AP Macroeconomics Cram Notes:

1. Basic Economic Concepts

• Scarcity: Resources (land, labor, capital, entrepreneurship) are limited, but human wants are unlimited. Scarcity forces society to make choices and prioritize needs.

• Opportunity Cost: The value of the next best alternative that must be forgone when a choice is made. It reflects the trade-off involved in decision-making.

• Factors of Production:

  • Land: Natural resources used to produce goods (e.g., water, minerals, forests).

  • Labor: Human effort used in production, including physical and mental work.

  • Capital: Tools, machinery, buildings, and technology used to produce goods and services.

  • Entrepreneurship: Individuals who combine the other factors of production to create goods and services and take on business risks.

2. Economic Systems

• Market Economy: Decisions about production and pricing are driven by supply and demand in a free market. Prices are determined by consumers and producers without government intervention (e.g., the U.S. economy).

• Command Economy: The government makes all economic decisions regarding production, pricing, and distribution of goods. Examples include North Korea and Cuba.

• Mixed Economy: Combines elements of market and command economies, where the government may intervene in certain sectors (e.g., healthcare, defense), but the market operates freely in others (e.g., consumer goods). Most economies, including the U.S., are mixed economies.

3. Gross Domestic Product (GDP)

• GDP: The total value of all final goods and services produced within a country’s borders during a given time period, typically a year or a quarter.

  • Nominal GDP: GDP measured using current prices, without adjusting for inflation.

  • Real GDP: GDP adjusted for inflation, showing the true growth in an economy by comparing it to a base year.

  • GDP Per Capita: GDP divided by the population of the country; a measure of a country’s economic output per person, used to compare standards of living.

  • Expenditure Approach: GDP = Consumption + Investment + Government Spending + (Exports - Imports).

  • Income Approach: GDP = Wages + Rent + Interest + Profit. It sums all income earned by individuals in the economy.

4. Unemployment

• Unemployment Rate: The percentage of the labor force that is actively seeking work but is unable to find a job.

  • Labor Force: People who are employed or actively seeking employment.

  • Types of Unemployment:

    • Frictional Unemployment: Temporary unemployment as people move between jobs or enter the workforce.

    • Structural Unemployment: Caused by changes in the economy (e.g., automation or industry shifts) that make certain skills obsolete.

    • Cyclical Unemployment: Caused by downturns in the economy (e.g., recessions), leading to a decrease in demand for goods and services.

    • Seasonal Unemployment: Occurs due to the time of year or season (e.g., ski instructors or farm workers).

  • Natural Rate of Unemployment: The level of unemployment that occurs in a growing and healthy economy, including frictional and structural unemployment, but not cyclical.

5. Inflation

• Inflation: The increase in the general price level of goods and services in an economy over time, leading to a decrease in purchasing power.

  • Consumer Price Index (CPI): A measure of the average change in prices paid by urban consumers for a fixed basket of goods and services over time. It's used to calculate the inflation rate.

  • Inflation Rate: The percentage change in the CPI from one period to the next.

  • Demand-Pull Inflation: Occurs when aggregate demand (consumer spending, investment, government spending) exceeds aggregate supply, causing prices to rise.

  • Cost-Push Inflation: Caused by an increase in the cost of production (e.g., higher wages or raw material prices), which raises the price of goods and services.

  • Hyperinflation: An extremely high and typically accelerating inflation, often caused by excessive money printing or political instability (e.g., Zimbabwe in the 2000s).

6. Monetary Policy

• Monetary Policy: Actions taken by the central bank (the Federal Reserve in the U.S.) to control the money supply and interest rates to influence economic activity.

  • Federal Reserve Tools:

    • Open Market Operations (OMO): Buying or selling government bonds to increase or decrease the money supply.

    • Discount Rate: The interest rate at which banks can borrow from the Federal Reserve. Lowering the rate increases borrowing and money supply.

    • Reserve Requirements: The percentage of deposits banks must hold in reserve, which impacts how much they can lend out.

  • Expansionary Monetary Policy: Aimed at increasing the money supply and decreasing interest rates to stimulate the economy during a recession (e.g., lowering the Federal Funds Rate).

  • Contractionary Monetary Policy: Aimed at decreasing the money supply and increasing interest rates to control inflation during an economic boom (e.g., raising the Federal Funds Rate).

7. Fiscal Policy

• Fiscal Policy: Government use of taxes and spending to influence the economy. Managed by Congress and the President.

  • Expansionary Fiscal Policy: Increases government spending or decreases taxes to boost economic activity during a recession.

  • Contractionary Fiscal Policy: Decreases government spending or increases taxes to slow down an overheated economy and control inflation.

  • Budget Deficit: Occurs when government spending exceeds revenue.

  • National Debt: The total amount of money the government owes due to borrowing over the years.

8. The Business Cycle

• Business Cycle: The recurring pattern of expansion and contraction in economic activity.

  • Expansion: A period of economic growth where GDP increases, unemployment falls, and inflation may rise.

  • Peak: The highest point in the business cycle, where the economy is at full capacity.

  • Recession: A decline in economic activity for two or more consecutive quarters, leading to increased unemployment and reduced demand.

  • Trough: The lowest point in the cycle, after which the economy begins to recover and grow again.

9. Money and Banking

• Money: A medium of exchange used to facilitate trade, a store of value, and a unit of account.

  • Functions of Money:

    • Medium of Exchange: Used to buy goods and services.

    • Unit of Account: Provides a standard measurement of value.

    • Store of Value: Can be saved and used for future purchases.

  • Money Supply: The total amount of money circulating in the economy.

  • Banking System: Banks lend money to borrowers and keep deposits. They play a central role in managing the money supply.

10. International Trade

• Comparative Advantage: The ability of a country to produce a good at a lower opportunity cost than another country. Countries should specialize in producing goods where they have a comparative advantage and trade.

• Exports and Imports:

  • Exports: Goods and services sold to other countries.

  • Imports: Goods and services purchased from other countries.

• Balance of Trade: The difference between the value of exports and imports. A trade surplus means exports exceed imports, while a trade deficit means imports exceed exports.

• Exchange Rates: The price of one country's currency in terms of another's. A higher exchange rate can make exports more expensive for foreign buyers.

11. Economic Growth

• Economic Growth: The increase in a country's output of goods and services over time, often measured by the increase in real GDP.

  • Long-Term Growth: Driven by improvements in technology, capital (factories, machines), labor productivity, and education.

  • Short-Term Growth: Can be influenced by changes in demand, investment, government policies, and monetary policy.

12. Supply and Demand

• Law of Demand: As the price of a good increases, the quantity demanded decreases, and vice versa.

• Law of Supply: As the price of a good increases, the quantity supplied increases, and vice versa.

• Market Equilibrium: The point where the quantity supplied equals the quantity demanded, determining the price and quantity in the market.

• Shifts in Demand: Changes in income, tastes, or prices of related goods can cause the demand curve to shift right (increase) or left (decrease).

• Shifts in Supply: Changes in production cost, technology, or the number of sellers can cause the supply curve to shift right (increase) or left (decrease).