AP Macroeconomics – Unit 5 Final Exam Note Sheet

Modules 41–44 + Phillips Curve

📌 CAPITAL FLOWS & BALANCE OF PAYMENTS (MOD 41)

Strong vs. Weak Dollar

Strong U.S. Dollar → AD ↓

  • U.S. goods become expensive → exports fall

  • Imports rise → net exports fall → AD falls

Weak U.S. Dollar → AD ↑

  • U.S. goods cheaper → exports rise

  • Imports fall → AD increases

Trade Deficit Example

  • U.S. imports from China (2018): $549B

  • U.S. exports to China: $120.3B

    → U.S. has a goods trade deficit

    → China has a goods trade surplus

Goods Trade Deficit = Exports − Imports (negative)

📌 BALANCE OF PAYMENTS (BOP)

BOP = Current Account + Financial (Capital) Account = 0

1. Current Account

Tracks money flows for goods, services, and income:

  • Balance of trade (goods & services)

  • Factor income (wages, interest, dividends)

  • Transfers (remittances, gifts, foreign aid)

Money INTO the U.S. (credit):

  • Foreigners buy U.S. goods/services

  • Foreigners pay U.S. workers/assets

  • Foreigners send transfers to U.S. residents

Money OUT of the U.S. (debit):

  • U.S. buys foreign goods/services

  • U.S. pays foreign labor/assets

  • U.S. sends transfers abroad

2. Financial (Capital) Account

Tracks asset purchases:

  • U.S. sells assets → capital inflow

  • U.S. buys foreign assets → capital outflow

Financial Account Balance = Capital Inflows − Capital Outflows

Remember:

➡ If Current Account is negative, Financial Account must be positive

➡ BOP must sum to zero

📌 CAPITAL FLOWS + INTEREST RATES

“Money flows to where the return is highest.”

Interest rate ↑ →

  • More foreign savers invest there

  • More capital inflow

  • Currency appreciates

Loanable Funds (International Version):

  • If France r = 5% and U.S. r = 2%

    • Investors put money in France → S increases in France

    • Borrowers choose U.S. → D increases in U.S.

📌 FOREIGN EXCHANGE MARKET (FOREX) – MOD 42 & 43

Key Terms

Exchange Rate: price of one currency in another currency.

Appreciation: currency value ↑

Depreciation: currency value ↓

Demand for a Currency

Who demands U.S. Dollars?

➡ Foreigners

  • To buy U.S. goods (exports)

  • To buy U.S. assets

  • To travel in the U.S.

Inverse relationship:

Exchange rate ↑ → Qd ↓

Supply of a Currency

Who supplies U.S. Dollars?

➡ Americans

  • Buying imports

  • Buying foreign assets

  • U.S. tourists abroad

Direct relationship:

Exchange rate ↑ → Qs ↑

📌 FOREX SHIFTERS (THE 4 SHIFTERS)

🚨 Whatever currency is DEMANDED will APPRECIATE.

1. Changes in Tastes & Preferences

Ex: Europeans want to vacation in U.S. →

  • Demand for USD ↑ → USD appreciates

  • Supply of Euros ↑ → Euro depreciates

2. Changes in Incomes

Higher income → more imports

Ex: U.S. incomes ↑ → buy more British goods

  • Demand for GBP ↑ → GBP appreciates

  • Supply of USD ↑ → USD depreciates

3. Changes in Relative Price Levels (Inflation)

Double shifter: both D and S change.

Ex: U.S. inflation ↑ → U.S. goods more expensive

  • Demand for USD ↓

  • Supply of USD ↑ (Americans buy cheaper imports)

    ➡ USD depreciates

    ➡ Foreign currency appreciates

4. Changes in Interest Rates

“Money chases the highest interest rate.”

Ex: U.S. interest rate ↑

  • Foreigners demand more USD → USD appreciates

  • They supply more of their own currency → foreign currency depreciates

📌 EXCHANGE RATE REGIMES

Fixed (Pegged): gov’t actively keeps currency tied to another

Floating: market determines exchange rate

Gov’t can influence exchange rates by:

  • Changing interest rates

  • Buying/selling foreign currency

  • Tariffs/quotas to change trade flows

📌 TRADE RESTRICTIONS (MOD 44)

Protectionism

Goal: protect domestic industries

Tools:

  • Tariffs (tax on imports)

  • Quotas (limit on imports)

Tariffs

Effects:

  • Raises price of imports

  • Helps domestic producers

  • Creates government revenue

  • Reduces quantity demanded of imports

Quotas

Effects:

  • Limits supply of imports

  • Raises price

  • Increases domestic production

  • No government revenue (unlike tariffs)

📌 PHILLIPS CURVE (MOD 34)

Short-Run Phillips Curve (SRPC)

Shows inverse relationship between

➡ Inflation

➡ Unemployment

Movements ALONG SRPC caused by AD shifts:

  • AD ↑ → inflation ↑ & unemployment ↓

  • AD ↓ → inflation ↓ & unemployment ↑

Long-Run Phillips Curve (LRPC)

  • Vertical at Natural Rate of Unemployment (NRU)

  • No tradeoff in the long run

  • If AD increases, economy moves right of NRU → inflation ↑

  • Eventually SRPC shifts upward

AS Shifts on Phillips Curve

  • SRAS ↑ (positive supply shock) → Inflation ↓ & Unemployment ↓

    ↳ SRPC shifts DOWN

  • SRAS ↓ (negative supply shock) → Inflation ↑ & Unemployment ↑

    ↳ SRPC shifts UP

📌 QUICK FORMULAS YOU NEED

  • Net Exports (NX) = Exports − Imports

  • BOP Identity: Current Account + Financial Account = 0

  • Currency Appreciates: demand ↑ OR supply ↓

  • Currency Depreciates: demand ↓ OR supply ↑

📌 WHAT TO ALWAYS REMEMBER FOR EXAM

  • Money flows to high interest rates.

  • Imports cause currency supply to increase.

  • Exports cause currency demand to increase.

  • Current account deficit = financial account surplus.

  • AD shifts cause movement along SRPC.

  • AS shifts cause SRPC to shift.