AP Macroeconomics Notes

UNIT 1: Basic Economic Concepts

  • Economics: Study of how people satisfy unlimited wants with scarce resources.

  • Scarcity: Limited goods/services available for unlimited wants, leading to choices.

  • Macroeconomics: Studies the whole economy, including inflation, price levels, GDP, economic growth, national income, and unemployment.

  • Trade-offs: Losing all other options when making a choice.

  • Opportunity Cost: The loss of potential gain from other alternatives when one alternative is chosen.

4 Factors of Production

  • Land

  • Labor

  • Capital

    • Capital goods: Goods made for production, not direct consumption (e.g., oven for baking cookies).

    • Human goods: Skills that benefit production (e.g., education).

  • Entrepreneurship

Production Possibility Frontier (Curve)

  • PPF: Displays unlimited wants for limited goods.

  • Types of PPF: Increasing, constant, and decreasing opportunity cost.

Comparative Advantage

  • Comparative Advantage: Ability to produce a product at a higher efficiency.

  • Example:

    • Country A produces 10 cars or 5 bikes (2:1 ratio).

    • Country B produces 8 cars or 2 bikes (4:1 ratio).

    • Country A gives up 1 bike to make 2 cars; Country B gives up 4 cars to make 1 bike. Country A has a comparative advantage in producing cars.

    • Country A gives up 2 cars to make 1 bike; Country B gives up 4 cars to make 1 bike. Country B has a comparative advantage in producing bikes.

  • Absolute Advantage: Producing a greater amount; Country A has an absolute advantage in car production in the example above.

Supply and Demand

  • Law of Demand: Price and quantity demanded are inversely related. As price increases, demand decreases.

  • Law of Supply: Price and quantity supplied are directly related. As price increases, supply increases.

Shifters of Supply

  • Cost of inputs

  • Change in productivity/technology

  • Number of sellers

  • Government Actions: Taxes

  • Government Actions: Subsidies

  • Government Regulations

  • Expectations of future profit

Shifters of Demand

  • Number of consumers

  • Change in tastes & preferences

  • Change in income

  • Change in the price of substitute goods

  • Change in the price of complementary goods

  • Future expectations

  • Price and Quantity Relationship Examples:

    • As price increases, quantity increases.

    • As price decreases, quantity decreases.

Market Equilibrium

  • Equilibrium: Market supply and demand balance each other, resulting in stable prices.

UNIT 2: Economic Indicators and the Business Cycle

Gross Domestic Product (GDP)

  • GDP: Total monetary value of all final goods/services produced in a country in a period.

Expenditures Approach to Calculating GDP

  • Sum of spending by households, businesses, and the government.

Other Ways to Calculate GDP

  • Income Approach: Sum of income earned (total national income, sales taxes, depreciation, net foreign factor income).

  • Value-Added Approach: Gross value of output - value of intermediate consumption.

What is not Included in the GDP

  • Sales of non-new items or items that doesn't produce a new product (e.g., sale of stock, used goods).

  • Final goods are included, but intermediate goods (used to make the product) are not (e.g., flour in a cupcake).

  • Illegal activities are not included.

The Circular Flow Model

  • Demonstrates how money and transactions flow: factor market, households, product market, and businesses.

Unemployment

  • Unemployment: A capable person searching for work but unable to find a job. (Person is of age and does not have a disability preventing work.)

Types of Unemployment

  • Frictional: In between jobs (e.g., quitting Dunkin' Donuts for Starbucks).

  • Structural: Unemployed due to technological advancements (e.g., replaced by a frosting machine).

  • Seasonal: Unemployed due to the season (e.g., lobster fisherman in winter).

Calculating Unemployment

  • Unemployment rate = (Number of unemployed people / Labor Force) * 100

  • Labor force: People working and those willing and able to work.

Consumer Price Index (CPI)

  • CPI: Index representing price changes of a product over time.

  • Inflation: General increase in a product’s price, leading to decreased purchasing power.

GDP Deflator

  • Measure of the economy’s prices of final goods in a period.

Real vs. Nominal GDP

  • Nominal GDP: Market value of final production at current market prices.

  • Real GDP: Market value of final production adjusted for price changes.

Unit 3 - National Income and Price Determination

Aggregate Demand Curve

  • Shows relationship between aggregate price level & quantity of aggregate demand

  • Downward Sloping Because of…:

    • Real-balance effect: Increase in price level decreases purchasing power of money

    • Interest rate effect: Increase in interest rate decreases borrowing and spending

    • Open economy effect: Higher price levels decreases net exports

    • Made up of consumption, investment, government spending, and net exports

  • Shifters:

    • Changes in expectations (optimistic beliefs increase demand)

    • Changes in wealth (rise in asset value increase demand)

    • Size of existing physical capital (small existing stock of physical capital increases demand)

    • Fiscal Policy: Government spending increase or tax cuts increase demand.

    • Monetary Policy: Quantity of money increases demand.

Short-run Aggregate Supply (SRAS)

  • When firms haven’t made price changes in response to an economic shock (sticky prices).

  • Upward sloping because of…

    • The misperception theory (producers mistaken price increase as greater profit)

    • Sticky Price Theory (producers temporarily reduce quantity b/c of menu costs)

    • Sticky Wage Theory (production costs can be higher from union contracts)

  • Shifters:

    • Changes in commodity prices (lower commodity price increases SRAS)

    • Changes in nominal wages (lower nominal wages increases SRAS)

    • Changes in productivity (more productive workers increases SRAS)

Long-run aggregate supply (LRAS)

  • After producers have adjusted their prices according to economic shocks

  • All production costs are fully flexible

  • It is an economy’s potential output (represent the full-employment output)

  • Shifters that cause and increase

    • Increases in the quantity of resources (e.g., land, labor)

    • Increases in the quality of resources (e.g., education)

    • Technological progress can increase LRAS

  • LRAS shifts indicate changes in full-employment level of output & economic growth.

AD-AS Model

  • If aggregate price level is above equilibrium, AS will exceed AD and cause the aggregate PL to fall, pushing it back to the equilibrium. If aggregate price level is below equilibrium, AD will exceed AS and cause the aggregate price level to rise, pushing it back to the equilibrium.

  • Positive demand shock increases aggregate price and aggregate output (demand-pull). Negative demand shock decreases aggregate price and aggregate output.

  • Positive supply shock decreases aggregate price and increases aggregate output. Negative supply shock increases aggregate price and decreases aggregate output (supply-push).

  • Recessionary gap: Exists when SRAS equilibrium is less than LRAS equilibrium so wages would fall and SRAS shifts to the right.

  • Inflationary gap: Exists when SRAS equilibrium is greater than LRAS equilibrium so wages would rise and SRAS would shift to the left.

  • Economy self-corrects in the long-run.

Equilibrium

  • Short-run equilibrium is when AD & SRAS are equal

  • Long-run equilibrium is when AD & SRAS are equal and intersect on LRAS

Fiscal Policies (affect AD)

  • Expansionary Fiscal policies that increase aggregate demand:

    • Increase in government spending (has greatest effect) Multiplier = MPC = {(Change \ in \ consumer \ spending) \over change \ in \ disposable \ income}
      MPC+MPS = 1

    • Cut in taxesMultiplier = {MPC \over MPS}
      MPS = 1 - MPC

    • Increase in government transfers

  • Contractionary Fiscal Policies that decrease aggregate demand:

    • Decrease in government purchases

    • Increase in taxes

    • Decrease in government transfers

  • Expansionary policies are used in recessions and contractionary fiscal policies are used in expansions.

Automatic Stabilizers

  • Government spending and taxation rules that cause fiscal policy to be automatically expansionary during recessions and contractionary during expansions.

    • Ex. Tax revenues automatically decrease as GDP falls, increasing consumption.

    • Ex. Tax revenues automatically increase as GDP rises, decreasing consumption.

UNIT 4: The Financial Sector

Economic Growth

  • Comes from increases in human capital and physical capital.

  • Savings = Investment Spending

  • National Savings + Capital Inflow = Investment Spending

Financial Asset Types

  • Loans

  • Bonds (bonds & interest rates for bonds are inversely related)

  • Loan-backed securities

  • Stocks

  • Bank Deposits

Financial Intermediaries Types

  • Mutual Funds

  • Life insurance companies

  • Pension funds

  • Banks (meant to reduce transaction costs, reduce risk, and provide liquidity)

Inflation & Interest Rate

  • Inflation rate: {[(PL \ in \ Year \ 2 - PL \ in\ Year \ 1) \over PL \ in \ Year \ 1] * 100}

    • Inflation does not make everyone poorer (because increase in wages & increase in price of goods → no real change)

    • Nominal interest rate is unadjusted for inflation.

    • Real interest rate = Nominal interest rate - actual interest rate

      • Higher inflation than expected:

        • Winners: Borrowers

        • Losers: Lenders

      • Lower inflation than expected:

        • Winners: Lenders

        • Losers: Borrowers

  • Interest rate: Additional rate charged by lenders to borrowers for money lent.

  • National Savings = Private savings + budget balance

  • Capital inflow: Net inflow of funds into a country.

  • Liquid: Easily converted to cash without loss of value.

  • Illiquid: Loses value when converted to cash.

  • Diversification: Investing in various assets to avoid total loss.

Money

  • Any asset accepted as a means of payment

  • Roles in economy

    • Medium of exchange

    • Unit of account

    • Store of value

  • Types

    • Commodity money

    • Commodity-backed money

    • Fiat Money

  • Is measured using monetary aggregates M1 & M2

    • M1 = Currency in circulation + traveler’s checks + checkable bank deposits

    • M2 = M1+ near-moneys (savings account, time deposits, small denotation CDs)

  • Present and future worth of a dollar
    PV = {FV \over (1 + i)^n}

  • Net Present Value = PV of current & future benefits - PV of current & future costs

Banks

  • Accept and keep funds as deposits

  • T-accounts are used to show one’s liabilities and assets

Bank Runs

  • When a lot of depositors go to the bank and demand their money at the same time are caused by rumors that a bank failure has occurred, bank regulations have been created to prevent bank-runs and ensure depositors' money

    • Deposit insurance (guarantees security of the first 250,000 of every bank account)

    • Reserve requirements (banks are required to maintain the required reserve ratio)

    • Discount Window (banks can get loans and money from the FED)

    • Capital requirements (assets have to be > deposits)

  • Can decrease the money supply by removing currency in circulation and putting them in bank vaults

  • Can increase the money supply by making loans and creating money

    • Money multiplier = 1 \over reserve \ ratio

  • Total amount created from every $ increase in monetary base
    Total Increase in checkable bank deposits = {(excess \ reserves) \over (reserve \ ratio)}

  • Banks have required reserves and excess reserves (basis for the creation of money)
    Required reserve ratio: Portion of deposits banks are required to keep as reserves.

Money Market

Short-term interest rates tend to move together.

  • Affects the money supply, unlike long-term interest rates.

  • Demand for money is driven by the opportunity cost of holding money and short-term interest rate (money that could be earned from holding other assets).

  • Money demand (relationship of quantity of money demanded and interest rate) shifters

Aggregate Price Level

  • Increase in aggregate price level increases money demand
    Changes in Real GDP Increase in GDP increases money demand
    Changes in technology Inventions that decrease difficulty of changing assets to currency in circulation increase money demand.
    Changes in institutions
    Money Supply (shows relationship of quantity of money supplied and interest rate) shifters are monetary policy tools.
    Reserve requirement (lower required reserve ratio increases money supply)
    Discount rate (lower discount rate increases money supply)
    Open-Market operations (Fed buying more T-bills increases money supply.)
    Money Supply is chosen by the FED and does not change from changes in the interest rate.
    Liquidity Preference Model (name for money market model)
    Equilibrium is achieved when the nominal interest rate is such that money demand & money supply are equal.

Market for Loanable Funds

  • Suppliers - savers/lenders

  • Demanders - borrowers
    Demand curve shifters
    Changes in perceived business opportunities (optimistic beliefs increase demand)
    Changes in government borrowing (more borrowing increases demand)
    Supply curve shifters
    Changes in private savings behavior (them saving more increase supply)
    Changes in capital inflows (optimistic views of country from other countries increases supply)
    National Savings = public savings + private savings

  • In open economy, investment = national savings + net capital inflow

Fisher Effect

  • A rise in expected future inflation → a rise in the interest rate

  • A fall in expected future inflation → a fall in the interest rate

  • Federal Reserve:

  • Government spending can cause lower investment spending from the crowding out effect.

  • The equilibrium interest rate for the liquidity preference model & the loanable funds model are the same in the short-run & long-run. Federal Reserve:

Functions

  • Provides financial services (ex. Holds reserves, clears checks)

  • Supervises banking institutions (ex. Makes sure they follow required reserve ratio.)

  • Maintains stability of financial system (provides liquidity to all commercial banks)

  • Conducts monetary policy

Expansionary

  • Decrease in required reserve ratio

  • Lower discount rate

  • Fed buying more T-bills (has greatest effect on money supply)

Contractionary

  • Increase in required reserve ratio

  • Increase in discount rate

  • FED sells T-bills (has greatest effect on money supply)Most banks strive to stay on the federal funds rate!

UNIT 5: Long-run Consequences of Stabilization Policies

Fiscal Policies

  • Expansionary Fiscal Policy increases AD curve in short-run (fixes recessionary gap & creates a budget deficit).

  • Contractionary Fiscal Policy decreases AD curve in short-run (fixes expansionary gap & creates a budget surplus).

  • Expansionary Monetary Policy increases AD (helps fix recessionary gaps).

  • Contractionary Monetary Policy decreases AD (helps fixes expansionary gap).

  • Combination of fiscal & monetary policies can influence AD, real output, PL, and interest rates.

  • Thus, in the short run, government deficits can cause an inflationary gap and raise interest rates which can delay economic growth.

  • In the long run, government deficits can add to rising government debt.

Short-Run Phillips Curve

  • Shows short-run trade-off between the unemployment rate & inflation rate

  • Negative supply shock shifts SRPC up; positive supply shock shifts SRPC down

  • SRPC also shifts up the same amount that the expected inflation rate increases

  • Demand shocks move the economy along the SRPC

  • Supply shocks shift SRPC

Long-Run Phillips Curve (LRPC)

  • Is the natural rate of employment

  • The point where the economy would not have accelerating inflation Acceleration inflation rate: constantly increasing from the government trying to make the unemployment rate below the natural rate.

  • Shifters of the natural rate of unemployment also shift the LRPC

  • Long-run equilibrium is the intersection of SRPC & LRPC

  • Economy is in an inflationary or recessionary gap if left to the equilibrium.

  • Rapid uses of expansionary monetary policy can cause inflation

  • When the economy is at full-employment, changing the money supply would have no effect on real output in the long-run.

Quantity Theory of Money

  • The money supply and price level are in direct proportion

Budget Balance

  • Budget Balance = Tax revenue - government spending + transfer payments

  • Budget surplus - tax revenue > government spending

  • Budget deficit - tax revenue < government spending

  • Government has to pay interest on accumulated debt which increases national debt.

Crowding-Out

  • Government usually starts borrowing a budget deficit

  • May decrease private investment, lower rate of physical capital accumulation, & less economic growth in the long-run

Economic Growth

  • Growth rate of GDP/capita over time = 70 / (Annual \ growth \ rate \ of \ variable)

  • Sources: Labor productivity, technology, physical, and human capital

  • PPC curve is analogous to the LRAS curve

  • Public policies affecting productivity & # of employed workers affect RGDP/capita & economic growth

Supply-Side Fiscal Policies

  • Affects AD, SRAS, & potential output in the short-run

UNIT 6: Open Economy- International Trade and Finance

Balance of Payments

  • The balance of payments is the difference between all international purchases and sales in a period of time.

  • Balance of payments can be classified into the current account and the financial account

Types of Accounts

  • Current Account:

    • Net exports/imports of goods (Balance of Trade)

    • Net exports/imports of services

    • Net income (investment income plus employee compensation)

    • Net transfers

  • Capital Account:

    • Purchase and sale of fixed assets - example → real estate

  • Financial Account:

    • Net foreign direct investment

    • Net portfolio investment

  • OTHER FINANCIAL ASSETS: Reserves

    • Changes in the official monetary reserves

Trade Deficits and Trade Surplus

  • Trade Deficit: Imports are greater than exports → BUYING more than SELLING

  • Trade Surplus: Exports are greater than imports → SELLING more than BUYING

Exchange Rates

  • Appreciation: The general increase in the price of an asset overtime.

  • Depreciation: The general decrease in the price of an asset overtime.

Regarding Currency

  • Appreciation: The value of a nation’s currency increases

  • Depreciation: The value of a nation's currency decreases

Foreign Exchange Market

  • Represents the currency foreign exchange rates for countries

  • Equilibrium Exchange Rate: The quantity of currency demanded is equal to the quantity of currency supplied

  • Floating exchange rate: The price of a nation's currency is determined by the foreign exchange market (relation to other currencies)

There is a SUPPLY and a DEMAND for the currency

  • In the foreign exchange market, there is a BUYER and a SELLER of currency

  • Countries are trading currency and are based on levels of appreciation or depreciation.

Shifters of the Foreign Exchange Market

  • Change in preference: A nation will want less of a certain currency

  • Change in national inflation

  • Change in real interest rates

Real Interest Rate

  • Is the interest rate that is adjusted for inflation by subtracting the rate of inflation.

  • Change in wages and income
    Change in inflation and income

Currency Market

Domestic Price: The cost of a good.

Graph Example

  • Quantity of pesos and the exchange rate of pesos

Extra Notes:

Unit 1

  • Economics: Study of satisfying unlimited wants with scarce resources.

  • Scarcity: Limited resources for unlimited wants, necessitates choices.

  • Macroeconomics: Studies the entire economy (inflation, GDP, unemployment, etc.).

  • Trade-offs: All options lost when a choice is made.

  • Opportunity Cost: Potential gain lost from alternatives when one choice is made.

4 Factors of Production

  • Land

  • Labor

  • Capital: Goods for production (e.g., oven), Human capital: Skills for production (e.g., education).

  • Entrepreneurship

Production Possibility Frontier (Curve)

  • PPF: Unlimited wants for limited goods.

  • Types: Increasing, constant, decreasing opportunity cost.

Comparative Advantage

  • Comparative Advantage: Produce at higher efficiency.

  • Absolute Advantage: Produce a greater amount.

Supply and Demand

  • Law of Demand: Price and quantity demanded are inversely related.

  • Law of Supply: Price and quantity supplied are directly related.

Shifters of Supply

  • Input costs, productivity/technology, number of sellers, government actions (taxes, subsidies, regulations), future profit expectations.

Shifters of Demand

  • Number of consumers, tastes & preferences, income, price of substitutes/complements, future expectations.

Market Equilibrium

  • Equilibrium: Supply and demand balance, resulting in stable prices.

UNIT 2: Economic Indicators and the Business Cycle

Gross Domestic Product (GDP)

  • GDP: Total monetary value of final goods/services produced in a country.

Expenditures Approach to Calculating GDP

  • Sum of spending by households, businesses, and government.

Other Ways to Calculate GDP

  • Income Approach: Sum of income earned.

  • Value-Added Approach: Gross value of output - intermediate consumption value.

What is not Included in the GDP

  • Sales of non-new items, intermediate goods, illegal activities.

The Circular Flow Model

  • Money and transactions flow: factor market, households, product market, businesses.

Unemployment

  • Unemployment: Capable person seeking but unable to find a job.

Types of Unemployment

  • Frictional: Between jobs.

  • Structural: Due to technological advancements.

  • Seasonal: Due to the season.

Calculating Unemployment

  • Unemployment rate = {(Number unemployed people / Labor Force) * 100}

  • Labor force: Employed and those able/willing to work.

Consumer Price Index (CPI)

  • CPI: Tracks price changes over time; Inflation: General price increase, decreased purchasing power.

GDP Deflator

  • Measures economy’s final goods prices.

Real vs. Nominal GDP

  • Nominal GDP: Current market prices.

  • Real GDP: Adjusted for price changes.

Unit 3 - National Income and Price Determination

Aggregate Demand Curve

  • Shows price level & aggregate demand relationship.

  • Downward Sloping: Real-balance, interest rate, open economy effects.

  • Includes: consumption, investment, government spending, net exports.

  • Shifters: Expectations, wealth, physical capital, fiscal/monetary policy.

Short-run Aggregate Supply (SRAS)

  • Firms haven’t made price changes (sticky prices).

  • Upward sloping: Misperception, sticky price, sticky wage theories.

  • Shifters: Commodity prices, nominal wages, productivity.

Long-run aggregate supply (LRAS)

  • Producers adjusted prices; all costs flexible; potential output.

  • Shifters: Quantity/quality of resources, technology.

  • Shifts indicate changes in full-employment & economic growth.

AD-AS Model

  • Price level above equilibrium: AS exceeds AD, price level falls.

  • Price level below equilibrium: AD exceeds AS, price level rises.

  • Positive demand shock: Price and output increase (demand-pull).

  • Negative demand shock: Price and output decrease.

  • Positive supply shock: Price decreases, output increases.

  • Negative supply shock: Price increases, output decreases (supply-push).

  • Recessionary gap: SRAS equilibrium < LRAS equilibrium; wages fall, SRAS shifts right.

  • Inflationary gap: SRAS equilibrium > LRAS equilibrium; wages rise, SRAS shifts left.

  • Economy self-corrects long-run.

Equilibrium

  • Short-run: AD = SRAS; Long-run: AD = SRAS = LRAS.

Fiscal Policies (affect AD)

  • Expansionary: Increase government spending (greatest effect; {Multiplier = MPC}, {MPC+MPS = 1}), cut taxes ({Multiplier = MPC / MPS}, {MPS = 1 - MPC}), transfers.

  • Contractionary: Decrease government purchases, increase taxes, decrease transfers.

  • Expansionary in recessions, contractionary in expansions.

Automatic Stabilizers

  • Automatic expansion during recessions, contraction during expansions (e.g., tax revenues).

UNIT 4: The Financial Sector

Economic Growth

  • Increases in human/physical capital; Savings = Investment Spending; National Savings + Capital Inflow = Investment Spending.

Financial Asset Types

  • Loans, bonds (inversely related to interest rates), loan-backed securities, stocks, bank deposits.

Financial Intermediaries Types

  • Mutual funds, insurance, pension funds, banks (reduce costs/risk, provide liquidity).

Inflation & Interest Rate

  • Inflation rate: {[(PL in Year 2 - PL in Year 1) / PL in Year 1] * 100}

  • Real interest rate = Nominal interest rate - actual inflation rate.

  • Higher inflation than expected: Winners-Borrowers, Losers-Lenders

  • Lower inflation than expected: Winners-Lenders, Losers-Borrowers

  • National Savings = Private savings + budget balance; Capital inflow: Net inflow of funds.

  • Liquid: easily converted to cash; Illiquid: loses value when converted; Diversification: various assets to avoid loss.

Money

  • Asset accepted as payment; Roles: medium of exchange, unit of account, store of value; Types: commodity, commodity-backed, fiat.

  • Measured by M1 & M2: M1 = currency + traveler’s checks + checkable deposits; M2 = M1 + near-moneys.

  • Present/future worth: {PV = {FV / (1 + i)^n}}; Net Present Value = PV benefits - PV costs.

Banks

  • Accept deposits, T-accounts show liabilities/assets.

Bank Runs

  • Depositors demand money simultaneously (prevented by deposit insurance (250,000), reserve/capital requirements, discount window).

  • Decrease money supply when currency put in vaults; Increase money supply by making loans.

  • Money multiplier = {1 / reserve ratio}; Total Increase = {(excess reserves) / (reserve ratio)}.

  • Required reserve ratio: deposits banks keep as reserves.

Money Market

  • Short-term interest rates move together; Money demand driven by opportunity cost & interest rate.

  • Money demand shifters: aggregate price level, real GDP, technology, institutions.

  • Money Supply shifters: reserve requirement, discount rate, open-market operations.

  • Liquidity Preference Model: money market model; Equilibrium: nominal interest rate = money demand & supply.

Market for Loanable Funds

  • Suppliers-savers/lenders; Demanders-borrowers; Demand shifters: business opportunities, government borrowing.

  • Supply shifters: private savings behavior, capital inflows; In open economy, investment = national savings + net capital inflow.

Fisher Effect

  • Rise in expected inflation → rise in interest rate; Fall in expected inflation → fall in interest rate.

Functions

  • Provides services (reserves, clears checks), supervises banks, maintains stability (liquidity), conducts monetary policy.

Expansionary

  • Decrease reserve ratio/discount rate, Fed buys T-bills.

Contractionary

  • Increase reserve ratio/discount rate, Fed sells T-bills.

UNIT 5: Long-run Consequences of Stabilization Policies

Fiscal Policies

  • Expansionary: increases AD short-run (recessionary gap, budget deficit).

  • Contractionary: decreases AD short-run (expansionary gap, budget surplus).

  • Combination can influence AD, real output, price level, interest rates.

  • Short run: deficits cause inflationary gap, raise interest rates, delay growth; Long run: deficits add to government debt.

Short-Run Phillips Curve

  • Shows unemployment/inflation trade-off.

  • Negative supply shock shifts SRPC up; positive shifts down.

  • SRPC shifts with expected inflation; Demand shocks move along SRPC; Supply shocks shift SRPC.

Long-Run Phillips Curve (LRPC)

  • Natural rate of employment; Economy without accelerating inflation.

  • Shifters of natural rate shift LRPC; Long-run equilibrium: SRPC & LRPC intersection.

  • Economy in inflationary/recessionary gap if left to equilibrium; Rapid expansionary policy causes inflation.

  • Full-employment: money supply change has no effect on real output long-run.

Quantity Theory of Money

  • Money supply/price level are proportional.

Budget Balance

  • Tax revenue - government spending + transfers; Surplus: revenue > spending; Deficit: revenue < spending.

  • Government pays interest on debt, increases national debt.

Crowding-Out

  • Government borrowing for deficit may decrease private investment, physical capital accumulation, & economic growth.

Economic Growth

  • Growth rate {= 70 / (Annual growth rate)}; Sources- labor, technology, physical/human capital.

  • PPC is analogous to LRAS; Public policies affect productivity/employment, RGDP/capita, & economic growth.

Supply-Side Fiscal Policies

  • Affect AD, SRAS, & potential output.

UNIT 6: Open Economy- International Trade and Finance

Balance of Payments

  • Difference between international purchases & sales; Classified into current & financial accounts.

Types of Accounts

  • Current Account: net exports/imports (trade balance), services, income, transfers.

  • Capital Account: fixed asset purchases/sales.

  • Financial Account: foreign direct/portfolio investment.

  • Reserves: changes in official monetary reserves.

Trade Deficits and Trade Surplus

  • Trade Deficit: Imports > exports; Trade Surplus: Exports > imports.

Exchange Rates

  • Appreciation: asset price increase; Depreciation: asset price decrease.

Regarding Currency

  • Appreciation: nation’s currency value increases; Depreciation: nation's currency value decreases.

Foreign Exchange Market

  • Currency exchange rates; Equilibrium: currency demanded = currency supplied; Floating rate: price determined by market.

There is a SUPPLY and a DEMAND for the currency

  • Based on levels of appreciation or depreciation.

Shifters of the Foreign Exchange Market

  • Preference, national inflation, real interest rates.

Real Interest Rate

  • Adjusted for inflation.

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