COMMON MISTAKES ON THE AP MACRO EXAM

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COMMON MISTAKES ON THE AP MACRO EXAM
Mr. Redelsheimer AP Macroeconomics Semester II
2007
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The difference between a change in demand and a
change in quantity demanded
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GRAPHING DEMAND
Price of Corn
What if Demand Increases?
P
5 4 3 2 1
CORN
5 4 3 2 1
10 20 35 55 80
D
o
Q
10 20 30 40 50 60 70 80
Quantity of Corn
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GRAPHING DEMAND
Price of Corn
Increase in Quantity Demanded
P
5 4 3 2 1
CORN
30 40 60 80
5 4 3 2 1
10 20 35 55 80
Increase in Demand
D
D
o
Q
10 20 30 40 50 60 70 80
Quantity of Corn
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The difference between a change in supply and a
change in quantity demanded
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GRAPHING SUPPLY
Price of Corn
P
What if Supply Increases?
S
5 4 3 2 1
CORN
5 4 3 2 1
60 50 35 20 5
o
Q
10 20 30 40 50 60 70 80
Quantity of Corn
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GRAPHING SUPPLY
Price of Corn
P
Increase in Supply
S
S
5 4 3 2 1
CORN
80 70 60 45 30
5 4 3 2 1
60 50 35 20 5
Increase in Quantity Supplied
o
Q
10 20 30 40 50 60 70 80
Quantity of Corn
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Mislabeling or NOT labeling graphs correctly
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EQUILIBRIUM REAL OUTPUT AND THE PRICE LEVEL
P
AS
Equilibrium in the Intermediate Range
Price Level
Pe
AD
Q
Qe
Real Domestic Output, GDP
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GROWTH IN THE AD-AS MODEL
ASLR1
ASLR2
C
A
Price Level
Capital Goods
Q1
Q2
B
D
Consumer Goods
Real GDP
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ECONOMIC GROWTH IN THE EXTENDED AD AS MODEL
ASLR1
ASLR2
AS2
AS1
Price Level
P2
P1
AD2
AD1
o
Q1
Q2
Real GDP
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THE MONEY MARKET
Sm1
Sm
Use this graph when the FED changes the money
supply to change interest rates.
10 7.5 5 2.5 0
ie
Nominal Interest Rate
Dm
0 50 100 150 200 250 300
Amount of money demanded (billions of dollars)
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Net effects of Monetary Policy and/or Fiscal
Policy onInterest Rate
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FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION
AS
Fiscal Policy And Inflation
Price level
P1
AD1
AD2
495
515
505
Real GDP (billions)
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Expansionary Fiscal Policy Interest Rate
INCREASE

• Exp. Fiscal Policy (Govt deficit) ? Increase
  Demand for Money ? Increase Interest Rate.
• Higher Price Level ?Increase Demand for Money
  ?Increase Interest Rate.

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Expansionary Monetary Policy ? Interest Rate
DECREASE
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MONETARY POLICY AND EQUILIBRIUM GDP
Sm1
Sm2
Investment Demand
10 8 6 0
10 8 6 0
Nominal interest rate
Dm
Quantity of money
Amount of investment, I
AS
Money Supply Increases
Interest Rate Decreases
Price level
Investment Increases
P2
P1
AD GDP Increases with slight inflation
AD2
AD1
Real domestic output, GDP
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MONETARY POLICY AND EQUILIBRIUM GDP
Sm1
Sm2
Sm3
Investment Demand
10 8 6 0
10 8 6 0
Real rate of interest, i
Dm
Quantity of money demanded and supplied
Amount of investment, i
AS
More Money Supply
P3
Lower Interest Rates
Price level
More Investment
P2
P1
Still higher AD GDP with significant inflation
AD2
AD3
AD1
Real domestic output, GDP
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MULTIPLIER(S) CONFUSION
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THE MULTIPLIER EFFECT
MPC and the Multiplier
MPC
Multiplier
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MONEY MULTIPLIER

• 1 / Required Reserve Ratio
• Maximum Multiple Money Expansion

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MULTIPLE DEPOSIT EXPANSION PROCESS
400.00
Total amount of money created by the banking
system
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Balanced Budget Multiplier 1(Net Result on GDP)
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FEDERAL RESERVE PURCHASE OF BONDS FROM PUBLIC
New reserves
200 Required reserves
Purchase of a 1000 bond from public...
800 Excess Reserves
1000 Initial Deposit
4000 Bank System Lending
Total Increase in Money Supply (5000)
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Someone deposits 1000 in new Reserves at a bank.
New reserves
200 Required reserves
800 Excess Reserves
1000 Initial Deposit
4000 Bank System Lending
Total Increase in Money Supply (4000)
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Fed Buys A 1,000 Bond From Joes Bank
New reserves
1,000 Excess Reserves
20 RR
5,000 PMC thru Bank Lending
TMS is 5000
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OUTCOME OF MONEY EXPANSION
100 New reserves
20 Required reserves
80 Excess reserves
400 Bank system lending
100 Initial Deposit
Money Created
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100 New reserves
20 Required reserves
80 Excess reserves
400 Bank system lending
100 Initial Deposit
Money Created
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UNEMPLOYMENT
Types of Unemployment
Frictional Unemployment Structural
Unemployment Cyclical Unemployment
Natural rate of Unemployment Structural
Frictional (Around 4-5)
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Confusing Comparative AdvanatgeCalculations
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LOANABLE FUNDS MARKET
S
This graph shows how the supply and demand for
loanable funds affects long-term interest rates!
r
real interest rate
D
Q
Quantity of Loanable Funds
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Loanable Funds Market Graph(Long-Term Interest
Rates)

• What changes Supply
• Increase in Household savings
• Increase in Govt 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 govt
  has a budget deficit!) (the crowding -out
  effect)

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Remembering the difference between Real
andNominal
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Nominalwith InflationRealAdjusted for
Inflation
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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

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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)

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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

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Nominal vs. Real


Inflation Premium
Nominal Interest Rate
Real Interest Rate
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Real Interest Rate Nominal I.R. inflation rate
Real I.R.
-

Real Interest Rate
Inflation Premium
Nominal Interest Rate
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Demand-Pull Inflationvs.Cost-Push Inflation
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DEMAND-PULL INFLATION
ASLR
AS2
AS1
c
P3
Price Level
b
P2
a
P1
AD2
AD1
o
Q1
Real domestic output
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COST-PUSH INFLATION
Occurs when short-run AS shifts left
ASLR
AS2
AS1
Price Level
b
P2
a
P1
AD1
o
Q2
Q1
Real domestic output
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COST-PUSH INFLATION
Government response with increased AD
ASLR
AS2
AS1
Even higher price levels
c
P3
Price Level
b
P2
a
P1
AD2
AD1
o
Q2
Q1
Real domestic output
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COST-PUSH INFLATION
ASLR
AS2
AS1
Price Level
b
P2
a
P1
AD1
o
Q2
Q1
Real domestic output
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COST-PUSH INFLATION
If government allows a recession to occur
ASLR
AS2
AS1
Nominal wages fall (which increases AS AS
returns to its original location
Price Level
b
P2
a
P1
AD1
o
Q2
Q1
Real domestic output
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Inflationary Expectations
People must believe Fed is serious about stopping
inflation.
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Phillips Curve
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THE PHILLIPS CURVE CONCEPT
7 6 5 4 3 2 1 0
As inflation declines...
Unemployment increases
Annual rate of inflation (percent)
1 2 3 4 5 6 7
Unemployment rate (percent)
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THE PHILLIPS CURVE CONCEPT
LRPC Natural Rate of Unemployment
7 6 5 4 3 2 1 0
Annual rate of inflation (percent)
1 2 3 4 5 6 7
Unemployment rate (percent)
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THE LAFFER CURVE
100
n
Tax rate (percent)
m
m
Maximum Tax Revenue
l
0
Tax revenue (dollars)
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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

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GENERAL EXAM ADVICE

• Draw graphs large enough for the reader to tell
  whats going on.
• Explain your reasoning the price increased,
  why?
• No Calculators
• If you can eliminate one answer, answer the
  question.