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AP MACROECONOMICS Name: ________________________ MACRO Review Study Guide Instructions: _______/30pts You have the OPTION to turn this in for 30pts (assuming a good job!) It is a great way to prepare for the 35 question quiz/test Monday May 9th MEASURING ECONOMIC GROWTH Section 1: 1) There are 4 types of unemployment. Circle appropriate answer or answers for each question below. 2) a. Created during a recession: cyclical, frictional, structural, seasonal b. Gov’t policy is concerned with which 2: cyclical, frictional, structural, seasonal c. Full Employment is the rate with only which 2: cyclical, frictional, structural, seasonal (which 2 don’t go away at peak of business cycle—remember seasonal is adjusted out!)) Circle which are NOT included in GDP a. Final goods, intermediate goods, 3) GDP = C + I + G + NX used goods, new goods, foreign made goods, financial transactions Circle the component or components of GDP which changes a. Purchase of a new home: GDP = C + I + G + NX b. Purchase of new factory: GDP = C + I + G + NX c. Purchase of a new domestic made car GDP = C + I + G + NX d. Purchase of a new foreign made car GDP = C + I + G + NX (2 change here!) 4) GDP deflator versus CPI Index: circle which it applies to a. Is the broader measure of inflation GDP deflator CPI Index b. Uses a market basket of goods GDP deflator CPI Index c. Includes international goods GDP deflator CPI Index d. Includes all domestic goods GDP deflator CPI Index 5) List the 2-types of inflation: _________________ 6) Inflation hurts people who: a. not in debt ___________________ Circle all that apply: live on fixed income borrowing money at fixed interest rate, borrow money at adjustable rate 7) Please calculate the following based on the following information: a. 2000 b. 2003 Calculate: Sold 1,000 coffee Sold 1,500 coffee at $3 at $6 Nominal GDP Real GDP 2000 _________ _______ 2003 _________ Price Index 100 (2000 is the base year) ________ ______ (in 2000 dollars) 1 Consumption, Savings Function & AD/AS Model Section 2 8) Disposable Income = _____________________ 9) MPC + MPS = ______ 10) Marginal Propensity to Consume (MPC) = .80 Calculate the following: a. The Government spending or investment multiplier is _____________ b. The Tax multiplier is ________________ c. The Balanced Budget Multiplier is __________ The consumption function measures how consumers respond to changed in DISPOSABLE INCOME. As we earn more DI we move up along our consumption and/or savings curve. Typically if Consumption shifts up (left), savings must shift down (right). For example, an increase in wealth will shift consumption left and savings left. However a change in taxes is different. 11) Explain how a change in taxes or government transfers will shift the consumption function and the savings function. a. Hint: will it shift left or right on each function? b. Be careful: see graph above: DI is on x-axis & consumption on y-axis _________________________________________________________________________________________________ _________________________________________________________________________________________________ Price Level SRAS Price Level LRAS AD1 AD1 Real GDP Real GDP 12) 3-Reasons why AD is downward sloping: _________________________________________________________ 2 13) The SRAS is upward sloping due to sticky wages and stick prices. a. Explain why sticky wages lead to an upward sloping SRAS (2-3 sentences or clear/efficient bullet points) b. Relevance: current financial crisis—unemployment is high in part because wages are sticky => wages should fall today => which should lead to more people being hired and a return to full employment. But wages are sticky! ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ _______________________________________________________________________________________________________ 14) Explain why & at what point the LRAS is vertical: (2-3 sentences or clear/efficient bullet points) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ _______________________________________________________________________________________________________ 15) Name 2 factors which ONLY shift SRAS ______________________________ (not LRAS) 16) Name 5 factors which will shift both SRAS & LRAS _____________________________________________ FISCAL & MONETARY POLICY Section 3 : BANK 1 BANK 2 Assets Assets Liabilities Deposits Deposits Loans Loans Total Assets Assets Liabilities Liabilities Required Reserves Required Reserves BANK 3 Total Liabilities Required Reserves Deposits Loans Total Assets Total Liabilities Total Assets Total Liabilities 17) Assume the required reserve ratio is 10% and a bank holds no excess reserves a. Joe deposits $20,000 into Bank 1 b. Fill in the balance sheet for each bank which shows the effect of Joe’s deposit c. Calculate the total new money creation caused by Joe’s deposit: d. If instead the Federal Reserve had purchased $20,000 worth of bonds, what would the new money creation be? i. Explain the difference versus the answer for 17c ii. (hint: Remember the Fed’s money is NOT the same as your money….) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ _______________________________________________________________________________________________________ 3 GRAPH A: Money Market Nominal Interest Rate GRAPH B: Loanable Funds Real Interest Rate MS MD -------------- ------------- R1 i1 ------------ E1 S1 E1 D1 Q1 Qty $ Qty Q1 Loanable Funds Hint: remember the Federal Reserve uses the Money Market graph in their open market operations in conducting monetary policy. This is a nominal interest rate (really the federal funds rate). Money Demand is based on speculative demand, precautionary demand & price level. So we hold more money when consumers get ‘scared”. You rarely shift MD on AP tests—but sometimes they do require it! The loanable funds market is the market for public & private savings & is a real interest rate. It better reflects long term interest rates and is the graph you use for any change in real rates such as crowding out. 18) Graph A: Assume the Federal Reserve conducts open market operations using contractionary monetary policy a. The Fed would ________ securities (bonds) b. Modify the above graph to show the effect on equilibrium interest rate & qty of money. 19) Graph B: Assume the Federal Government increases taxes on interest income. a. Modify the market for Loanable funds in Graph B (remember D = people who need $, Savings = people who save $) b. Show the effect on equilibrium interest rate & qty of money. INFLATIONARY GAP Price Level LRAS1 RECESSIONARY GAP Price Level SRAS1 LRAS1 SRAS1 Real GDP Real GDP 20) Draw a correctly labeled inflationary gap equilibrium in the 1st graph. a. Label Equilibrium Price & Output (you need to add an AD curve) 21) Draw a correctly labeled recessionary gap equilibrium in the 1st graph. 22) How would the Federal Reserve use Monetary Policy to correct an inflationary gap using the following tools: a. Reserve Ratio ___________ b. Discount Rate ___________ c. Open Market Operations ______________ d. On the inflationary graph above, draw the effect of this policy & label the new Equilibrium price & Quantity 4 23) How would the Federal Government use Fiscal policy to correct a recessionary gap: a. Income Taxes ________ b. Government Spending _________ c. On the above graph, draw the effect of this policy & label the new Equilibrium price & quantity 24) Explain what Economists mean in regard to Money Neutrality. a. Hint: MV = PQ ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ 25) Explain the Theory of Liquidity Preference (Keynes’s theory) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ The Phillips Curve (b) The Phillips Curve Inflation Rate Inflation Rate (percent per year) 6 Long-run Phillips curve 3. . . . and increases the inflation rate . . . B B A A 2 Phillips curve 0 4 (output is 8,000) Unemployment 7 (output is Rate (percent) 7,500) 0 Natural rate of unemployment Unemployment Rate 26) Explain what the short run Phillips Curve implies about Unemployment & inflation a. Why does this relationship hold true in the short run only? ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ 5 Balance of Payments & Exchange Rates Section 4 27) What is included in the Current Account: buying a car interest on a stock buying a factory (we will cover t Balance of payments after your quiz on Monday…..so you can skip this for now…) 28) The current account is equal to what component of GDP: ___________________ 29) What is included in the Capital Account: buying a car interest on a stock buying a factory 30) If the Current Account > Capital Account, the country is running a BOP ______________ Hint for next problem: All currency transactions go through the “house of money” which is actually the MARKET FOR FOREIGN EXCHANGE. For Example, If real interest rates rise in Japan then foreigners will want to save money in Japan. Therefore Americans will go to the house of money and supply dollars & demand Yen so they can buy Japanese bonds. House of Money 31) Assume that inflation is suddenly higher in Europe than in the USA. (there are no other changes) a. Properly label each graph below (mkt for dollars & market for euros) b. Modify each graph based on the changing inflation rate Market for Dollars Market for Euros S1 Q1 . D1 House of Money -------------- -------------- -------------- -------------- . S1 D1 Q1 32) According to the modified graphs above: a. The U.S. dollar _______________ versus the Euro. b. The Euro _________________ versus the dollar. c. Explain the effect on aggregate demand (AD) in the USA due to this change 33) Explain what determines whether the USA is a net exporter or net importer of a good.: a. Hint: it has to do with relative prices of goods: (price of domestic rice versus imported rice) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ 34) Explain how crowding out and the Net Export Effect can sometimes drastically hurt (offset) the goal of expansionary Fiscal Policy. (expansionary shifts AD to the right => why do these to shift AD to the left) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ 6