1
Real domestic output
COST-PUSH INFLATION
Occurs when short-run AS shifts left
ASLR
AS2
Price Level
AS1
b
P2
a
P1
AD1
o
Q2 Q 1
Real domestic output
COST-PUSH INFLATION
Government response with increased AD
ASLR
AS2
Price Level
AS1
c
P3
b
P2
a
P1
Even
higher
price
levels
AD2
AD1
o
Q2 Q 1
Real domestic output
COST-PUSH INFLATION
If government allows a recession to occur
ASLR
AS2
Price Level
AS1
b
P2
a
P1
AD1
o
Q2 Q 1
Real domestic output
COST-PUSH INFLATION
If government allows a recession to occur
ASLR
AS2
Price Level
AS1
b
P2
a
P1
Nominal
wages fall &
AS returns
to its original
location
AD1
o
Q2 Q 1
Real domestic output
Phillips Curve
vs.
Laffer Curve
THE PHILLIPS CURVE CONCEPT
Annual rate of inflation
(percent)
7
As inflation declines...
6
5
Unemployment
increases
4
3
2
1
0
1
2
3
4
5
6
7
Unemployment rate (percent)
THE LAFFER CURVE
Tax rate (percent)
100
l
0
Tax revenue (dollars)
THE LAFFER CURVE
Tax rate (percent)
100
m
l
0
Tax revenue (dollars)
THE LAFFER CURVE
100
Tax rate (percent)
n
m
l
0
Tax revenue (dollars)
THE LAFFER CURVE
Tax rate (percent)
100
n
m
m
Maximum
Tax
Revenue
l
0
Tax revenue (dollars)