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AP MACROECONOMICS-2016 Name: ________________________ MACRO Review Study Guide This Study guide is not required. Complete this only it will help you best prepare for the AP EXAM You can turn in for normal credit if you would like….:) (30 points) 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 types will not go away at peak of business cycle—remember seasonal is adjusted out!)) Circle which are NOT included in GDP a. 3) Final goods, intermediate goods, 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 4) GDP deflator & the CPI Index both measure inflation: (2 change here!) circle which it applies to each index a. Is the broader measure of inflation GDP deflator CPI Index b. Uses a consumer market basket of goods GDP deflator CPI Index c. Includes international goods GDP deflator CPI Index BOTH d. Base Year Index is always 100 GDP deflator CPI Index BOTH 5) Please calculate the following based on the following information: a. 2000 b. 2003 Sold 1,000 coffee Sold 1,500 coffee Calculate: Nominal GDP (current price & qty sold) at $3 at $6 Base Year = $3/$3 X 100 = 100 Index Index = current year cost / base year cost X 100 Real GDP Price Index (in 2000 dollars) 2000 _________ _______ 100 2003 _________ ________ ______ 6) List the 2-types of inflation: 7) Inflation hurts people who: a. not in debt ___________-pull (printing money type) (2000 is the base year) ______________-push (supply type) Circle all that apply: live on fixed income borrowing money at fixed interest rate, 1 borrow money at adjustable rate Consumption, Savings Function & AD/AS Model Section 2 8) Disposable Income = Gross income - taxes & government _______________ payments. 9) MPC + MPS = ______ (all money is either consumed or saved!) 10) If Marginal Propensity to Consume (MPC) = .80 Calculate the following: 1/MPS = Gov’t spending multiplier a. The Government spending or investment multiplier is _____________ b. The Tax multiplier is ________________ c. The Balanced Budget Multiplier is ALWAYS __________ (RAISE TAXES & RAISE GOV’T SPENDING) 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 consumer confidence or “wealth” will shift consumption upward (left) and savings downward. (right) However a change in taxes or government transfers is the only time both curves shift in same direction. For example, cutting taxes will lead to BOTH more consumption and more savings! 11) Explain how a increase in government transfer payments 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 _________________________________________________________________________________________________ Long Run Equilibrium 12) AD = ________________________________ 13) 3-Reasons why AD is downward sloping: _________________________________________________________ (hint: why does GDP rise as the price level (inflation) falls) 2 14) 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! ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ _______________________________________________________________________________________________________ 15) Explain at what level of Real GDP the LRAS is vertical and how this relates to the PPF Graph. a. (1-2 sentences or clear/efficient bullet points—think PPF curve) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ 16) Name 2 factors which ONLY shift SRAS ______________________________ (not LRAS or PPF) 17) Name 5 factors which will shift both SRAS & LRAS _____________________________________________ (for LRAS to shift right => PPF must shift right) 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 18) Assume the required reserve ratio is 10% and a bank holds no excess reserves (multiplier = 1/rr) 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 18c ii. (hint: Remember the Fed’s money is NOT the same as your money----it is not part of the current money supply. think Magic Money or new money! Joe’s money was already part of money supply) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ _______________________________________________________________________________________________________ 3 GRAPH A: Money Market Nominal Interest Rate GRAPH B: Real Interest Rate MS S1 -------------- MD ------------- R1 i1 ------------ E1 Q1 Loanable Funds E1 Q1 Qty $ D1 Qty Loanable Funds Review: The Money Market graph is used in open market operations when conducting monetary policy. This is a nominal interest rate ( federal funds rate). The Fed “targets” an interest rate and then adjusts money supply to reach it. Money supply shifts left or right as the Fed buys or sells bonds. Money Demand Graph is the desire to “hold” money. It 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 (national savings) & label it real interest rate. The demand curve is investors who want to borrow money for capital investment. The supply curve is “savers”. People who buy bonds. (it also includes Government) You use this graph for crowding out. As supply shifts to the left => real interest rates rise => less capital investment (I falls) => AD falls => RGDP falls 19) Graph A: a. b. Assume the Federal Reserve conducts open market operations using contractionary monetary policy The Fed would ________ securities (bonds) Modify the above graph to show the effect on equilibrium interest rate & qty of money. 20) Graph B: a. Assume the Federal Government suddenly has a much larger deficit. Modify the market for Loanable funds in Graph B Show the effect on equilibrium interest rate & qty INFLATIONARY GAP Price Level LRAS1 RECESSIONARY GAP Price Level SRAS1 LRAS1 SRAS1 Real GDP Real GDP 21) Draw a correctly labeled inflationary gap equilibrium in the 1st graph. a. Label Equilibrium Price & Output (you need to add an AD curve) 22) Draw a correctly labeled recessionary gap equilibrium in the 1st graph. 23) How would the Federal Reserve use Contractionary Monetary Policy to correct an inflationary gap: 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 24) 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 4 25) Explain what Economists mean in regard to Money Neutrality. a. Hint: MV = PQ (equation of exchange) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ 26) The main schools of economic thought are Classical Economists, Keynesian Economists, Monetarists & Supply Side Economists. Some schools of thought believe in Government intervention while some rely more on self-regulation. a. During a recession a Keynesian economist would recommend ___________________ policy. policy is _______________________ One risk of this b. During a recession a Classical economist would recommend ___________________ policy. One risk of this policy is _______________________ c. A monetarist economists believes money is ______________ and expansionary monetary policy is relatively _______________ in the long run. 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) 0 Unemployment 7 (output is Rate (percent) 7,500) Natural rate of unemployment Unemployment Rate 27) The short run long run Phillips demonstrates the tradeoff between inflation and unemployment. In the short run you can have lower unemployment only if you accept higher _________________ What is the trade off between unemployment and inflation in the long run? ________________________________ NOTE: The SRPC will shift in the opposite direction of the SRAS curve. The LRPC rarely shifts => the natural rate of unemployment would have to change for it to shift! Balance of Payments & Exchange Rates Section 4 Review: The current account is basically NX + investment income. It is often referred to as our trade balance. The financial account is buying financial assets of another country. (like their stocks, real estate, etc…) The current account & the financial account generally must sum to zero. If one is negative (deficit) the other is in surplus. 28) What is included in the Current Account: 29) What is in the Financial Account: buying a car buying a foreign bond interest on a stock buying a factory interest on a foreign stock buying a foreign factory 30) If the Current Account + Financial Account > 0, the country is running a BOP ______________ 31) The USA currently has a current account ____________ with China and a financial account ___________ with China. 5 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. Hint: Think of who “needs” foreign currency to achieve their goal. If you want to buy something from another country or save money in that country => you need to supply your currency and demand the foreign currency. 32) 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 . -------------- D1 Q1 -------------- -------------- -------------- . S1 D1 Q1 33) 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 34) 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: (If the price of domestic rice is higher than imported rice => we become a net importer) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ 35) 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) ________________________________________________________________________________________________________ ________________________________________________________________________________________________________ _______/30pts 6