AP Macroeconomics Vocabulary Flashcards

Flashcards for reviewing key vocabulary terms in AP Macroeconomics.

Aggregate Spending (GDP)

The sum of all spending from four sectors of the economy. GDP = C+I+G+Xn

Aggregate Income (AI)

The sum of all income earned by suppliers of resources in the economy. AI=GDP

Nominal GDP

The value of current production at the current prices

Real GDP

The value of current production, but using prices from a fixed point in time

Base year

The year that serves as a reference point for constructing a price index and comparing real values over time.

Price index

A measure of the average level of prices in a market basket for a given year, when compared to the prices in a reference (or base) year.

Market Basket

A collection of goods and services used to represent what is consumed in the economy

GDP price deflator

The price index that measures the average price level of the goods and services that make up GDP.

Real rate of interest

The percentage increase in purchasing power that a borrower pays a lender.

Expected (anticipated) inflation

The inflation expected in a future time period. This expected inflation is added to the real interest rate to compensate for lost purchasing power.

Nominal rate of interest

The percentage increase in money that the borrower pays the lender and is equal to the real rate plus the expected inflation.

Business cycle

The periodic rise and fall (in four phases) of economic activity

Expansion

A period where real GDP is growing.

Peak

The top of a business cycle where an expansion has ended.

Contraction

The period where real GDP is falling

Recession

Two consecutive quarters of falling real GDP.

Trough

The bottom of the business cycle where a contraction has stopped.

Depression

A prolonged, deep contraction in the business cycle

Consumer Price Index (CPI)

The price index that measures the average price level of the items in the base year market basket. This is the main measure of consumer inflation.

Inflation

The percentage change in the CPI from one period to the next.

Nominal Income

Today’s income measured in today’s dollars. These are dollars unadjusted by inflation.

Real income

Today’s income measured in base year dollars.

Consumption Function

A linear relationship showing how increases in disposable income cause increases in consumption.

Autonomous Consumption

The amount of consumption that occurs no matter the level of disposable income. In a linear consumption function, this shows up as a constant and graphically it appears as the y intercept.

Saving function

A linear relationship showing how increases in disposable income cause increases in savings.

Dissaving

Another way of saying that saving is less than zero. This can occur at low levels of disposable income when the consumer must liquidate assets or borrow to maintain consumption.

Autonomous saving

The amount of saving that occurs no matter the level of disposable income. In a linear saving function, this shows up as a constant and graphically it appears as the y intercept.

Marginal Propensity to Consume (MPC)

The change in consumption caused by a change in disposable income, or the slope of the consumption function. MPC = ▲C/▲DI.

Marginal Propensity to Save (MPS)

The change in saving caused by a change in disposable income, or the slope of the saving function. MPS = ▲S/▲DI

Determinates of Consumption and Saving

Factors that shift the consumption and saving functions in the opposite direction are Wealth, Expectations, and Household Debt. The factors that change consumption and saving in the same direction are Taxes and Transfers.

Expected Real Rate of Return

The rate of real profit the firm anticipates receiving on investment expenditures. This is the marginal benefit of an investment project.

Real rate of interest

The cost of borrowing to fund an investment. This can be thought of as the marginal cost of an investment project.

Decision to invest

A firm invests in projects so long as the real expected real rate of return is greater than the i.

Investment Demand

The inverse relationship between the real interest rate and the cumulative dollars invested. Like any demand curve, this is drawn with a negative slope.

Autonomous investment

The level of investment determined by investment demand. It is autonomous because it is assumed to be constant at all levels of GDP.

Market for loanable funds

The market for dollars that are available to be borrowed for investment projects. Equilibrium in this market is determined at the real interest rate where the dollars saved (supply) is equal to the dollars borrowed (demand)

Demand for loanable funds

The negative relationship between the real interest rate and the dollars invested by firms.

Private Saving

Saving conducted by households and equal to the difference between disposable income and consumption.

Public Saving

Saving conducted by government and equal to the difference between tax revenue collected and spending on goods and services.

Supply of loanable funds

The positive relationship between the dollars saved and the real interest rate.

Fiscal Policy

Deliberate changes in government spending and net tax collection to affect economic output, unemployment, and the price level. Fiscal policy is typically designed to manipulate AD to “fix’ the economy.

Expansionary Fiscal Policy

Increases in government spending or lower net taxes meant to shift the aggregate expenditure function upward and shift AD to the right:

Contractionary fiscal policy

Decreases in government spending or higher net taxes meant to shift the aggregate expenditure function downward and shift AD to the left.

Sticky prices

If price levels do not change, especially downward, with changes in AD, then prices are thought of as sticky or inflexible. Keynesians believe the price level does not usually fall with Contractionary policy.

Budget deficit

Exists when government spending exceeds the revenue collected from taxes.

Budget surplus

Exists when government spending is less than revenue collected from taxes.

Automatic stabilizers

Mechanisms built into the tax system that automatically regulate, or stabilize, the macroeconomy as it moves through the business cycle by changing net taxes collected by the government. These stabilizers increase a deficit during a recessionary period and increase a budget surplus during an inflationary period, without any discretionary change on the part of the government.

Crowding out effect

When the government borrows funds to cover a deficit, the interest rate increases and households and firms are pushed out of the market for loanable funds.

Net export effect

A rising interest rate increases foreign demand for U.S. dollars. The dollar then appreciates in value, causing net exports from the U.S. to fall. Falling net exports decreases AD, which lessens the impact of the expansionary fiscal policy.

Productivity

The quantity of output that can be produced per worker in a given amount of time.

Human capital

The amount of knowledge and skills that labor can apply to the work they do and the general level of health that the labor force enjoys.

Non-renewable resources

Natural resources that cannot replenish themselves. Coal is a good example.

Renewable resources

Natural resources that can replenish themselves if they are not over-harvested.

Technology

A nation’s knowledge of how to produce goods in the best possible way.

Investment tax credit

A reduction in taxes for firms that invest in new capital like a factory or piece of equipment.

Supply side fiscal policy

Fiscal policy centered on tax reductions targeted to AS so that GDPr increases with very little inflation. The main justification is that lower taxes on individuals and firms increase incentives to work, save, invest and take risks.

Aggregate Demand AD

The inverse relationship between all spending on domestic output and the average price level of that output. AD measures the sum of consumption spending by households, investment spending by firms, government purchases of goods and services, and the net exports bough by foreign customers.

Foreign sector substitution effect

When the avg. price of U.S. output increases, consumers naturally begin to look for similar items produced elsewhere.

Interest rate effect

If the avg. price level rises, consumers and firms might need to borrow more money for spending and capital investment, which increases the interest rate and delays current consumption. This postponement reduces current consumption of domestic production as the price level rises.

Wealth effect

As the avg. PL rises, the purchasing power of wealth and savings begins to fall. High prices therefore tend to reduce the quantity of domestic output purchased.

Determinates of AD

Ad is a function of the four components of domestic spending (CIGXx) If any of these components increases or decreases, holding the others constant, AD shifts right or left.

Aggregate Supply AS

The positive relationship between the level of domestic output produced and the avg. price level of that output.

Macroeconomic short run

A period of time during which the prices of goods and services are changing their respective markets, but the input prices have not yet adjusted to those changes in the product markets. During the SR, the AS curve has three stages – horizontal, upward sloping and vertical.

Macroeconomic long run

A period of time long enough for input prices to have fully adjusted to market forces. In this period, all product and input markets are in a state of equilibrium and the economy is operating at FE. Once all markets in the economy have adjusted and there exists this long-run equilibrium, the AS curve is vertical at GDPr.

Determinates of AS

AS is a function of many factors that impact the production capacity of the nation. If these factors make it easier, or less costly, for a nation to produce, AS shifts to the right. If these factors make it more difficult, or more costly, for a nation to produce, then AS shifts to the left.

Macroeconomic Equilibrium

Occurs when the Q of real output D is equal to the Q of real output supplied. Graphically this is at the intersection of AD and AS.

Recessionary Gap

The amount by which full-employment GDP exceeds equilibrium GDP.

Inflationary Gap

The amount by which equilibrium GDP exceeds full-employment GDP.

Demand-pull inflation

This inflation is the result of stronger C from all sectors of AD as it continues to increase in the upward sloping range of AS. The PL begins to rise and inflation is felt in the economy.

Deflation

A sustained falling PL, usually due to weakened AD and a constant AS.

Recession

In the AD and AS model, this is described as falling AD with a constant AS curve. GDPr falls far below FE levels and the U% rises.

Circular Flow of Economic Activity

A model that shows how households and firms circulate resources, goods and incomes though the economy. This basic model is expanded to include the G and Foreign sector.

Closed economy

A model that assumes there is no foreign sector (M and X)

Aggregation

The process of summing the microeconomic activity of households and firms into a more macroeconomic measure of economic activity.

Gross Domestic Product

The market value of the final goods and services produced within a nation in a given year.

Final goods

Goods that are ready for their final use by consumers and firms.

Intermediate goods

Goods that require further modification before they are ready for final use.

Double counting

The mistake of including the value of intermediate stages of production in GDP on top of the value of the final good.

Second hand sales

Final goods and services that are resold. Even if they are resold many times, final goods and services are only counted once, in the year in which they were produced.

Nonmarket transactions

Household work or do-it-yourself jobs are missed by GDP accounting. The same is true of G transfer payments and purely financial transactions.

Underground economy

These include unreported illegal activity, bartering, or informal exchange of cash.

Domestic Price

The equilibrium price of a good in a nation without trade.

World Price

The global equilibrium price of a good when nations engage in trade.

Balance of Payments statement

A summary of the payments received by the U.S. from foreign countries and the payments sent by the U.S. to foreign countries.

Current account

This account shows current import and export payments of both goods and services and investment income sent to foreign investors of U.S. and investment income received by U.S. citizens who invest abroad.

Capital account

This account shows the flow of investment on real or financial assets between a nation and foreigners.

Official reserves account

The Fed’s adjustment of a deficit or surplus in the current and capital account by the addition or subtraction of foreign currencies so that the balance of payments is zero.

Exchange rate

The price of one currency in terms of a second currency.

Appreciating (depreciating) currency

When the value of a currency is rising (falling) relative to another currency, it is said to be appreciating (depreciating)

Determinates of exchange rates

External factors that increase the price of one currency relative to another.

Revenue tariff

An excise tax levied on goods not produced in the domestic market.

Protective tariff

An excise tax levied on a good that is produced in the domestic market so that it may be protected from foreign competition.

Import Quota

A limitation on the amount of a good that can be imported into the domestic market.

Asset Demand

The amount of money demanded as an asset. As nominal interest rates rise, the oc of holding money begins to rise and you are more likely to lesson your asset D for money.

Money Demand

The D for money is the sum of money demanded for transactions and money demanded as an asset. It is inversely related to i%.

Theory of Liquidity Preference

Keynes’ theory that the i% adjusts to bring the money market into equilibrium.

Fractional Reserve Banking

A system in which only a fraction of the total money deposited in banks is held in reserve as currency.

Reserve Ratio

The fraction of total deposits that must be kept on reserve

Required reserves

The portion of a deposit that must be held at the bank for withdrawals.

Excess reserves

The portion of a deposit that may be borrow by customers.