Mr.

Mayer
AP Macroeconomics Review

I. Fundamentals of Economic Analysis Market Equilibrium

Scarce Resources
Production Possibilities III. Macroeconomic Measures of Performance
Circular Flow
II. Supply, Demand, Market Equilibrium & Welfare Analysis Accounting for Output and Income
Demand Inflation and CPI, GDP deflator
Supply Unemployment

I. Fundamentals of Economic Analysis

A. Scarce Resources
Allocative Economic Resources - natural, manufactured and human resources used to produce goods and services
Efficiency Economics Defined  social science concerned with efficient use of scarce resources to achieve maximum utility
Land, Labor, Capital & Entrepreneurship (the factors of production)
MC Scarcity - limited resources that regulates the production and sale of certain goods
Trade-offs - giving up certain goods & services in order to gain others (remaining choices after opportunity cost)
Opportunity Cost - the next best choice, or the cost of what you give up in order to get something else
Output [G=B/G, B=G/B] To be used with comparative advantage
MB Input [G=G/B, B=B/G]
Marginal Analysis - process of choosing a second additional choice based on MB & MC
Marginal - extra/ additional
Marginal Benefit & Marginal Cost - the benefit must be greater than the doubt in order for people to invest in it.

B. Production Possibilities
Assume for PPC Production Possibilities Frontier (Curve) Economic Growth: Move Up if new resources were
-full employment of Line = Efficient tapped into or new innovations were found.
resources & productive Below = Inefficient
efficiency
Above = Unattainable Move Down if there is a decrease in labor or
-fixed resources &tech.
-2 goods an economic depression.
Resource Substitutability

Law of Increasing Opportunity Cost - the more of a product produced, the greater its opportunity cost.
Comparative Advantage & Specialization
Absolute Advantage - occurs if one nation works more efficiently than another in producing a particular good or service.
Comparative Advantage - occurs if one nation can produce at a lower opportunity cost than another.
Specialization - efficient way to maximize output; based on human talents and geographic conditions.
Efficiency - best use of scarce resources
Productive efficiency (on the PPC line) - cheapest way to produce 2 goods with the available tech. and resources.
Allocative efficiency (one point on PPF where MB=MC) - cheapest way to produce goods in demand.
Economic Growth - the ability to produce a larger output than in the past
-increased resources  maximizes production of both goods Economic Growth on the PPF
-increase in quality of resources curve shifts up/ right as value increases
-technological innovation  leads to quality &quantity of products

II. Demand, Supply, Market Equilibrium, & Welfare Analysis

A. Demand - amount of product a consumer can and will buy at a given price
Law of Demand - as prices increase, demand decreases and vice versa
Income Effect - lower prices increase the purchasing power of the buyer's income, resulting in higher demand for goods
Substitution Effect - buyers substitute the relatively expensive good for the cheaper one because it’s a better deal
Law of Diminishing Marginal Utility - the law states that in order for consumers to continue buying a product, the prices should
progressively decrease
The Demand Curve
Quantity Demanded - move along the point on the curve
Price due to change in price
Demand - the curve shifts left or right due to change in
demand

Quantity (D)

Determinants of Demand [TRIPE]

Tastes and Preferences
Price of Substitute Goods - price of substitute goods [B] should be higher to entice people into buying A
Price of Complementary Goods - price of complementary goods [B] must be low in order to encourage people to buy A
Consumer Income - higher income  more money to spend on luxuries  higher demand
# of Buyers - good communication, etc. results in added buyers
Consumer Expectations - consumers expect prices to rise  stock up now

B. Supply - amount of product a producer can and will produce based on the incentive [price]
 Law of Supply - as prices decrease, supply decreases
Law of Increasing Marginal Costs - the law states that in order for suppliers to continue supplying a product, the prices should
progressively increase
The Supply Curve
Quantity Supplied - move along the point on the curve
Price due to change in price
Supply - the curve shifts left or right due to change in
supply

Quantity (S)

Determinants of Supply [NICEJAG}

Cost of Inputs - natural disasters
- high cost of resources = low profit &incentive; low cost of resources = high profit &incentive
Technology and Productivity - improvements in tech. leads to lower cost of inputs and greater profit (competition)
Producer Expectations - expect future prices to rise so save supply for future use
# of Sellers - the supply of a related product [B] increases, the supply of A increases
Price of Related Outputs - price of other goods [B] produced by the same business should remain low in order to
encourage producer to produce more of A (alternative good)
Taxes or Subsidies - treat tax as cost of inputs (Gov't)

C. Market Equilibrium
P Equilibrium - point where supply and demand curves cross to eliminate shortage &surplus and to determine market price
Shortage - high demand and low supply lead to high prices
Surplus - high supply and low demand lead to low prices
Change in Demand
Q Increase in demand = Q↑P↑ Simultaneous Changes in Supply & Demand
Decrease in demand = Q↓P↓ D↑S↑ = P↑; Q indeterminate
= surplus Change in Supply D↓S↓ = P↓; Q indeterminate
-- shortage Increase in supply = Q↓P↑ D↑S↓ = Q↑; P indeterminate
Decrease in supply = Q↑P↓ D↓S↑ = Q↓; P indeterminate

Macroeconomic Measures of Performance

A. The Circular Flow Model - a web of decision making and economic activity involving businesses, households &markets [product &resource]
Open v. Closed

Private Sector
Households - provide labor for income and consume final products for price
Firms - employ labor for wages and produce final products for profit
Public Sector
Government - taxes households and firms in order to raise revenue for public works and regulate business activitty
Foreign Sector
Rest of the World

The Model Illustrated

Cost Income
Resource Market
Resources Factors of Resources

Subsidies Subsidies
Businesses Government Households

Taxes
G&S G&S

Revenue Product Market Expenditure

B. Accounting for Output and Income

Valuing Production

GDP = C + Ig + G +Xn [Spending method of calculating GDP]

What’s counted?
Final goods - products sold to consumers, this accounts for all costs incurred in producing good and taxes
What’s not counted?
Intermediate goods - goods needed to produce final good; prevents double counting
Underground economy - unknown actions; no gov't account for activity
Second-hand sales - resold goods do not add to profit made by economy
Aggregate Spending (Aggregate Expenditures)
C = Consumption
Ig = Inventments
Business investment - on capital goods, land, produce
Inventories - unsold goods saved to be sold the following year
Household investment -
 G = Government Spending on public projects
Transfer payments - not counted because it doesn’t have true value
Xn = Net export [X - M]
X – Exports –

M – Imports –

C. National Income Concepts

GDP = C + Ig + G + Xn = Aggregate Spending = Aggregate Income (Y)

Factor Payments

D. Real and Nominal GDP

Nominal GDP – GDP not adjusted for inflation over time
Real GDP - GDP adjusted for inflation
Deflating Nominal GDP to get Real GDP Real GDP = Nominal GDP/ Price Index (price of market basket over time)
GDP deflator

P Business Cycles
R E Expansion or Recovery - work towards full employment and output [prices rise]
Peak - near or full employment and output is close economic capacity
T Contraction or Recession - decline in output, income, employment and trade (prices don’t decline)
Trough or Depression - decline in GDP &severe rise in unemployment (prices decline)

E. Inflation and CPI

The Consumer Price Index = price of most recent market basket/ price of same basket previously *100
Problems with CPI

Inflation - rise in general level of prices which decreases purchasing power

Demand- pull inflation – resources are fully employed yet demand increases, thus prices rise
Cost –push inflation - cost of inputs rise resulting in low supply, thus prices rise; usually leads recession.
CPI v. GDP deflator -

Nominal v. Real Income - Nominal income is the wage received; Real income is the purchasing power of the wage
Is Inflation Bad?
Expected Inflation
COLA - many unions rally for cost of living adjustment
Nominal Interest Rate = real interest rate + Expected Inflation
 banks and lenders charge nominal interest to prevent loss [real = purchasing power; nominal = wage]
Unexpected Inflation
Winners and Losers
Employers and Employees - employers benefit due to high profits & lower value wages for employees
Variable Income and Fixed Income - variable income receivers benefit from inflation as
wages rise
Borrowers and Savers - borrowers will loose at the hand of the savers as the value decreases
Asset Price Inflation - value of assets increase as their price increases, unlike value of money which decreases
as purchasing power decreases

F. Unemployment Rate = unemployed/ labor force *100

The Labor Force ≠ under 16, those not seeking work [fulltime students, homemakers, etc.]
Employed - Part-time employed and full- time employed
Unemployed [severe on unskilled, females, teenagers, ethically diverse, those unemployed for long periods]
Discouraged Workers - those not actively seeking a job
Self-employment - those working in the family business, etc.
Types of Unemployment
Frictional - searching/ waiting unemployment; workers move from one job to another to better themselves.
Common / not harmful Seasonal - caused by the end of a period of raised consumption due to a holiday, etc.
Structural - caused by change in demand which usually renders some skills unwanted
Cyclical - caused by reduced spending
Full Employment - when only structural &frictional unemployment exist and the economy is producing its potential output.