common mistakes on the ap macro exam compiled by: john ostick malvern prep malvern, pa 19355
TRANSCRIPT
The difference between a change in demand and the resultant movement along
a demand curve
vs.
Shifting of the demand curve
P
Qo
$5
4
3
2
1
P QD
$54321
1020355580
D
Price of Corn
Quantity of Corn
CORN
10 20 30 40 50 60 70 80
What if
Demand
Increases?
GRAPHING DEMAND
P
Qo
$5
4
3
2
1
P QD
$54321
D
Price of Corn
Quantity of Corn
CORN
10 20 30 40 50 60 70 80
D’
Increase
in
Demand
Increase
in Quantity
Demanded1020355580
30406080 +
GRAPHING DEMAND
The difference between a change in supply and the resultant movement along
a supply curve
vs.
Shifting of the supply curve
SP
Qo
$5
4
3
2
1
10 20 30 40 50 60 70 80
$54321
60503520 5
P QS
Price of Corn
Quantity of Corn
CORN
What if
Supply
Increases?
GRAPHING SUPPLY
SP
Qo
$5
4
3
2
1
10 20 30 40 50 60 70 80
Price of Corn
Quantity of Corn
$54321
60503520 5
P QS
CORN
8070604530
S’Increase
in
Supply
Increase
in Quantity
Supplied
GRAPHING SUPPLY
Pric
e Le
vel
Real Domestic Output, GDP
Q
P AS
AD
Equilibrium in theIntermediate Range
QeQ1 Q2
EQUILIBRIUM: REAL OUTPUTAND THE PRICE LEVEL
P1
Pe
GROWTH IN THE AD-AS MODEL
A
B
C
D
Ca
pit
al G
oo
ds
Consumer Goods
Pri
ce
Lev
el
Real GDP
ASLR1 ASLR2
Q1 Q2
ECONOMIC GROWTH IN THEEXTENDED AD – AS MODEL
Pri
ce L
evel
Real GDP
o
P1
AS2
ASLR1
AD2
Q1
ASLR2
Q2
AD1
AS1
P2
Ra
te o
f in
tere
st,
i (p
erce
nt)
Amount of money demanded(billions of dollars)
0 50 100 150 200 250 300
10
7.5
5
2.5
0
Dm
ie
Sm
A temporary shortageof money will requirethe sale of some assetsto meet the need.
Sm1
THE MONEY MARKET
FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION
Pric
e le
vel
Real GDP (billions)
AS
AD2
$495 $515
P1
AD1
Fiscal PolicyAnd Inflation
$505
Expansionary Fiscal Policy >> Interest Rate
INCREASEDraw Money Market
Increase Spending (AD)>>Increase Demand for Money>>Increase Interest Rate
Higher Price Level>>Increase Demand for Money>>Increase Interest Rate
Real domestic output, GDP
Dm
InvestmentDemand
Rea
l rat
e of
inte
rest
, i
10
8
6
0Quantity of money demanded and supplied Amount of investment, i
MONETARY POLICY AND EQUILIBRIUM GDPSm1
AS
AD1P1
10
8
6
0
Sm2
AD2
P2
Money Supply Increases
Interest Rate Decreases
Investment Increases
AD & GDP Increaseswith slight inflation
If the moneysupply increasesto stimulate the
economy...
Pri
ce le
vel
AD3
Pri
ce le
vel
Real domestic output, GDP
Dm
InvestmentDemand
Rea
l rat
e of
inte
rest
, i
10
8
6
0Quantity of money demanded and supplied Amount of investment, i
MONETARY POLICY AND EQUILIBRIUM GDPSm1
AS
AD1P1
10
8
6
0
Sm2
AD2
P2
More Money Supply
Lower Interest Rates
More Investment
Still higher AD & GDPwith significant inflation
Sm3
P3 If the moneysupply increases
again…
Income (Spending) Multiplier
Multiplier = 1/ 1 – MPC or 1/ MPS
Initial Change in Spending X MULTIPLIER = Change in Output
MULTIPLE DEPOSIT EXPANSION PROCESS
BankAcquired reserves
and depositsRequiredreserves
Excessreserves
Amount bankcan lend - Newmoney created
ABCDEFGHIJKLMNOther banks
$100.00 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 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
$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
$400.00Total amount of money created by the banking system
Remembering the difference between the
Amount of Money Created
and theChange in the Money
Supplywhen dealing with the Money Multiplier and
Money Creation
New reserves$800
ExcessReserves
$4000Bank System Lending
FEDERAL RESERVEPURCHASE OF BONDS
Purchase of a$1000 bondfrom a bank...
$200Requiredreserves
$1000Initial
Deposit
Total Increase in Money Supply ($5000)
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
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 calculationsusing
MPC / MPSto determine changes necessary to correct
Recessionary andInflationary Gaps
FULL-EMPLOYMENT GDP
Ag
gre
gat
e E
xpen
dit
ure
s (b
illio
ns
of
do
llars
)
o45
o
Real domestic product, GDP (billions of dollars)
490 510 530
AE0
Recessionary Gap
AE1
530
510
490
Recessionary Gap= $5 Billion
Full Employment
FULL-EMPLOYMENT GDP
Ag
gre
gat
e E
xpen
dit
ure
s (b
illio
ns
of
do
llars
)
o45
o
Real domestic product, GDP (billions of dollars)
490 510 530
AE0
Inflationary Gap
AE2
530
510
490
Inflationary Gap= $5 Billion
Full Employment
Q2
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Q1
Pri
ce L
evel
Real domestic output
bP2
AS2
Occurs when short-run AS shifts left
Q2
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Q1
Pri
ce L
evel
Real domestic output
bP2
P3
AD2
AS2
Government response with increased AD
c
Evenhigherpricelevels
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Q1
Pri
ce L
evel
Real domestic output
bP2
AS2
If government allows a recession to occur
Q2
Q2
COST-PUSH INFLATION
o
P1
AS1
ASLR
AD1
a
Q1
Pri
ce L
evel
Real domestic output
bP2
AS2
If government allows a recession to occur
Nominal wages fall &AS returns
to its originallocation
An
nu
al r
ate
of in
flat
ion
(per
cen
t)
Unemployment rate (percent)
7
6
5
4
3
2
1
01 2 3 4 5 6 7
As inflation declines...
THE PHILLIPS CURVE CONCEPT
Unemploymentincreases