Common Mistakes On The AP Macro Exam

COMMON MISTAKES ON THE AP MACRO EXAM Mr. Redelsheimer AP Macroeconomics Semester II: 2008

The difference between a change in demand and a change in quantity demanded

GRAPHING DEMAND P Q o $5 4 3 2 1 $5 4 3 2 1 10 20 35 55 80 D Price of Corn Quantity of Corn CORN 10 20 30 40 50 60 70 80 What if Demand Increases? P Q D

GRAPHING DEMAND P Q o $5 4 3 2 1 $5 4 3 2 1 D Price of Corn Quantity of Corn CORN 10 20 30 40 50 60 70 80 D’ Increase in Demand Increase in Quantity Demanded 10 20 35 55 80 30 40 60 80 + P Q D

The difference between a change in supply and a change in quantity demanded

GRAPHING SUPPLY S P Q o $5 4 3 2 1 10 20 30 40 50 60 70 80 $5 4 3 2 1 60 50 35 20 5 Price of Corn Quantity of Corn CORN What if Supply Increases? P Q S

GRAPHING SUPPLY S P Q o $5 4 3 2 1 10 20 30 40 50 60 70 80 Price of Corn Quantity of Corn $5 4 3 2 1 60 50 35 20 5 CORN 80 70 60 45 30 S’ Increase in Supply Increase in Quantity Supplied P Q S

Mislabeling or NOT labeling graphs correctly

Price Level Real Domestic Output, GDP Q P AS AD Equilibrium in the Intermediate Range Q e EQUILIBRIUM: REAL OUTPUT AND THE PRICE LEVEL P e

GROWTH IN THE AD-AS MODEL A B C D Capital Goods Consumer Goods Price Level Real GDP AS LR1 AS LR2 Q 1 Q 2

ECONOMIC GROWTH IN THE EXTENDED AD – AS MODEL Price Level Real GDP o P 1 AS 2 AS LR1 AD 2 Q 1 AS LR2 Q 2 AD 1 AS 1 P 2

Nominal Interest Rate Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 10 7.5 5 2.5 0 D m i e S m Use this graph when the FED changes the money supply to change interest rates. S m1 THE MONEY MARKET

Net effects of Monetary Policy and/or Fiscal Policy on Interest Rate

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Price level Real GDP (billions) AS AD 2 $495 $515 P 1 AD 1 Fiscal Policy And Inflation $505

Expansionary Fiscal Policy = Interest Rate INCREASE
Exp. Fiscal Policy (Gov’t deficit)  Increase Demand for Money  Increase Interest Rate.
Higher Price Level  Increase Demand for Money  Increase Interest Rate.

Expansionary Monetary Policy  Interest Rate DECREASE

Real domestic output, GDP D m Investment Demand Nominal interest rate 10 8 6 0 Quantity of money Amount of investment, I MONETARY POLICY AND EQUILIBRIUM GDP S m1 AS AD 1 P 1 10 8 6 0 S m2 AD 2 P 2 Money Supply Increases Interest Rate Decreases Investment Increases AD & GDP Increases with slight inflation Price level If the money supply increases to stimulate the economy...

AD 3 Price level Real domestic output, GDP D m Investment Demand Real rate of interest, i 10 8 6 0 Quantity of money demanded and supplied Amount of investment, i MONETARY POLICY AND EQUILIBRIUM GDP S m1 AS AD 1 P 1 10 8 6 0 S m2 AD 2 P 2 More Money Supply Lower Interest Rates More Investment Still higher AD & GDP with significant inflation S m3 P 3 If the money supply increases again…

MULTIPLIER(S) CONFUSION

THE MULTIPLIER EFFECT MPC Multiplier MPC and the Multiplier Change in GDP = Multiplier x initial change in spending Multiplier = or 1 MPS 1 1 - MPC .9 .8 .75 .67 .5 10 5 4 3 2

MONEY MULTIPLIER
1 / Required Reserve Ratio
Maximum Multiple $$$ Money Expansion

MULTIPLE DEPOSIT EXPANSION PROCESS $400.00 Total amount of money created by the banking system Bank Acquired reserves and deposits Required reserves Excess reserves Amount bank can lend - New money created A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 21.97 $20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40 $80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57 $80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57

Balanced Budget Multiplier= 1 (Net Result on GDP)

New reserves $800 Excess Reserves $4000 Bank System Lending FEDERAL RESERVE PURCHASE OF BONDS FROM PUBLIC Purchase of a $1000 bond from public... $200 Required reserves $1000 Initial Deposit Total Increase in Money Supply ($5000)

New reserves $800 Excess Reserves $4000 Bank System Lending Someone deposits $1000 in new Reserves at a bank. $200 Required reserves $1000 Initial Deposit Total Increase in Money Supply ($4000)

New reserves $1,000 Excess Reserves $5,000 PMC thru Bank Lending Fed Buys A $1,000 Bond From Joe’s Bank TMS is $ 5000 20% RR

$20 Required reserves $100 New reserves $100 Initial Deposit $400 Bank system lending Money Created $80 Excess reserves OUTCOME OF MONEY EXPANSION Leakages exist...(Savings) Currency Drains Excess Reserves

$20 Required reserves $100 New reserves $100 Initial Deposit $400 Bank system lending Money Created $80 Excess reserves Injections: Additional Spending into Income – Expenditures stream: Investment, G, or Xn

UNEMPLOYMENT Types of Unemployment Frictional Unemployment Structural Unemployment Cyclical Unemployment Natural rate of Unemployment = Structural + Frictional (Around 4-5%)

Confusing Comparative Advanatge Calculations

real interest rate Quantity of Loanable Funds LOANABLE FUNDS MARKET r D Q S This graph shows how the supply and demand for loanable funds affects long-term interest rates!

Loanable Funds Market Graph (Long-Term Interest Rates)
What changes Supply :
Increase in Household savings
Increase in Gov’t savings
Increase in Business savings
Increase in Business savings
Increase in Foreigners’ savings
What changes Demand :
Increase in Household borrowing
Increase in business Investment
Increase in Foreign borrowing
Increase in Government borrowing (When the gov’t has a budget deficit!) = (the crowding -out effect)

Price Index Price Index Price of market basket in specific year in a given = --------------------------------------------- X 100 Year Price of same market basket in base year Nominal GDP Real GDP = --- ---------------------------- Price Index (in hundredths)

Remembering the difference between Real and Nominal

Nominal: with Inflation Real: Adjusted for Inflation

GDP
Nominal GDP: GDP measured in terms of current Price Level at the time of measurement. (Unadjusted for inflation)
Real GDP: GDP adjusted for inflation; GDP in a year divided by a GDP deflator (Price Index) for that year

INCOME
NOMINAL INCOME: number of dollars received by an individual or group for its resources during some period of time
(Not adjusted for Inflation)
REAL INCOME: amount of goods and services which can be purchased with nominal income during some period of time
(nominal income adjusted for inflation)

INTEREST RATES
NOMINAL: interest rate expressed in terms of annual amounts currently charged for interest.
REAL: interest rate expressed in dollars of constant value (adjusted for Inflation) and equal to the NOMINAL i % minus the EXPECTED RATE OF INFLATION

Nominal Interest Rate Real Interest Rate Inflation Premium = + Nominal vs. Real 11% 5% 6%

Nominal Interest Rate Real Interest Rate Inflation Premium - Real Interest Rate [ Nominal I.R. – inflation rate = Real I.R. ] = 16% 10 % 6%

Demand-Pull Inflation vs. Cost-Push Inflation

DEMAND-PULL INFLATION o P 1 AS 1 AS LR AD 1 a Q 1 Price Level Real domestic output b P 2 P 3 AD 2 AS 2 c

Q 2 COST-PUSH INFLATION o P 1 AS 1 AS LR AD 1 a Q 1 Price Level Real domestic output b P 2 AS 2 Occurs when short-run AS shifts left

Q 2 COST-PUSH INFLATION o P 1 AS 1 AS LR AD 1 a Q 1 Price Level Real domestic output b P 2 P 3 AD 2 AS 2 Government response with increased AD c Even higher price levels

COST-PUSH INFLATION o P 1 AS 1 AS LR AD 1 a Q 1 Price Level Real domestic output b P 2 AS 2 Q 2

Q 2 COST-PUSH INFLATION o P 1 AS 1 AS LR AD 1 a Q 1 Price Level Real domestic output b P 2 AS 2 If government allows a recession to occur Nominal wages fall (which increases AS & AS returns to its original location

Inflationary Expectations People must believe Fed is serious about stopping inflation.

Phillips Curve

Annual rate of inflation (percent) Unemployment rate (percent) 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 As inflation declines... THE PHILLIPS CURVE CONCEPT Unemployment increases

Annual rate of inflation (percent) Unemployment rate (percent) 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 THE PHILLIPS CURVE CONCEPT LRPC = Natural Rate of Unemployment

GENERAL EXAM ADVICE
Free Response:
Do not restate question
Use correct terminology
Even if a graph is not required, draw one anyway and explain.
Use same outline as question
Use Good Handwriting

GENERAL EXAM ADVICE
Draw graphs large enough for the reader to tell what’s going on.
Explain your reasoning: “the price increased”, why?
No Calculators
If you can eliminate one answer, answer the question.

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Common Mistakes On The AP Macro Exam

by MrRed on May 13, 2008

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Common Mistakes On The AP Macro Exam — Presentation Transcript