Whether you're preparing for your AP exam or you just want to learn for fun, you've come to the perfect place. This video will cover all the content in AP macroeconomics. Let's get started. So, this video will go in the same order as the units in AP macroeconomics. Here they are, as well as the approximate percentage of the exam that they make up. Each unit will begin with the list of the topics covered in that unit and end with the summary to help you remember everything. Here is unit one, basic economic concepts. Economics is a branch dealing with the production, distribution and consumption of goods and services. The need for economics comes from the fundamental problem of economics based on scarcity which is the idea that there are limited resources for production but wants are unlimited. Examples of scarce resources include workers because there's only a finite number of people and each worker is only willing to work for a limited amount of time and machines because those are also finite. Resources are grouped into four factors of production. The first is land also known as natural resources because it includes not only land but also other natural goods such as water and air. So this is basically anything that comes from the environment. Labor is people's effort. So this is any worker that you can think of. Capital is something produced to produce another good. Examples include factory buildings which hold workers and machines that produce a good, machines and trucks. Trucks is a tricky one, but it transports goods. And getting goods to a place where consumers can buy them is part of the production process. And finally, entrepreneurship. a person who combines the other factors of production. So this is typically people who make decisions. Opportunity cost is the value of the best forgone alternative when you choose between mutually exclusive options. Mutually exclusive means that you can only choose one of them. Here's an example. If Alice prefers a cherry over an apple, a banana over a cherry, and a kiwi over a banana, and she is only allowed to choose one of these fruits to eat, what is the opportunity cost of choosing a kiwi? The answer is a banana, because that is the best alternative that she would have if she did not choose a kiwi. Now, we're getting into our first graph of this video, the production possibilities curve, or PPC. The PPC shows possible combinations of amounts of two goods that can be produced. For example, we could have capital goods on the x-axis and consumer goods on the y-axis. And we're given a table right here that shows possible quantities of amounts of two goods. And if we plot them all out and connect them, we get our production possibilities curve. If we're on a point that's on the curve, that means we're efficient. we are optimally using our resources and producing the potential amount of output that we could produce. Any point that's inside the curve such as two capital goods and 150 consumer goods is underallocation. It means that we're not allocating our resources efficiently and we could be producing more. For example, 240 consumer goods and two capital goods. And you may have heard that any point that's outside the curve is unattainable, but it's actually possible in the short run when the economy is overheating. So like people are working longer shifts than usual. An analogy to real life would be periods of time where you're pulling allnighters to study for exams. However, this is not sustainable. You'll learn in unit three that if we're outside the curve, then it will cause workers to demand higher wages and work fewer hours until eventually we're back on our curve. And the shape of the production possibilities curve. So in this case, it's curved outward. And what that means is increasing opportunity cost, which means as we produce more and more capital goods, the opportunity cost to produce an additional capital good increases. And the same is true for consumer goods. And we can see why this is true. To go from three to four capital goods, we must sacrifice a larger amount of consumer goods than when we were going from two to three capital goods. On the other hand, if the production possibilities curve is straight, that means a constant opportunity cost. While if it's curved inward, then it means decreasing opportunity costs. The production possibilities curve can shift. If economic growth, which you'll learn more about in unit five, but basically it means a sustainable increase in output occurs, then the production possibilities curve will shift outward because it means that we can produce higher quantities of both goods. And keep in mind, it has to be sustainable. It can't just be a period of time where the economy is overheating. If economic decline occurs, for example, if the cost of oil, which is a key input in many products rises, then many companies won't be able to produce as much and therefore the production possibilities curve will shift inward. Now, we're getting into comparative advantage and trade. Trade is beneficial to economies because it can help them attain combinations that are beyond the production possibilities curve. So suppose that country A can produce either 200 apples or 400 oranges and country B can produce either 400 apples or 600 oranges. And we're also going to assume constant opportunity cost and that each country will produce only one good. And if each country wants both fruits, what country should produce each and what should the terms of trade be? All right. To solve this, first we should know what is absolute advantage and what is comparative advantage. Absolute advantage is when one economy can produce more of a good than the other. And comparative advantage is when one economy can produce a good at a lower opportunity cost than the other. And to solve the problem that we just saw, each economy should produce the good which it has a comparative advantage in. And later we'll see why it's impossible for one economy to have a comparative advantage in both goods. So who has the absolute advantage in each good? The answer is country B for both goods because it can produce 400 apples while country A can only produce 200 and it can produce 600 oranges while country A can produce only 400. So now who has the comparative advantage in apples? To determine this, we would find the opportunity cost of producing apples for each country. Country A can produce either 400 oranges or 200 apples. So, if we divide them, we'll get that their opportunity cost is two oranges for every apple. And country B has an opportunity cost of 1.5 oranges for every apple. So since country B sacrifices fewer oranges for every apple, country B has a comparative advantage in apples. And to determine which country has the comparative advantage in oranges, we can just take the reciprocal and we'll see that country A has the comparative advantage in oranges. All right. So now the terms of trade. So we've established which good each country has a comparative advantage in. So, country A produces 400 oranges and country B produces 400 apples. We have the opportunity cost of producing apples for each country listed here. And the terms of trade must be in between these two opportunity costs because, for example, if it was lower than 1.5 oranges per apple, then country B would not be willing to purchase oranges from country A because they could get more oranges by producing oranges themselves. And similarly, if it was greater than two oranges per apple, then country A would not be willing to purchase apples. So, we must pick any number in between these two opportunity costs, such as 1.75. So, country A trades seven oranges for every four apples from country B. All right? And sometimes you will see the numbers not listed as how many of a product each firm or country can produce, but instead how long it takes them to produce it. And for these problems, you can take the reciprocal of the numbers to find how many of the products each firm or country can produce in a certain amount of time. And then with that, you can solve the problem normally. For example, finding which good each firm or country has a comparative advantage in the demand for a good is the amount of that good that consumers are willing to purchase at a certain price. The law of demand states that a higher price of a good will cause a lower demand for that good. And this is pretty intuitive because if a good is more expensive then people are less willing to buy it. So on the graph for a particular good we have price on the vertical axis and quantity on the horizontal axis and the demand curve is downward sloping due to the law of demand. At lower prices a higher quantity will be demanded. Here are the determinants of demand which form the acronym insect. I do not recommend putting too much effort into remembering these because unit one has the lowest weight on the exam and most of these are pretty intuitive. The first determinant is income. Normal goods have demand that rises as income rises and this is consistent with the income effect which states that if consumers have more income and thus more to spend then they would demand and purchase more goods. Inferior goods have demand that falls as income rises. So these are typically goods that are more basic but less expensive. For example, small houses. If consumers don't have a lot of income, then they would purchase more small houses because they're less expensive. But if consumers get more income, then they would purchase fewer small houses in favor of larger houses. And then number of buyers, if there are more buyers, then there would be more demand. Substitute goods. So the substitution effect states that demand of a good rises as price of a substitute rises. An example of two substitutes are Coke and Pepsi. If the price of Coke rises, then some consumers will turn to purchasing Pepsi because Pepsi is now less expensive relative to Coke. So therefore, the demand for Pepsi rises. Expectation of future price. Present demand is higher if prices expected to rise because consumers would want to purchase it right now before the prices rise. Complimentary goods which are goods that are often used together. And demand falls as demand of compliment falls. So an example of complimentary goods are bread and butter. If people demand less bread then they would also demand less butter. And then finally taste. So what consumers want. The supply of a good is the amount of a good that producers are willing to produce at a certain price. The law of supply states that a higher price of a good will cause a higher supply for that good. And this is also pretty intuitive. If a good is more expensive, then producers are able to earn more money from it and therefore they're more willing to produce it. So therefore, the supply curve will be upward sloping. Here are the determinants of supply which form the acronym petting. Again, I do not recommend spending too much effort to remember these. The first determinant is the prices of other goods that firms can produce and supply is higher if price of other goods is lower. So for example, if a firm produces tennis balls and tennis rackets, then if the price of tennis balls decreases, then that means tennis balls are now less profitable relative to tennis rackets. So the firm will turn to producing more rackets and thus the supply of tennis rackets increases. Expectations of future price. Present supply is higher if price is expected to fall because firms want to sell it now before the price falls. Technology. If there's better technology, then firms can produce and supply more. Taxes and subsidy. Taxes mean that some of the profit that firms make has to go to the government and that would decrease the supply because now firms have less incentive since they make less profits. Whereas subsidies means that the government gives the firm money for producing the good and that would increase the incentive to produce and therefore the supply. Input costs. So supply falls as input costs rise because if it's more expensive to produce then firms will produce less. Number of sellers. If there's more sellers then there would be more supply. And finally government regulations. If there are more regulations firms would face less profit which would decrease the supply. The market will automatically adjust the quantity and price to the intersection of the market supply and demand curves. To see why this is true. If we suppose that the price was greater than the market equilibrium price, then there would be more supply than demand and some producers would not be able to sell their goods. So they would offer a lower price to the buyers and that would shift the price down. Similarly, if the price was below the equilibrium price, then there would be more quantity demanded than supplied and so the people who are not able to purchase it will be willing to pay the producers more money and that would increase the price. So, the price will automatically converge to the intersection of the supply and demand curve. And this is true in general. We're going to see a lot more graphs in this video which include a supply and demand curve. And in each of those cases, the intersection of the supply and demand curve determines the equilibrium. The equilibrium can shift. A change in demand is a shift of the demand curve due to a change in one of the determinants of demand. While a change in quantity demanded is a movement along the demand curve due to a change in price. So the main distinction is a change in demand is a shift of the curve while a change in quantity demanded is a movement along the curve. And the same is true for supply. Here's an example of a shift. Bread and butter are complimentary goods. The price of butter decreases causing the demand for butter to increase. Know the impact this will have on the market for bread. All right. So the first thing you need to know is will it shift the supply or demand? The answer is demand because complimentary goods are one of the determinants of demand. And since bread and butter are consumed together and the demand for butter increase, that means that the demand for bread will increase as well, which means a rightward shift of the demand curve because at each possible price, the demand for bread will be higher than it previously was. All right. And then now make sure you label these as P1 and Q1 respectively to show that they're the new equilibrium. We're finished with unit one. The summary for this unit is four slides long. Pause to read over it. Here is the first slide. Here is the second slide. Here's the third slide. And here's the fourth slide. Unit two will be on economic indicators and the business cycle. We start off with gross domestic product or GDP, which is the market value of all final goods and services produced within a country in a given period. Market value means the price that they're sold at, and you'll see what final means soon. So, here's the circular flow of income, which includes households and firms. And households pay firms in order to purchase goods and services. And the total amount that consumers spend is equal to the total revenue by firms. Whereas, households provide the factors of production for firms. So, firms pay wages, rent, and dividends to households. And the total expenditure by firms equals total household income. So what this tells us is that total expenditures equals total income and both of these are equal to GDP. So this gives us two different ways we can calculate GDP. And a note about transfer payments. So GDP does not include transfer payments such as selling a home constructed in a previous year or stocks because neither of these represents a new good or service. They're just transfers of money. So here's the expenditure approach to calculate GDP which is the most common. GDP consists of household consumption spending on final goods such for example if you purchased an egg from a store in order to make food and eat it at home that would be considered a final good and investment by firms which includes capital goods or machinery and inventory which is the amount that firms spend to produce things that are not sold in the given period but they store in order to sell in a later year. But this does not include intermediate goods. For example, if a restaurant purchased eggs in order to make omelets, then the eggs would not be part of GDP, whereas the omelets, the price that they're sold for would because otherwise the eggs would be counted twice. And then plus government purchases, which does not include transfer payments plus net exports. So exports minus imports because exports are produced at in the country, but they're sold to people abroad. Whereas imports they are not produced in the country and therefore should be subtracted. All right. So GDP equals C household consumption plus I investment by firms plus G plus X minus M. Note that I is gross investment and net investment is equal to gross investment minus depreciation or the decrease in value of capital goods. For example, tractors may wear out over time. So, you may need to spend like $1,000 to repair a tractor in a certain year. That would be considered depreciation. So, the $1,000 invested into repairing the tractor would be considered part of gross investment, but not part of net investment. The income approach is not as commonly used, but basically it says that GDP equals wages plus interest plus rents plus profits. So these four make up total national income plus statistical adjustments which includes depreciation, sales tax and net foreign factor income which is income made by foreigners residing in the US minus income made by US citizens residing somewhere else. And then the value added approach. So suppose a company produces a car which it sells for $20,000 to a consumer. So that should be $20,000 contributed to GDP. Now suppose that that company bought tires and metals from two other companies and the company that produced the tires bought rubber from another company. Well, we can calculate the value added at each step by taking the cost that that company sold its product for minus the input cost if there were any. And then if we add together all these values added, then the total value added will be the total contribution to GDP. So here are some limitations of GDP. First, it doesn't include non-market transactions or the underground economy. For example, if a friend drives you to the airport, it's not included in GDP. But if a taxi drives you, it is even though they're technically the same service. Another example is illegally selling fireworks. And it doesn't capture overall well-being because there could be other issues in the country like pollution, stress, product quality. Doesn't capture depreciation. So for example, if two countries have similar GDP, but country A spends more in order to cover depreciation, then technically country B is producing more new goods and services. So net domestic product, which subtracts depreciation, is a potential alternative measure. And GDP doesn't indicate income inequality. So now we're getting into unemployment. The unemployment rate is equal to the number of unemployed people divided by the size of the labor force times 100. And the labor force includes people actively working or seeking a job. It does not include people who aren't looking for a job or discourage job finders. So this leads to a criticism of the unemployment rate which is that it understates the actual level of unemployment because if a person wants to find a job but they can't find a job and therefore get discouraged then they would not be part of the labor force anymore. And then the labor force participation rate is equal to the labor force divided by the civilian non-institutional population times 100. In the US, the civilian non-institutional population is adults who are 16 or older who are not in institutions such as prisons or nursing homes. There are several types of unemployment. Frictional unemployment is a person who is looking for a job or in between jobs such as people have just graduated and haven't found a job yet. Structural unemployment means that a person doesn't have the skills or means necessary for a job. For example, if technology advances replace a job, then that skill may no longer be needed. And cyclical unemployment is caused by a period of economic recession. A recession is a period in which real GDP decreases. So that means that activity in the economy is slowing down and companies are producing less, so they're laying off workers. And natural unemployment is the sum of frictional and structural unemployment. Now we're getting into inflation, which is a general rise in price levels, and that's equivalent to money losing value because each dollar is not able to purchase as many goods as before. The consumer price index, which measures inflation, is equal to the cost of a market basket with current prices divided by the cost of the same market basket with base prices times 100. So for example, we're given a table right over here and it asks us to calculate the CPI for 2017 with 2016 as the base year. All right. So the market basket is 50 lamps and 100 light bulbs. And although it's not required, you could actually simplify this down to one lamp and two light bulbs. And the cost of one lamp and two light bulbs with 2017 prices is $33. Whereas the cost of the same market basket with 2016 prices is equal to 30. So therefore the CPI is equal to 33 / 30 * 100 which is 110. All right. Now here's the limitation of CPI substitution bias. If the price of a good goes up by too much, consumers may substitute it with cheaper options. So inflation which causes general prices to rise doesn't necessarily mean that the amount that consumers need to spend is greater by the same proportion. And the inflation rate is the current CPI minus past CPI all over the past CPI time 100. So in the last problem it would be 110 - 100 all over 100 * 100 which is 10%. So nominal variables are not adjusted for inflation whereas real variables are. So for example if a bank charges an interest rate of 5% annually on a loan that would be their nominal interest rate. However, if the inflation rate is 3% over the year, then we would have to subtract it to get 2% as the real interest rate. So, nominal GDP is determined using current prices and real GDP is determined using base prices. So, in this example, what is the nominal GDP for 2017? And what's the real GDP using 2016 as the base year? Well, nominal GDP is just sum of price times quantity in 2017. So 60 * 25 + 70 * 4 which is 1,780. And then for real GDP we would have to use 2016 base prices. So it would be 60 * 20 + 70 * 5 which is 1550. The GDP deflator is equal to nominal GDP divided by real GDP * 100. And if unexpected inflation occurs then borrowers would benefit at the expense of lenders. For example, if a bank charges a nominal interest rate of 5% but and expects an inflation rate of 3% but the actual inflation rate was 6% then the real interest rate was negative 1%. So they've actually technically lost money and whereas the borrowers they would have gained because their depth is worth less due to the inflation. And here's the business cycle. So we have time on the x axis and real GDP on the y- axis. This dotted line right here represents potential output which is the output at the natural rate of unemployment. Remember natural unemployment includes frictional and structural and potential outputs steadily increases because as technological advances occur productivity and real GDP can increase. However, in reality the economy actually goes up and down. So there are periods where the actual output is greater than the potential output and periods where there are economic downturns. So actual output is less than potential output. So an expansion is a period where real GDP increases whereas a recession is a period where it decreases and a peak is a local maximum real GDP point in this graph. Whereas a trough is a local minimum and the output gap at any given time is equal to the actual output minus potential output. So that's it for unit two. Here's the summary. Pause to read over it. Slide number two, slide number three, slide number four, and final slide. Before we continue, I want to let you know that I have lots of other content, including videos for other AP courses, which you can use to prepare for your other AP exams or just to learn for fun. And I also have many other interesting types of content, including entertaining multitasking challenges, logic puzzles I invented, and clearly explained videos. It's worth checking these out whenever you're not too busy. Unit 3 will be on national income and price determination. So most of unit 3 is based on this graph. If you understand this graph, you already understand about 80% of this unit. So we have price levels on the y-axis and real GDP or output on the x-axis. And keep in mind that price levels in this case mean the general price level in the economy and it could be measured by something like the inflation rate or CPI but this is not the price level of a single good. All right. So we have aggregate demand which is downward sloping, shortrun aggregate supply which is upward sloping and long run aggregate supply which is vertical. And keep in mind that higher real GDP means lower unemployment because to produce more more employees are required. So aggregate demand is the total quantity of goods and services demanded in economy. And as we saw if price levels decrease more will be demanded. And there are three reasons for this. The wealth effect is that people can purchase more goods and services with their money. So for example, if the average price level just hald overnight, then with your money, you could purchase twice as much as you could previously. So you would demand more the interest rate effect. So if price levels went down, then people don't have to spend as much money, so they could save more money. And you'll see in unit four that saving more would cause interest rates to go down, which encourages borrowing money for investment. And investment is part of aggregate demand. Again, you'll understand this better when we get into unit four. and the exchange rate effect. So lower interest rates encourage people to convert out of that currency, depreciating that currency or causing it to become less valuable, making domestic goods relatively cheaper to foreigners, increasing exports. You'll understand this better once we get into unit six. The factors which could cause aggregate demand to shift are just the four components of GDP. So for example, household consumption. If taxes decrease, then people have more money that they could spend. So therefore, aggregate demand would shift to the right. And if people are more confident in spending, the same would occur. If firms are more confident in investing, aggregate demand would shift to the right. If government spending increases, aggregate demand shifts to the right. If other countries demand more than exports and aggregate demand would increase. If a country makes more domestic goods and imports less, then aggregate demand would increase. Aggregate supply is the total output that firms are willing to produce. And as we saw, since shortrun aggregate supply is upward sloping, if price levels increase, then firms are willing to produce more in the short run, which is the period of time where wages and some other input costs are fixed. And the reason for this is because of sticky wages and prices. Although prices for a product go up, the production costs are relatively stable. So producing more leads to more profit. So, as an example, if general price levels were to double in a single day, including for a certain company's product, however, wages are set for a contract of, let's just say, one month. All right? So, the company would make twice as much revenue, but the input costs would stay relatively constant. So, they would produce more in order to get more profit. The shortrun aggregate supply curve shows a trade-off between inflation and unemployment. So consider two points on the curve and the lower point notice that it has lower inflation because lower price levels. However, it also has higher unemployment because of lower output. Whereas the upper point has higher inflation and lower unemployment. So if the short run aggregate supply curve doesn't shift, then there's a trade-off between inflation and unemployment. Now here are some things that could cause it to shift. So productivity if productivity increases then companies could produce more at a fixed price level which would cause a rightward shift and input cost. So if input costs rise then companies would produce less at each price level so that would cause a leftward shift and labor market. So if it's easier to find people to work, then that could cause a rightward shift and government taxes and subsidies could also influence the curve. In the long run, which is the period of time where wages and other input costs can adjust to price changes, output is independent of price levels. The reason is because wages and other input costs adjust to price changes. So the profit maximizing quantity returns to its natural level. So in our previous example, if general price levels across the economy were to double, including for a firm's product, then workers are going to realize that their cost of living has doubled and they're going to demand double the wage. So all the prices have changed proportionally and we're back at the level of potential output. In the short run, the equilibrium is the intersection of the aggregate demand and shortrun aggregate supply curve. Supply and demand shocks. So a positive shock would shift either aggregate demand or aggre shortrun aggregate supply to the right whereas a negative shock would shift it to the left. And there are two types of inflation. Demand pull inflation is caused by a positive shock in aggregate demand. Whereas cost push inflation is caused by a negative shock in shortrun aggregate supply. As you can see from the graph in both of these cases we have a higher price level in the new equilibrium than in the previous equilibrium. So long run self adjustment without government intervention. So now we have the long run aggregate supply curve and if the shortrun equilibrium is not at that output then what would happen? The key point is without government intervention the shortrun aggregate supply curve would shift to establish long run equilibrium. So let's consider the current scenario where current output is less than the long run aggregate supply output. Well, in that case, unemployment is higher than the natural rate of unemployment. And so, people who are unemployed would be willing to work at a lower wage. So, wages and other input costs would fall. And that would cause shortrun aggregate supply to shift to the right until we've established long run equilibrium. On the other hand, if the current output is greater than long run aggregate supply, then the economy is overheating and people are working too many hours. So they will demand higher wages and work for fewer hours total causing shortrun aggregate supply to shift left until we reach the long run equilibrium. Long run aggregate supply ties back to the business cycle. So if we consider three points so if we're above the level of potential output such as YC in this case then the current output is greater than the long run aggregate supply. If we're on the dotted line then current output equals long run aggreate supply. And if we're below, then it's less. And it also ties back to the production possibilities curve. So if we're outside the curve, then the economy is overheating and current output is greater than longer negative supply. If we're on the curve, then it's equal. If we're inside the curve, then it's less than. Marginal propensity to consume is equal to the change in consumption spending divided by the change in disposable income. and marginal propensity to save is equal to the amount the change in amount saved divided by the change in disposable income. And the sum of these should be equal to one. So these tell you that if someone earns an extra dollar in income, then on average, how much of it would they spend and how much of it will they save? So here's the multiplier effect. So suppose the marginal propensity to consume in an economy is 0.8. If Albert spends $10 to buy a good from Ben, then Ben would spend 0.8 times that, which is $8 buying a good from someone else, let's say Charlie. And Charlie spends 0.8 time $8 or $6.40 buying a good from someone else, Daniel. All right? And so on. So total expenditures, which is the total change in GDP, is equal to 10 + 10 * 0.8 + 10 * 0.8 2 and so on. So this is an infinite geometric series and you may know the formula for infinite geometric series. A1 / 1 - r. So the total change in GDP would be equal to $50. This is the multiplier effect. All right. So the general formula is that the total change in GDP equals initial spending over 1 minus MPC or just MPS. So in general the change in GDP is equal to the multiplier value times the initial change of that value. So we saw that the spending multiplier should be equal to 1 / 1 minus the marginal propensity to consume. And the tax multiplier is equal to negative MPC over 1 minus MPC. So this measures if the tax were to increase by a certain amount how by what amount would the GDP change? And it's negative because if you increase taxes, then people would have less disposable income. Therefore, GDP would decrease. And the reason why there's MPC in the numerator instead of one is because the decrease in initial spending is the tax amount times MPC rather than the tax amount itself. Fiscal policy consists of government spending and taxation or transfers in order to shift aggregate demand. And it's useful because the government can employ contractionary fiscal policy which is either decreasing spending or increasing taxes to fix inflation because this would cause the aggregate demand to shift to the left and or they can employ expansionary fiscal policy which is either increasing spending or decreasing taxation to fix a recession. And the government must note that the initial shift in aggregate demand is multiplied by the corresponding multiplier. So let's suppose that the government increases spending by this distance right over here. All right. So that's the initial increase in spending. Now suppose the MPC is equal to 0.5. So the multiplier would be equal to two. Then the total shift in the aggregate demand curve would be two times that distance of initial increase in spending. Some fiscal policies are called automatic stabilizers because they automatically counteract inflation or recessions without changing the policies. For example, income taxes are a percentage of income, so they automatically rise, which is contractionary fiscal policy during periods of inflation and fall during periods of recession. The advantage of automatic stabilizers over discretionary fiscal policy is that there's no lag between either inflation or recession and the change in tax amounts because discretionary fiscal policy takes time to implement. They have to write the laws and then implement them which takes time. We're done with unit three. The summary is two slides long. Here is the first slide and here is the second. Unit four will be on the financial sector. So here are some examples of financial assets. Cash is the simplest one. Demand deposits, which is money that's put in checking accounts. Bonds, which are purchased, and they have a set principal value that's paid off at a set end date, for example, after a period of one year. You must wait one year in order to get that money. And stocks, which represent partial ownership of a company. So, here's some info about some financial assets. Cash in demand deposits are the most liquid or easy to convert to spendable cash. Because you can easily spend them at any time and prematurely cashing in bonds either incurs a penalty or is not allowed. Therefore, bonds aren't as liquid. You can't spend them as easily. You have to wait. The price of previously issued bonds is inversely related to the current interest rate. So if the current interest rate is higher then people are more likely to save their money right now in order to earn interest rather than purchase previously issued bonds. So lower demand for previously issued bonds causes price to go down. The opportunity cost of holding money is the interest that could have been earned from bonds because by holding on to money you're not earning interest and financial risk comes from uncertainty about the future value of an asset. Nominal interest rate is unadjusted for inflation. And to calculate real interest rate, the expected real interest rate is the nominal interest rate minus the expected inflation rate. Whereas actual real interest rate is equal to nominal interest rate minus the actual inflation rate. Money serves three functions. The first is a medium of exchange. It can be used to purchase goods and services. The second is a store of value. So you can store money right now to use in the future. And the third is a unit of account. So it measures the value of a good or service. And when hyperinflation occurs, then the money no longer serves as a store of value because its value is quickly going down or a unit of account because prices are quickly going up making it hard to measure the value of something. So here are different types of the money supply. M0 or the monetary base is the total amount that the central bank prints which is equal to the currency in circulation plus the money held in bank reserves. M1 consists of the most liquid money. So, it's the currency in circulation plus checkable deposits plus traveler's checks. So, anything that could be easily spent. And M2 includes M1 plus some less liquid money such as money in savings accounts, small CDs, and short-term securities. So, here are what bank balance sheets look like. On the left we have assets which is what the bank has. And on the right we have liabilities and equity which is what the bank owes others and what the bank owns. And assets should be equal to liabilities plus equity. So here's an example. Let's suppose that stockholders have invested $1,500,000 and 1 million of that is property while 500,000 is reserves. Money from stockholders is equity because the bank doesn't owe the stockholders anything. Now suppose that somebody makes a checkable deposit for $500,000. Checkable deposits are a liability because the bank must pay those people back if they want to withdraw their money. The reserves would go up by $500,000 to $1 million. So banks operate using fractional reserve banking which means they keep a fraction of checkable deposits as reserves and lend out the rest. The required reserve ratio is the minimum percentage of checkable deposits that must be held in reserve. So let's suppose that the required reserve ratio is 20%. Well in that case since checkable deposits are $500,000 20% of that is $100,000. So that is what's required and that means that the remaining reserves $900,000 are excess reserves. So the bank can loan them out and if it loans out $800,000 then it would be left with $100,000 in excess reserves. Banks can cause M1 and M2 to expand. So let's suppose the required reserve ratio is 20%. and Albert puts $1,000 into their checking account and then their bank would loan 80% of that or $800 to Ben. And Ben puts the $800 into their checking account and then their bank loans out $640 to the next person who puts the $640 into their checking account and so on. So in the end, the maximum total amount of money that's in checking accounts is an infinite geometric series and it is equal to 5,000. And the reason why it's the maximum is because not all banks will loan out all of their excess reserves and not all people will put all their money into their checking account. All right. So in general, the maximum total checkable deposits is equal to the initial deposit divided by the required reserve ratio. Indeed, in this case, it's 1,000 divided by 0.2, which is 5,000. The maximum total loans is the initial loan divided by the required reserve ratio. In this case, it's $800 divided by 0.2, which is $4,000. Here is the money market graph. We have nominal interest rate on the vertical axis and quantity of money held on the horizontal axis. The supply is vertical at M1. And the demand is how much money people are willing to hold on to at each interest rate for purposes such as spending or maybe as a precaution in case something happens that requires you to have money in hand. And demand is downward sloping because at higher interest rates, people are less willing to hold on to their money due to a higher opportunity cost, which is the interest rate that they're foregoing by saving it. Here are some factors that could shift money demand. So if price levels increase, then people would need to spend more for the same amount of goods. So they need to hold on to more money. So money demand increases. If national income increases, people have more to spend. So money demand increases. And if it becomes harder to convert assets to cash, then money demand increases because people hold on to more of it to stay safe. Monetary policy targets the nominal interest rate and quantity of money held in order to counteract inflation or recession. Expansionary monetary policy aims to decrease the nominal interest rate which would increase the quantity of money held. Therefore, people would spend and invest more. Whereas contractionary monetary policy aims to increase the nominal interest rate and decrease the quantity of money held in order to counteract inflation. There are several monetary policy tools the central bank can implement in limited reserves which means a downward sloping demand curve as we just saw. The first is open market operations which means buying or selling bonds. So when you buy something from someone you have to give them money. So the central bank buying bonds essentially means that they're injecting money into the economy. So the money supply increasing would be expansionary monetary policy whereas selling bonds would be contractionary. The discount rate is the interest rate that commercial banks can borrow from the central bank for. A commercial bank may have to borrow from the central bank if people want to withdraw more money than it has reserves. So the discount rate is essentially a penalty for commercial banks that do not have enough reserves. However, if this decreases, then the penalty is lower. So, commercial banks are willing to take more risks by loaning out more, which causes the money supply to increase. And that's expansionary monetary policy. If the discount rate increases on the other hand, that's contractionary monetary policy. And the required reserve ratio. So, if it's lower, then that means commercial banks are able to loan more and that's expansionary. If the required reserve ratio increases, that would be contractionary. And notice that in all of these situations, the direction the money supply shifts determines whether it's expansionary or contractionary. In 2008, the US central bank implemented a new policy in response to the financial crisis, which is that US commercial banks could deposit their reserves to the US central bank and earn interest on those reserves. And the federal fund rate is the interest rate commercial banks charge each other for overnight loans. So this interest on reserves policy introduces us to a new model called the reserve market model. On the vertical axis we have federal funds rate and on the horizontal axis we have quantity of reserves. As we can see in the middle the demand is downward sloping because if a bank charges a lower federal funds rate then other banks are willing to demand more reserves. However we have an upper and a lower bound. The upper bound is the discount rate and the reason is because commercial banks could borrow from the central bank at that rate. Therefore, if a bank charges higher than that rate, no one would borrow from them. And the interest on reserves rate is the lower bound because that's the interest that commercial banks earn for their reserves. So, they would not lend out at less than that rate because then they would earn less interest. And now this flat section is called ample reserves, which is what some economies such as the US are in. The monetary policy tool for ample reserves is to change the interest on reserves rates. If the central bank decreases it, then it makes it less appealing for commercial banks to hold the reserves at the central bank and encourages them instead to loan out more of their reserves. And more borrowing equals more spending and investing. Whereas if the central bank increases the interest on reserves rate, then that would be contractionary monetary policy. The loanable funds graph. So we have real interest rate on the vertical axis and quantity of loanable funds on the horizontal axis. The suppliers of loanable funds are savers and if the real interest rate is higher then that means people earn a higher interest on what they save. So they would be willing to save more. That's why supply is upward sloping. And the demanders of loanable funds are the borrowers. And factors affecting demand include investment profitability. If an investment is more profitable, then the company would be willing to invest and borrow more at each interest rate, shifting the demand curve to the right, and government borrowing as well. In a closed economy, national savings equals private savings, which is savings by individuals plus public savings, which is savings by the government. We know that GDP is equal to C plus I plus G in a closed economy because there are no exports or imports. And we can rearrange this to get I on the right side. And now we can add and subtract a T on the left side, which is the amount of tax money collected. And that doesn't change anything. And notice now that GDP minus C minus T, which is total income, minus consumer expenditures minus how much people have to pay in taxes, is equal to private savings. and t which is the amount of tax money the government collects minus g which is how much it spends is equal to public savings. We know that private plus public savings equals national savings. So what this tells us is in a closed economy gross investment is equal to national savings. Now in an open economy we have to add net capital info on the right side which is the amount of money entering the economy minus the amount that's exiting it. For example, if foreigners were to purchase $100 million of bonds from the United States, that would be an inflow of $100 million. All right, we're all done with unit four, and the summary is six slides long. Here is slide number one. Here's slide number two. Here's slide number three, slide number four, slide number five, and slide number six. Unit five is on long run consequences of stabilization policies. The first idea for this unit is that fiscal and monetary policy work in parallel because fiscal policy is controlled by the government and monetary policy is controlled by the central bank. So they're often in effect simultaneously and may have opposite effects at any given time. For example, one might be expansionary while the other is contractionary. The Phillips curve shows the trade-off between unemployment and inflation. So we have inflation on the vertical axis and unemployment on the horizontal axis. And as we've seen in unit 3, the shortrun aggregate supply curve shows a trade-off between unemployment and inflation. And the full trade-off is graphed in the Phillips curve. So a movement along the shortrun aggregate supply curve would correspond to a movement along this shortrun Phillips curve which is downward sloping. Whereas shortrun aggregate supply shifting to the right would shift the shortrun Phillips curve to the left and vice versa. This is because a rightward shift of shortrun aggregate supply means lower price levels and lower unemployment. So the shortrun Phillips curve should shift to the left and the long run Phillips curve is vertical at the natural rate of unemployment. And if the natural rate of unemployment changes then the long run Phillips curve will change. So the intersection between the long run Phillips curve and the shortrun Phillips curve shows the long-term equilibrium. Now here's the quantity theory of money. So it says MV equals PQ where M is the money supply and V is the velocity of money or how many times a dollar gets spent on average. And if you think about this, this is equal to total expenditures. So total expenditures, we know that that is equal to the nominal GDP. And on the right side we have price level which is an index times the quantity of output which is real GDP. And notice that P * Q is equal to nominal GDP. So MV equals PQ. And the significance is that if the money supply increases while velocity of money and real output stay relatively constant then price levels increase in the long run. Though printing money without a matched increase in real output would lead to inflation is what the theory states. Now here's the difference between deficit and debt. Government deficit in a given year equals spending minus tax revenue and debt is how much the government owes in total and it's equal to accumulated deficits. So for example, if in the first year the government runs a deficit of $500 million and in the second year a deficit of 300 million, then by the second year their total debt is 800 million. And if in the third year the government has a surplus of $100 million because they make more in tax revenue than they spend, then their debt is down to $700 million. And note that the interest on depths for previous years is included in each year's spending and therefore the budget deficit calculation of each year. As we've seen, a government could spend more, which is expansionary fiscal policy, in order to combat a recession, and therefore they could perform deficit spending in order to combat a recession. How do they get the money? Well, they could get it from borrowing. But this leads to something called the crowding out effect which is that deficit spending funded by borrowing increases interest rates decreasing private investment. So this goes back to the loanable funds graph. If the demand for loanable funds increases because the government wants to borrow in order to do deficit spending that would increase the real interest rate and that would decrease private investment. So expansionary fiscal policy that is funded by borrowing could have an adverse effect which is contractionary. The last topic for this unit is economic growth, which is a sustained increase in real GDP per capita or per population. A sustained increase is not a temporary increase due to an inflationary gap when the economy is overheating, but rather a sustained increase or increase in potential output. So the graphical representations are the long run aggregate supply shifting to the right or production possibilities curve shifting outward. And labor productivity is the output per worker. The aggregate production function expresses total output as a function of capital stock and human capital. And human capital is not just the quantity of workers but also the quality. For example, like how much education they have because more educated workers are likely to be able to produce more and that would lead to increased labor productivity and therefore output. Economic growth is caused by an increase in the value of capital stock or human capital. This is consistent with the aggregate production function and technological advancement because better technology could lead to more productivity and therefore output. Here are some examples. Companies accumulating capital stock. So if a company decides to build more machines in a certain year then in future years it will have more machines which could improve output. Better education and hence worker skills, increase labor force participation rate. These both have to do with human capital. tax credit on businesses for research and investment. So they're encouraging businesses to do research and development which could lead to technological advancement and government investing in infrastructure such as highways. Highways are a capital good because they aid in transportation. So as you can see the topics in unit 5 are pretty short and the summary is only one slide long. Pause to read over it. Last unit, open economy, international trade and finance. So the balance of payments consists of two accounts. The current account which is the record of international transactions that do not create liabilities and the capital or financial account which is record of international transactions that do create liabilities. The current account consists of goods, services, and income and includes exports minus imports, income US citizens made abroad minus income foreigners made inside the US, and net unilateral transfers, which are one-way transfers of money that do not receive anything in return. And the financial account is mostly financial assets such as bonds and stocks. And it's equal to financial assets sold by US citizens and the US government to other countries minus financial assets bought by US citizens and the US government from abroad. And there are some other less important things in the capital account such as debt forgiveness which mostly just cancels out net unilateral transfers. All right. And the balance of payments states that theoretically the current account plus the capital account should equal zero because a surplus in one account should be canceled out by a deficit in the other. For example, if the US decides to export $1 million of goods to Europe, that would be a surplus of $1 million in the current account. And now with that $1 million that they've earned, they could buy financial assets such as bonds from Europe. and that would be a deficit in the capital account. However, in practice, this is not true because there's discrepancy. Countries are huge economies with a lot of different transactions and it's impossible to report every transaction perfectly. So therefore, there will be some discrepancy, but this is generally small compared to the GDP of the countries. The exchange rate of a currency is how much of a different currency is required to purchase one unit of the first currency. I'll show you an example soon. Appreciation of a currency is when that currency becomes more valuable relative to another. Whereas depreciation is that currency becoming less valuable relative to another. So here's an example. Let's suppose we have an economy with only the US and euro and only euros and the US dollar. Suppose the exchange rate of euros is initially $2 for one euro and then becomes $3 for one. Obviously these are just made up numbers. They're not the real numbers. So the euro has appreciated relative to the US dollar because each euro can now purchase more US dollars. Therefore, euros are now more valuable relative to the dollar. And if one appreciates, the other has to depreciate. So the US dollar has depreciated relative to the euro because now more US dollars are required to purchase each euro. So here's the foreign exchange market graph for US dollars. On the vertical axis we have the price or exchange rate of the US dollar and it's expressed in terms of euros per dollar. How many euros are required to purchase $1. And on the horizontal axis we have the quantity of US dollars and we have supply and demand of US dollars which are upward and downward sloping respectively. And this is the equilibrium. The demand for US dollars depends on Europe's demand for goods and assets from the US. So if the real interest rate of the US goes up then that would increase demand for US dollars because financial assets from the US are more profitable. Europeans could earn more interest by purchasing financial assets from the US. So they would want to purchase them more. However, since the financial assets are in the US, they need to purchase them with US dollars. Therefore, they would want to demand more US dollars and the price level of tradable goods from the US. A lower price level would increase demand for the goods from all consumers including European consumers. So therefore Europeans would want to purchase more US goods and to purchase them they need US dollars. Therefore the demand for US dollars increases. The national income of Europe. So if Europeans have more money to spend then they would demand more goods including goods from the US. Therefore the demand for US dollars increases. and tariffs on imports from the United States. So tariffs mean taxes. So if a tariff is implemented, that would decrease the demand for dollars because Europe will demand fewer goods from the US. Since they have to pay a tax, they're less willing to import goods and therefore they demand less US dollars. The supply of US dollars is dependent on the US's demand for goods and assets from Europe. Because if the US wants to purchase goods and assets from Europe, then they need to convert their US dollars into euros. And the more euros they want, the more US dollars they have to convert. So therefore, higher supply. So the determinance of supply are the same as demand except this time with the countries switched. So what would happen if the US dollar appreciates? What impact would that have on exports, imports, and aggregate demands? The answer is exports would decrease, imports would increase, and aggregate demand decreases because European goods are now relatively cheaper to the US. You can purchase more euros with each dollar. So assuming that prices stay constant, European goods are now relatively cheaper because now you need fewer US dollars to purchase the same number of euros and therefore goods. So therefore, US citizens would want to import more. On the other hand, the US's goods are now relatively more expensive to Europe because more euros are now required to purchase every US dollar. So therefore, Europeans would need to spend more euros to purchase the same quantity of goods, assuming price level stays constant. So since the exports decrease and imports increase, that would be a decrease in aggregate demand. On the other hand, if US dollars appreciate, then US exports would increase, imports would decrease and aggregate demand increases. So this shows that appreciation is not necessarily good and depreciation is not necessarily bad because of the impact that they could have on a country's output. So now here's the real interest rate effect on the capital account. So suppose the real interest rate of the US increases relative to Europe. Then as we saw previously, Europe will demand more financial assets from the US. All right. So we've seen that this would lead to an appreciation of US dollars and depreciation of the euro because the demand for US dollars increases. And this is capital inflow or a capital account surplus to the US and outflow from Europe because Europeans are purchasing financial assets from the US. And what effect this would have is an increase in supply of loanable funds in the US because there's capital info to the US whereas it would decrease the supply of loanable funds in Europe. And now going back to the loanable funds graph, if we increase the supply, which is a rightward shift of loanable funds in the US, then that would result in a new equilibrium whose real interest rate is lower than before. Whereas a leftward shift in the supply of loanable funds in Europe would result in a new equilibrium real interest rate that's higher than before. So the whole thing that started this entire process is real interest rates of the US increasing relative to Europe. And now we're saying that the flow of capital will cause the US's real interest rate to decrease and Europe's real interest rate to increase theoretically until the real interest rates are the same again. And theoretically, this means that the whole world should have the same interest rate because if one country's real interest rate changed, then the flow of capital will cause it to change back in the other direction until it's balanced again. However, in practice, this is not true because international loanable funds make up a very small percentage of loanable funds in each economy. People are not willing to go through this entire process of converting to different currencies just because one country's real interest rate is higher than anothers. All right, we're all done with new content. Here is the summary of unit six. This is the first slide. This is the second slide. And this is the final slide. If you're taking the exam, I would recommend reviewing all the unit summaries in order to ensure that you understand all the content in the course. After that, I would recommend doing practice problems and ensuring that you understand the solutions to questions you miss so that you can get them next time. Thanks for watching. Remember to subscribe for more free content or simply to support this channel. And check out my other content because it could be really useful or it could just be fun to watch. Have an awesome day and remember to stay confident.