AP Macroeconomics Unit 4

Economic Growth

• Defined as increases in human capital and physical capital.
• Key Relationship: Savings = Investment Spending
• National Savings + Capital Inflow = Investment Spending

Types of Financial Assets

• Loans: Borrowing money with an obligation to pay back.
• Bonds: Debt securities; prices and interest rates move inversely.
• Loan-backed Securities: Assets backed by loans.
• Stocks: Ownership in companies; can appreciate in value.
• Bank Deposits: Savings held in a bank.

Financial Intermediaries

• Mutual Funds: Pool money from many investors to purchase securities.
• Life Insurance Companies: Provide financial protection in exchange for premiums.
• Pension Funds: Investment pools for retirement plans.
• Banks: Provide services to reduce transaction costs, mitigate risk, and ensure liquidity.

Inflation & Interest Rates

• Inflation Rate Calculation:
  ext{Inflation Rate} = rac{ ext{PL in Year 2} - ext{PL in Year 1}}{ ext{PL in Year 1}} imes 100
• Nominal Interest Rate: Unadjusted for inflation.
• Real Interest Rate: ext{Real Interest Rate} = ext{Nominal Interest Rate} - ext{Inflation Rate}
• Inflation Effects:
  • Higher than Expected:
  • Winners: Borrowers (repay with less valuable currency)
  • Losers: Lenders
  • Lower than Expected:
  • Winners: Lenders
  • Losers: Borrowers

Savings and Capital Inflows

• National Savings Formula: National Savings = Private Savings + Budget Balance
• Capital Inflow: Net inflow of funds into the country.
• Liquidity: Ability to convert an asset into cash without significant loss of value.
• Illiquid: Assets that lose value quickly upon conversion to cash.

Diversification

• Strategy where an investor spreads investments across several assets to mitigate risk.

Money as an Economic Concept

• Money serves three primary roles:
  • Medium of Exchange: Used in trade for goods and services.
  • Unit of Account: Standardizing value for savings and pricing.
  • Store of Value: Assets can retain value over time.
• Types of Money:
  • Commodity Money: Intrinsic value (precious metals).
  • Commodity-Backed Money: Value from convertibility into goods.
  • Fiat Money: Government-ordered currency with no intrinsic value.

Measuring Money Supply

• M1: Includes currency in circulation + traveler's checks + checkable deposits.
• M2: Includes M1 + near-moneys (like savings accounts, time deposits).

Present Value and Future Value

• A dollar today is worth more than a dollar in the future due to inflation.
• Net Present Value Calculation:
  ext{NPV} = ext{PV of current & future benefits} - ext{PV of current & future costs}

Banking Activities

• Banks manage deposits and keep part as reserves, lending the rest.
• Bank Runs: Occurs when multiple depositors withdraw at once, often due to panic.
• Regulations to prevent bank runs include:
  • Deposit Insurance: Secures first $250,000 in accounts.
  • Reserve Requirements: Mandated proportion of deposits banks must hold.
  • Discount Window: Facility for banks to borrow from the FED.
  • Capital Requirements: Assets must exceed liabilities.

Money Creation

• Can affect money supply by adjusting reserves:
  • Reserve Ratio: ext{Money Multiplier} = rac{1}{ ext{reserve ratio}}
• Money Multiplier Effect: Total increase in deposits from each dollar increase in the monetary base.

Money Market Dynamics

• Interest Rates Influence: Short-term interest rates affect the money supply.
• Demand for Money Drivers:
  • Opportunity cost of holding money vs. other assets.
  • Aggregate price levels and GDP swings influence demand.

Loanable Funds Market

• Suppliers: Savers and lenders; Demanders: Borrowers.
• Demand Curve Shifters: Optimism on business opportunities, increased government borrowing increase demand for loans.
• Supply Curve Shifters: Increased savings or foreign investments lead to higher supply.

Fisher Effect

• Relationship between expected inflation and interest rates:
  • Increase in expected inflation leads to a rise in interest rates.
  • Decrease in expected inflation leads to a fall in interest rates.

Federal Reserve Functions

• Provides financial services and supervises banking institutions.
• Ensures financial system stability and conducts monetary policy:
  • Expansionary Policy: Reduce required ratios, lower discount rates, or buy T-bills.
  • Contractionary Policy: Increase required ratios or discount rates, or sell T-bills.

Key Economic Terms

• UMP: Unemployment
• PL: Price Level
• MB: Market Basket
• G&S: Goods and Services
• PV: Present Value
• FV: Future Value
• RGP: Real Gross Product
• AD: Aggregate Demand
• SRAS: Short-Run Aggregate Supply
• LRAS: Long-Run Aggregate Supply
• SRPC: Short-Run Phillips Curve
• LRPC: Long-Run Phillips Curve
• PPC: Production Possibilities Curve

Sources

• Course descriptions and AP resources from College Board.
• Various educational materials and platforms linked for further reference.