AP Macroeconomics Ultimate Guide

Economics

The study of how people, firms, and societies use their scarce productive resources to best satisfy their unlimited material wants.

Scarcity

All factors of production are scarce, leading to limited production of goods and services due to unlimited needs.

Macroeconomics vs

Macroeconomics focuses on the nation's economy as a whole, while microeconomics deals with individual units within the economy.

Resources or Factors of Production

Includes labor, land or natural resources, physical capital, and entrepreneurial ability.

Organizations of Society

Tradition, command, market, and mixed economies shape how resources are allocated in society.

Opportunity Cost

The value of the next best alternative foregone when a choice is made.

Trade-Offs

Decisions made due to the scarcity of resources, affecting individuals, firms, and governments.

Production Possibilities Curve

A model showing the trade-offs between producing two goods or services efficiently.

Efficiency

Productive efficiency, allocative efficiency, and optimal resource allocation in an economy.

Growth

Economic growth involves producing more over time, while economic contraction signifies a decrease in economic output.

Comparative Advantage and Trade

Comparative advantage explains how nations benefit from specializing in goods they can produce efficiently.

Demand

The law of demand, change in quantity demanded vs. change in demand, and determinants of demand.

Supply

The law of supply, quantity supplied vs. supply, and determinants of supply.

Market Equilibrium

The market-clearing price where demand equals supply, leading to equilibrium.

Market shortage

shortage (Excess demand) - A situation where the quantity demanded exceeds the quantity supplied at a market price, leading to a rise in price to eliminate the shortage.

Market surplus

Surplus (Excess supply) - A condition where the quantity supplied exceeds the quantity demanded at a market price, resulting in a price decrease to eliminate the surplus.

Circular flow of economic activity - A model illustrating how households and firms circulate resources, goods, and incomes through the economy, expanded to include the government and foreign sector.

Closed economy - A model assuming no foreign sector involvement (imports/exports) in economic activities.

Gross Domestic Product (GDP) - The market value of final goods and services produced within a nation in a specific period, calculated as the sum of consumer spending, investment spending, government spending, and net exports.

Aggregate income (AI) - The total income earned by resource suppliers in the economy, comprising wages, rent, interest, and profit.

Consumer Price Index (CPI) - A measure of the average price level of items in a base year market basket, used as the primary indicator of consumer inflation.

Labor force - The total of employed and unemployed individuals aged 16 and above, used to calculate the unemployment rate.

Full employment - A state where there is no cyclical unemployment in the economy, with the natural rate of unemployment typically between 4 to 6 percent in the United States.

Real GDP - The value of current production adjusted for inflation, using prices from a fixed point in time to allow for comparison over different periods.

Latte Price Index (LPI)

A measure used to calculate real GDP by adjusting nominal GDP based on the price of a latte in a specific year compared to a base year.

Business Cycle

The periodic fluctuations in economic activity characterized by four phases - expansion, peak, contraction, and trough.

Aggregate Demand (AD)

The total spending on domestic output in an economy, comprising consumption, investment, government purchases, and net exports.

Spending Multiplier

An economic measure that shows the impact of changes in government spending on the Gross Domestic Product (GDP) of a country.

Tax Multiplier

An economic measure that determines the maximum change in spending when the government alters taxes, calculated as the negative Marginal Propensity to Consume divided by the Marginal Propensity to Save.

Short-Run Aggregate Supply (SRAS)

The positive relationship between the level of domestic output produced and the aggregate price level in the short run.

Long-Run Aggregate Supply (LRAS)

The quantity of goods and services an economy can produce with full employment of resources in the long run.

Equilibrium Real GDP

The state where the quantity of real output demanded equals the quantity of real output supplied, occurring at the intersection of Aggregate Demand (AD) and Short-Run Aggregate Supply (SRAS) curves.

Inflationary Gap

The difference between GDPi and GDPf, representing the amount real GDP must decrease to reach GDPf.

Supply Shocks

Economy-wide events affecting firm costs and the SRAS curve, leading to positive or negative shifts.

Positive Supply Shocks

Result from increased productivity or lower energy prices.

Negative Supply Shocks

Arise from sudden economy-wide input price increases, like during the Gulf War of 1990 to 1991.

Recessionary Gap

Occurs when the economy operates below full employment, leading to falling real GDP and prices.

Adjustment to a Recessionary Gap

The self-correction process where falling prices lead to a rightward shift of the SRAS curve.

Inflationary Gap

Arises when AD increases, causing real GDP and prices to rise.

Adjustment to an Inflationary Gap

The process where rising factor prices shift the SRAS curve leftward to eliminate the inflationary gap.

Expansionary Fiscal Policy

Involves increasing government spending or lowering net taxes to shift AD rightward.

Contractionary Fiscal Policy

Involves decreasing government spending or increasing net taxes to shift AD leftward.

Sticky Prices

Prices that do not adjust downward with changes in AD, as believed by Keynesians.

Automatic Stabilizers

Fiscal policies already in place to counter economic fluctuations, like income taxes and anti-poverty programs.

Financial Assets

Investments yielding a rate of return, including stocks, bonds, loans, and bank deposits.

Liquidity

The ease of converting a financial asset into cash, with cash being the most liquid asset.

Rate of Return

The net gain or loss of an investment over a specified period, with higher rates preferred.

Stocks

Certificates representing ownership in a firm, part of equity financing.

Bonds

Certificates of indebtedness issued by firms, part of debt financing.

Nominal Interest Rates

Rates not adjusted for inflation, reflecting current market conditions.

Real Interest Rates

Rates adjusted for inflation, showing the actual purchasing power gained from interest.

Fiat Money

Paper and coin money backed by public trust in the government, lacking intrinsic value.

Commodity Money

Items with non-monetary uses that function as money, like gold or silver.

Functions of Money

Medium of exchange, unit of account, and store of value.

Money Supply

The quantity of money in circulation, measured by the Fed as M1 and M2.

Monetary Base

Physical currency in circulation and bank reserves, not included in the money supply.

Fractional Reserve Banking

System where only a fraction of deposited money is held in reserve.

Money Multiplier

Measure of new checking deposits created by a dollar of excess reserves, calculated as 1/(reserve ratio).

Transaction Demand

The amount of money held for transactions, increasing with nominal GDP but not influenced by interest rates.

Asset Demand

The money demanded as an asset, decreasing as nominal interest rates rise due to the opportunity cost of holding money.

Total Money Demand

The sum of transaction demand and asset demand, inversely related to the nominal interest rate.

Money Supply

The total amount of money available in an economy, determined by the central bank and independent of the nominal interest rate.

Open Market Operations (OMOs)

Monetary policy tool involving the buying or selling of securities to control the money supply and interest rates.

Federal Funds Rate

The interest rate on short-term loans between banks, influenced by the Federal Reserve's buying or selling of bonds.

Discount Rate

The interest rate commercial banks pay on short-term loans from the Fed, affecting excess reserves and the money supply.

Required Reserve Ratio

The percentage of deposits banks must hold as reserves, impacting excess reserves and the money supply.

Loanable Funds Market

The interaction between borrowers and lenders determining the real interest rate and quantity of credit in an economy.

Phillips Curve

Graphical representation showing the inverse relationship between inflation and unemployment rate in the short run.

Inflation

The increase in the general price level caused by factors like demand-pull or cost-push inflation.

Quantity Theory of Money

Theory stating that the quantity of money determines the price level and the growth rate of money affects inflation.

Money Supply

The total amount of money in circulation within an economy.

Inflation

A general increase in prices and fall in the purchasing value of money.

Fiscal Stimulus

The use of expansionary fiscal policy to boost economic activity.

Fiscal Restraint

The use of contractionary fiscal policy to slow down economic activity.

Budget Surplus

When government revenues exceed government expenditures in a given year.

Budget Deficit

When government expenditures exceed government revenues in a given year.

National Debt

The accumulation of deficits over multiple years.

Crowding Out Effect

Public sector spending reducing private sector spending.

GDP per Capita

The measure of economic output per person in a country.

Productivity

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

Exchange Rate

The price of one currency in terms of another currency.

Balance of Payments

A summary of payments received and sent by a country to foreign entities.

Foreign Exchange Market

The market where foreign currencies are bought and sold.

Monetary Policy

The control of the money supply by a central bank to achieve economic goals.

Aggregate Production Function

The relationship between production and capital in an economy.

Expansionary Monetary Policy

Policy involving decreasing the reserve ratio, discount rate, or buying bonds to increase the money supply and stimulate the economy.

Contractionary Monetary Policy

Policy involving increasing the reserve ratio, discount rate, or selling bonds to decrease the money supply and control inflation.

Revenue Tariff

An excise tax on goods not produced domestically, aimed at raising government revenue without significant trade restrictions.

Protective Tariff

An excise tax on domestically produced goods to shield them from foreign competition and support local industries.

Appreciating Currency

When a currency's value rises relative to another currency, affecting trade competitiveness.

Depreciating Currency

When a currency's value falls relative to another currency, impacting trade competitiveness.

Inbound Capital Flow

Funds injected into a domestic economy through the purchase of local assets by foreign investors, driven by high real interest rates.

Outbound Capital Flow

Funds extracted from a domestic economy through the purchase of foreign assets by local investors, influenced by low real interest rates.

Central Banks

Institutions influencing domestic interest rates through monetary policy tools like open market operations, discount rates, and reserve requirements.

Domestic Interest Rates

Rates affecting net capital inflows, with high rates attracting foreign investors and low rates discouraging investments.