AP Economics

Mr. Crawford

AP Exam Review Guide

Structure:

2/3RD

OF EXAM: 60 Multiple Choice questions in 70 minutes

1/3RD

OF EXAM: 3 Essays in 60 minutes

GRAPHS:

UNIT ONE

FUNDAMENTALS OF ECONOMICS

• CHOICE

o EUSR=MSUW

• OPPORTUNITY COST

o TINSTAAFL

• SCARCITY

o LIMITED AND DESIRABLE

• RATIONAL THINKING

• COST-BENEFIT ANALYSIS

o FUTURE UTILITY

o INVESTMENT

• MARGINAL THINKING

o IMPERFECT INFORMATION

ECONOMIC THEORY

• POSITIVE/OBJECTIVE

o FACTS

o THEORY

� INDUCTION

� DEDUCTION

• NORMATIVE/SUBJECTIVE

o POLICY

• FALLACIES

o POST HOC

o COMPOSITION

o DEFINITION

o BIAS

GAINS FROM TRADE

• GREATEST TOTAL PRODUCTION = ABSOLUTE

ADVANTAGE

• OC = L/G

• LOWEST OC = COMPARATIVE ADVANTAGE

• TERMS OF TRADE

o BUYERS OC > PRICE > SELLERS OC

• RELATIVE PRICE MUST FIT TERMS OF TRADE

GROWTH IS A SHIFT RIGHT OF THE CURVE CAUSED BY INCREASED PRODUCTIVITY DUE TO

• TRADE

• INVESTMENT IN CAPITAL

• MORE RESOURCES (LAND, LABOR, CAPITAL)

UNIT TWO

THE MARKET SYSTEM

• THE FOUR FUNDAMENTAL QUESTIONS

o WHAT

o HOW

o WHO

o HOW

• TRADITIONAL SYSTEMS

o BARTER

o COINCIDENCE OF WANTS

ADAM SMITH

• GREED

o PROFIT MOTIVE

• PRIVATE PROPERTY

• FREEDOM OF CHOICE

• MARKETS

• COMPETITION

• NO GOVT

o "LAISSEZ FAIRE"

o "INVISIBLE HAND"

• CAPITALISM

o SPECIALIZATION

o CAPITAL

o MONEY

• CONSUMER SOVEREIGNTY

o DERIVED DEMAND

SUPPLY AND DEMAND

DEMAND

Law of Demand

CHANGE IN P =INVERSE CHANGE IN Qd

• DMU

• YFX

• SFX

CHANGE IN NPD= CHANGE IN D

• TASTES

• INCOME

• MORE OR FEWER BUYERS

• EXPECTATIONS

• RELATED GOODS' PRICES

o SUB=SAME

o COMP=OPPOSITE

CHANGE IN D = P Q

CHANGE IN D = P Q

SUPPLY

Law of Supply

CHANGE IN P = DIRECT CHANGE IN Qs

• DMR/IC

• P X Q = TR

CHANGE IN NPD= CHANGE IN S

• GOVERNMENT

o TAXES/SUBSIDIES

o PRICE CONTROLS

• OTHER PROFIT

OPPORTUNITIES

• NUMBER

• INVESTMENT IN

TECHNOLOGY

• COST OF RESOURCE

• EXPECTATIONS

CHANGE IN S = P Q

CHANGE IN S = P Q

UNIT THREE

MARKET FAILURE

KARL MARX

• WEALTH = UTILITY

• LABOR THEORY OF VALUE

• FLAWS OF CAPITALISM

o EXTERNALITIES

� PUBLIC COSTS

o ASYMMETRIC INFORMATION

o PUBLIC GOODS

o IMPERFECT COMPETITION

� MONOPOLY

o INEQUITY

o BUSINESS CYCLES

MACROECONOMIC INSTABILITY

• SAYS' LAW: Y = C

• MARX: INHERENT INSTABILITY BECAUSE

o Y = C + S

• SOLUTION

o GOVERNMENT

� PUBLIC OWNERSHIP

SOCIALISM / COMMAND ECONOMY

AD/AS

AGGREGATE DEMAND

CHANGE IN NATIONAL OUTPUT (GDP,

EMPLOYMENT, NATIONAL INCOME) =

INVERSE CHANGE IN PL

• FOREIGN PURCHASES EFFECT

• WEALTH EFFECT

• INTEREST RATE EFFECT

CHANGE IN NPD = CHANGE IN AD

• TAXES/SUBSIDIES/ INCOME

• REAL WEALTH

• EXPECTATIONS of

FUTURE Y AND PL

• DEBT

CHANGE IN AD = PL AQ

CHANGE IN AD = PL QL

LONG RUN AGGREGATE SUPPLY

LRAS = PPF

• PERFECTLY INELASTIC; UNRELATED TO CHANGES

IN PL

• LIMITS OF POTENTIAL PRODUCTION AT FULL

EMPLOYMENT

CHANGE IN NPD= CHANGE IN LRAS

• TRADE

• INVESTMENT/TECHNOLOGY

• MORE/LESS RESOURCES

SHORT RUN AGGREGATE SUPPLY

CHANGE IN NATIONAL OUTPUT (GDP,

EMPLOYMENT, NATIONAL INCOME)

= DIRECT CHANGE IN PL

CHANGE IN NPD= CHANGE IN AS

• COST OF RESOURCE

• UNEXPECTED SHOCKS

• TAXES/SUBSIDIES

CHANGE IN SRAS = PL AQ

CHANGE IN SRAS = PL AQ

CLASSICAL THEORY

• JOSEPH SCHUMPETER

o Y = C + S

o S = I

o Y = C + I

• CYCLES ARE TEMP DISEQUILIBRIUM

o PRODUCT MARKET

o RESOURCE MARKET

o MONEY MARKET

• IF AD THEN S > I

o SURPLUS; RECESSION

o PRICES FALL: DEFLATION

o WAGES FALL

o INTEREST RATES DROP

o COSTS : SRAS AND S = I

• IF AD THEN S < I

o SHORTAGE; INFLATION

o PRICES RISE: INFLATION

o WAGES RISE

o INTEREST RATES RISE

o COSTS : AS AND S = I

SELF-CORRECTING!

UNIT FOUR

KEYNESIANISM

CRITIQUES OF CLASSICAL THEORY

• SAVINGS DOES NOT EQUAL

INVESTMENT

• RATCHET EFFECT

o DOWNWARD

INFLEXIBILITY OF

PRICES AND WAGES

• KEYNESIAN CONSUMPTION

MULTIPLIER

KCM = 1/MPS

NATIONAL INCOME

ACCOUNTING

• C + Ig + G + Xn =

GDP

• NY + KCA + IBT

= GNP

CONSUMER PRICE INDEX

• NOMINAL = PxQ

• REAL = NOMINAL/CPI x

100

• MARKET BASKET = HOLD

QUANTITY CONSTANT

• CPI = MARKET BASKET

OF THIS YEAR/MARKET

BASKET OF BASE YEAR x

100

UNEMPLOYMENT

• LABOR POOL + NOT COUNTED =

POPULATION

• UN RATE = UN/LABOR POOL

• UNEMPLOYMENT:

o ACTUAL

o FRICTIONAL

o CYCLICAL

o STRUCTURAL

• OKUN'S LAW

CYCLICAL UNEMP x 2.5 = GDP

GAP

KEYNESIAN AD/AS and LONG RUN

EQUILIBRIUM

There Is NO short-run Disequilibrium.

Equilibrium could settle at a level of economic activity

with large amounts of unemployment or Inflation due to

the Ratchet Effect and the Multiplier.

- If potential Real GDP is greater than what actual AD/AS

equilibrium, a recessionary gap exists and may persist

indefinitely. The solution to this unacceptable equilibrium

is to increase AD through FISCAL POLICY.

- If potential Real GDP is less than AD/AS Equilibrium,

an inflationary gap exists and the inflation may

persist indefinitely. The solution to this unacceptable level

of economic activity is to decrease AD with FISCAL

POLICY.

UNIT FIVE

MONETARY POLICY

MONETARY POLICY/SUPPLY SIDE CRITICISM OF KEYNESIANISM:

• STRUCTURAL DEBT

• EXPANSIONARY BIAS

• CROWDING OUT

• EXPORT SHOCK\

• PERMANENT INCOME THEORY

THE PHILIPS CURVE

• SHORT RUN PHILIPS CURVE IS INVERSE RELATIONSHIP

BETWEEN INFLATION AND UNEMPLOYMENT

• LONG RUN PHILIPS CURVE IS NON-INFLATIONARY RATE

OF UNEMPLOYMENT (NAIRU)

• MOVEMENTS OF SHORT RUN PHILIPS CURVE SHOW

INFLATIONARY OR RECESSIONARY CASCADE BASED ON

EXPECTATIONS. [A SHIFT FROM A TO B TO C WOULD BE

INFLATIONARY]

EQUATION OF EXCHANGE

MV = PQ

FEDERAL RESERVE MONETARY TOOLS

• OPEN MARKET

o BOND PRICES

• DISCOUNT RATE

o DISCOUNT WINDOW

• RESERVE RATIO

o HAMMER

o CHANGES BOTH M AND V

MONEY MARKET

TIGHT MONEY DECREASES MONEY SUPPLY, INCREASES r,

DECREASES INVESTMENT, LOWERS AD, GDP, AND EMPLOYMENT

EASY MONEY INCREASES MONEY SUPPLY, DECREASES r,

INCREASES INVESTMENT, INCREASING AD, GDP, AND

EMPLOYMENT, AND IN THE LONG RUN SHIFTING AS TO THE

RIGHT.

UNIT SIX

FOREIGN EXCHANGE

BALANCE OF TRADE: EXPORTS – IMPORTS

BALANCE OF PAYMENTS (CURRENT ACCOUNT):

INCOME – EXPENDITURES

FIXED EXCHANGE RATES (PEGGED OR GOLD STANDARD) REINFORCE/WORSEN CYCLES:

-PEAK CAUSES INCREASED PURCHASES OF

FOREIGN GOODS LEADS TO LESS CURRENCY IN

HOME COUNTRY = DEFLATION, RECESSION

-DECREASED PURCHASES OF FOREIGN GOODS

LEADS TO INCREASED CURRENCY IN HOME

COUNTRY = INFLATION

COUNTRIES COULD DEVALUE (DECREASE) OR

REVALUE (INCREASE) THE THEIR CURRENCIES

WHICH LED TO CURRENCY WARS IN THE 60s AND

70s

FLOATING EXCHANGE RATES THE PRIMARY DETERMINANT OF VALUE OF

CURRENCY IS COMPARATIVE INTEREST RATES.

RECESSION:

FISCAL POLICY

DEFICIT (G>TAXES)

-GOVERNMENT BORROWS

-INTEREST RATES INCREASE

-FOREIGNERS WANT HOME CURRENCY TO

INVEST, BUY HOME BONDS

BALANCE OF PAYMENTS SURPLUS

-DEMAND FOR HOME CURRENCY INCREASES

-HOME CURRENCY APPRECIATES (MORE

VALUABLE); FOREIGN CURRENCY DEPRECIATES

(LESS VALUABLE)

-FOREIGN GOODS CHEAPER: X DECREASE, M

INCREASES

BALANCE OF TRADE DEFICIT

MONETARY POLICY

EASY MONEY (BOND PRICES UP, DISCOUNT r

DOWN, RR DOWN)

-INTEREST RATES DECREASE

-HOME WANTS FOREIGN CURRENCY FOR

INVESTMENT, BONDS

BALANCE OF PAYMENTS DEFICIT

-DEMAND FOR HOME CURRENCY DECREASES

-HOME CURRENCY DEPRECIATES (LESS

VALUABLE); FOREIGN CURRENCY APPRECIATES

(MORE VALUABLE)

-FOREIGN GOODS MORE EXPENSIVE: X

INCREASES, M DECREASES

BALANCE OF TRADE SURPLUS