AP Macroeconomics Exam Review

hi everybody Jacob Reed here from revieweecon.com today we're going to be going over everything you need to know for your AP macroeconomics exam in this video I'm going to be flying through all the macroeconomics you need to know without a lot of explanations or examples this video is really designed for people who already have a good sense of macroeconomics but just need a quick review before the exam if you need a more in-depth review I suggest you start off with the macroeconomics summary review videos if after watching this video you still need a little more help head over to review econ.com and pick up the total review booklet it has practice sets practice exams answers and explanations a formulas cheat sheet a graphs cheat sheet and exclusive online games if you want to pick up yourself a copy head over to the link up there now let's get into the content first up we've got unit one basic economic Concepts if you already watched the microeconomics review video you can go ahead and Skip to unit 2 because this part is all repeat first up we've got unit one basic concepts number one concept is scarcity scarcity is the inability of limited resources to satisfy our wants there's less of an item than is wanted of that item the item is scarce it will have a positive price and you have to give up something to get it the reason why goods and services are scarce is because factors of production are scarce factors of production are land labor capital and Entrepreneurship we have two different types of economic systems that you need to know on the AP microeconomics exam the first one is market-based economies those emphasize private property rights and they use prices to distribute scarce resources and goods and services the other type of economy is a command economy command economies government bureaucrats allocate the resources and the goods and services that means that the economy is run by Central planners basic concept in economics is that every choice has a cost we call that cost opportunity cost that is the value of the next best alternative not chosen it's what you give up when you make a choice here we have a production possibilities curve it shows all combinations of two goods that can be produced with fixed resources this linear production possibilities curve shows constant opportunity costs and that's because the resources that are made to make one good are perfectly adaptable to produce the other good if we have a bowed out curve like this it means that we have increasing opportunity costs as you produce more and more of one of these Goods the opportunity costs in terms of the other Good Will consistently increase and that's because the resources that are used to produce these goods are not perfectly adaptable any point of production on a production possibilities curve means that the economy is productively efficient any point of production within the curve is inefficient and it means some resources are sitting idle and not being used in a macro economy it means we have a recession and we have high levels of unemployment points of production outside the curve are impossible because of scarce resources we can't have an unlimited amount of both corn and robots in this example if we have a greater quality or quantity of resources or greater productivity of those resources we call that economic growth and that is shown as an outward shift of the production possibilities curve if on the other hand we have a decrease in the quality or quantity of resources we are going to see a shift inward of the production possibilities curve and now the economy can't produce as many of those two goods next we have absolute advantage that's the ability to produce more of something or the same amount of something using fewer resources here with this chart we have an output problem and that means more production is better and Henry has the absolute advantage in the production of both strawberries and zucchini because he can produce more of both here we have an input problem for these numbers and that means lower quantities of inputs mean you have an absolute advantage in this case Amy has the absolute advantage in doing brake jobs and painting cars now comparative advantage is even more important than absolute advantage and that's the ability to produce something at a lower opportunity cost if you have an output problem meaning the numbers in the table are finished products like we have here strawberries and zucchini are finished products we will use the other over formula that means the opportunity cost of producing good a will be the numbers we have for the other one good B divided by good a in this example here Henry has the comparative advantage in the production of zucchini while Jason has the comparative advantage in the production of strawberries because that's where their lower opportunity costs are found if we get an input problem then the opportunity cost can be calculated with the it over formula that means the opportunity cost of producing one unit of a will be the numbers we have for that item a divided by B in this example Amy has the comparative advantage in the production of brake jobs well Eric has the comparative advantage in the production of painted cars now mutually beneficial terms of trade will fall between the two countries or in this case people's opportunity cost so with the opportunity cost we have here one painted car will be worth between four and six brake jobs if it's going to benefit both Amy and Eric if it falls outside that range one person is benefiting while the other is worse off the law of demand tells us that ceterus paribus consumers will buy more of a good at low prices and fewer units of a good at high prices that law of demand gives us a downward sloping demand curve and a change in price is going to cause movement along that curve price does not change Demand only quantity demanded here are our demand shifters we've got tastes and preferences Market size more consumers means more demand prices of related Goods substitutes have a direct relationship for the price of one good and the demand for the other good compliments have an inverse relationship the price of one good demand for the other good and then we have changes in income for normal goods and increase in income will cause an increase in the demand and for inferior Goods an increase in income will cause a decrease in the demand for the product and the last one is expectations for the future any of those changes happen and it's going to shift the actual demand curve this is a change in demand not just a change in quantity demanded it's something besides price that's changed remember is an increase and left is a decrease when it comes to the law of supply we have a direct relationship between price and quantity at higher prices producers will sell more of a good and at lower prices producers will sell less and when you graph out that relationship it gives us an upward sloping supply curve and again price does not change Supply it's only quantity Supply that changes and the change in price is Illustrated as movement along that curve those Supply shifters we have are input prices there's an inverse relationship between the price of resources and the supply curve government tools that's taxes subsidies and regulations the number of sellers an increase in the number of sellers will shift that supply curve to the right technology will increase Supply and the prices of other Goods that these producers can produce and then of course producer expectations is our last one if any of those things change it's going to shift our supply curve to the right if it's an increase or to the left if it's a decrease now if we graph supply and demand together where the two curves intersect that is the price where the quantity demanded equals the quantity supplied that is equilibrium it's the price that clears the market and markets are going to seek that equilibrium if price is above equilibrium we have a surplus meaning the quantity supplied is greater than the quantity demanded and prices will fall towards equilibrium if the price is below equilibrium prices are going to rise because we will have a shortage that means the quantity demanded is greater than the quantity supplied causing prices to go up towards that equilibrium if we have an increase in the demand within the market that's going to cause the equilibrium price to go up and the equilibrium quantity to also go up if we have a decrease in demand both equilibrium price and quantity will decrease if we have an increase in Supply then the price will fall and the quantity will increase and with a decrease in Supply price is going to increase and quantity is going to decrease if you get a double shift graph it out and see which of the axes conflict if we have a decrease in Supply with an increase in the demand that equilibrium quantity is going to be indeterminate because one shift will increase it and the other one will decrease it and it will depend on how big the shifts are as to whether or not the quantity is increasing or decreasing in the end but the price here both shifts are going to increase the price and that means the price is definitely going to increase here's another example with the supply curve increasing and the demand curve also increasing now it's that price axis that's indeterminate because one shift increases it while the other decreases it but both are going to increase the quantity so the quantity is determined as an increase next on to unit 2 that's macroeconomic indicators first off we have the circular flow diagram we have two economic actors in the circular flow diagram households and businesses households provide land labor and capital in the factor markets and they buy goods and services in the product Market businesses on the other hand buy land labor and capital in the factor market and they Supply goods and services in the product Market in a capitalist economy the government is also in the mix they are buying goods and services in the product market and also buying resources in the factor market they also provide public goods to both households and businesses now we measure the economic activity within that circular flow model with gross domestic product that's the total value of all final goods and services produced within a country during a calendar year one way of calculating GDP is with the value-added approach the value-added approach takes the added value each company within a country adds to the final product value another way of calculating GDP is through the income approach through the factor market there we're going to take rent wages interest and Prof profit add them together with some adjustments and that gives us the income approach to GDP now the method of calculating GDP you're going to see most on the AP macroeconomics exam is the output expenditure model here we are calculating the payments for goods and services within the economy we have sea consumption that's the things that consumers are buying IG that's gross investment those are the things that businesses are buying along with changes in inventory G is government purchases and xn is net exports those are the things that foreign people are buying from our country here are some things that are not counted in GDP used items intermediate goods and financial transactions now if you take GDP and divide it by the population that gives you per capita GDP and while that number is often used as an indicator of a country's standard of living it isn't perfect it has some drawbacks first of all it doesn't count the underground economy also non-market activity like home production is not counted so if you clean your own house the value of that clean house is not part of GDP when bad things happen the cleanup of the pollution for example is counted as a positive if on GDP and the last thing is that the gross domestic product does not count for income distribution next up is unemployment in order to be considered unemployed you have to be not working and actively looking for work if you're not actively looking for work you are not considered unemployed even if you don't have a job now the unemployment rate is the number of unemployed people divided by the labor force times 100 the labor force that we're dividing by is the number of people who are unemployed those actively looking for work without work and the people who are employed as well add those two together that's the labor force the labor force participation rate is the labor force divided by the civilian working age population times 100. we have three types of unemployment that you need to know first of all we have frictional unemployment that's just movement between jobs or finding your first job next we have structural unemployment that means the economy has changed and the job is no longer needed or robots are doing the job now or we have a skills mismatch between the jobs that are available and the skills the unemployed workers have the third type of unemployment is cyclical unemployment that's unemployment caused by the business side and when we have cyclical unemployment that means we have a recession the natural rate of unemployment is the rate of unemployment we will have when we're at long run equilibrium in the Asad model that's frictional unemployment plus structural unemployment add those two together that is our natural rate of unemployment it means cyclical unemployment is zero now our next economic indicator is the inflation rate the inflation rate is a general increase in prices within an economy we can measure that with a CPI which tracks changes in the prices of a market basket of goods or we can use the GDP deflator which tracks price changes for all Goods now you can calculate GDP using nominal or real nominal GDP is GDP that has not been adjusted for inflation in order to calculate that you take the value of the current Goods that are being produced times it by the current Year's prices so for the 2020 nominal GDP we would use 2020 quantities and 2020 prices now real GDP on the other hand is calculating the value of the current Year's goods and services but using the base years prices so 2020's real GDP will use 20 20s quantities but 2010s the base years prices we can calculate the GDP deflator by taking the nominal GDP dividing by the real GDP and then times seen by 100 that will give us an index number that is the GDP deflator you can also take nominal values and convert them to real values by using the GDP deflator you take the nominal value in the current year divided by the GDP deflator times 100 and that will give you the real value instead of a GDP deflator you could calculate a CPI which is a consumer price index or CPI you're calculating the value of a market basket of goods the CPI you're first going to take the value of that Market Basket in the current Year's prices then you're going to calculate the value of that Market Basket using the base years prices then times it by 100 and that will give you the CPI for the current year if you want to calculate the amount of inflation between two different years and you're given either a GDP deflator or a CPI you can find that by taking the new CPI minus the old CPI divided by the old CPI times 100. now the reason reason we track inflation is because it impacts people within the economy some people are helped and some people are hurt unexpected inflation helps borrowers because they pay back fewer real dollars thanks to the higher than expected inflation on the other hand unexpected inflation hurts Banks because they are paid back fewer real dollars and it hurts Savers because their savings are worth fewer real dollars as a result of the inflation now those economic indicators help us understand where we are within the business cycle when output is increasing we call that an expansion when output is decreasing we call that a contraction if the contraction lasts more than six months or two consecutive quarters it's usually called a recession and we have a high point called a peak a low Point called a trough and when our current output is greater than our long run potential output we call that an inflationary Gap and when current output is below our long run potential output we call that a recessionary gap and there we have cyclical unemployment and when that long-run potential output increases over time we call that economic growth on to unit 3 that's the Asad model and fiscal policy now when consumers earn income the government's going to take their share and what's left is called disposable income so disposable income is income minus taxes and with disposable income you can only do two things with it spend it or save it the marginal propensity to consume is the amount of new money that consumers are likely to spend it's expressed as a decimal so if I spend eighty percent of new money my marginal propensity to consume is 0.8 the marginal propensity to save is the percentage of new income that I would be likely to save so in that example 20 or 0.2 is my marginal propensity to save we can use the MPC and the MPS to calculate the simple spending multiplier that's one divided by the MPS or 1 divided by one minus the MPC any new consumer spending business investment government spending or net exports will be impacted by this multiplier and it will Ripple through the economy and increase GDP the tax multiplier on the other hand is the negative NPC divided by the MPS or the negative NPC divided by 1 minus the NPC the tax multiplier also has an absolute value one less than the government spending multiplier and that's because when there's a reduction in Government taxes consumers disposable income increases by the amount of the taxes but some of that money will be saved rather than spent the aggregate demand curve is a downward sloping curve that shows an inverse relationship between the price level and real GDP and that demand curve represents the demand for all goods and services within the economy now the aggregate demand curve will shift with any change in any component of the output expenditure model for GDP so if there's a change in consumption gross investment government purchases or net exports it will shift that aggregate demand curve to the right if there's an increase or to the left if there's a decrease when it comes to aggregate supply we have two curves the short run aggregate supply shows a direct relationship between real GDP and the price level it is the supply of all goods and services within the economy and it is upward sloping in the show run because wages are sticky in the short run the short run aggregate supply curve will shift because of prices of resources mostly wages productivity changes inflation expectations there's an inverse relationship increase in inflation expectations will shift that aggregate supply curve to the left and vice versa business taxes will shift it to the left or shift it to the right if they're decreased and last business regulations will decrease Supply if they're increased a shift to the left is a decrease a shift to the right is an increase now in the long run the economy will always be at full employment and that's because wages are flexible in the long run so the long run aggregate supply curve is vertical at YF that's the Full Employment level of output and at any price level we're going to get YF the long run aggregate supply curve shifters are the quantity of resources quality of resources productivity of those resources and Technology essentially anything that shifts the production possibilities curve inward will shift the long run aggregate supply curve to the left and anything that would shift the production possibilities curve outward will shift the LR as to the right that long run your supply curve is long run potential output now if we put the aggregate demand curve and the short run aggregate supply curve together it gives us short run equilibrium where those two curves intersect is the current price level and the current amount of real GDP real output also called national income if we add in the long run aggregate supply curve we can see where we are in relationship to our long run potential here we have an inflationary Gap because the current level of output is greater than the long run potential output that means unemployment is low and we're likely to see higher rates of inflation if the current level of output is less than the Full Employment output then that is a recessionary gap that means national income is lower than the long run potential output and that means the rate of unemployment is higher than the natural rate and when all three curves line up like we have here that means we are at long run equilibrium the current level of output equals the long run potential output and now the actual unemployment rate matches the natural rate if we have a positive demand shock to the economy the price level is going to increase and real output is also are going to increase we call that demand pull inflation if we have a negative demand shock to the economy the price level is going to fall and real output is going to fall that means national income is lower and unemployment has increased employment has decreased if we have a positive Supply shock that is a rightward shift of the supply curve that causes price levels to fall real output to increase and now we have an inflationary Gap that means national income has increased and unemployment has decreased if we have a negative Supply shock to the economy prices are going to rise and real output is going to fall we call this cost push inflation also known as stagflation we have higher prices and higher unemployment at the same time if we have a recessionary gap and there is no government action taken to close that recessionary Gap wages are eventually going to fall that is going to mean lower input costs for businesses and that will be a rightward shift of the short run aggregate supply curve bringing us back to long-run equilibrium in the long run thanks to flexible wages if on the other hand we have an inflationary Gap in the long run wage are going to rise those higher wages will mean higher input costs for businesses that will shift the short run aggregate supply curve to the left bringing us back to the Full Employment output in the long run thanks to flexible wages now if we don't want to wait for wages to change to bring us back to Long Run equilibrium the government could use fiscal policy to close the output Gap if we have a recessionary gap the government could use expansionary fiscal policy to fight unemployment that would be increasing government spending and or decreasing taxes that's going to increase the deficit or decrease the Surplus but it can bring us back to long-run equilibrium more quickly on the graph that expansionary fiscal policy will shift to aggregate demand curve to the right thanks to the increase in government spending or decrease in taxes which increases disposable income increasing with it consumption and that shifts the aggro demand curve to the right restoring long run equilibrium if we have a positive GDP Gap or an inflationary Gap the government could fight inflation by decreasing government spending or increasing taxes that would also decrease the budget deficit or increase the Surplus as well on the graph the contractionary fiscal policy is going to shift that aggregate demand curve to the left restoring long-run equilibrium now if the government doesn't take any discretionary action the business cycle will still be smoothed out somewhat by automatic stabilizers automatic stabilizers caused the budget deficit to decrease during expansions and increase during contractions taxes are one of those automatic stabilizers since they are based on people's income taxes are automatically going to increase during expansions and decrease during contractions transfer payments like unemployment compensation and welfare payments are also automatic stabilizers transfer payments decrease during expansions and increase during contractions next up we've got unit 4 financial markets first let's talk about money what is money well money has three functions it is a medium of exchange most importantly it's a unit of account that means it's a yardstick or measuring tool and third it's a store of value now when it comes to the money supply we have three measures of the money supply the first one is the monetary base that includes Bank Reserves which are not actually money but it does include currency paper and coins which is money the second measure of money is the M1 money supply that includes currency checkable deposits and savings accounts the third measure of money is the M2 money supply it's the most broad definition of money it includes all of the money that is in M1 along with small time deposits and money market mutual funds the Fisher formula shows us the difference between real interest rates and nominal interest rates is the inflation rate little I is the nominal interest rate Pi is the inflation rate take nominal interest rate minus the inflation rate and that will approximately give you little r the a real interest rate this formula can also be used to calculate the difference between nominal rates of change and real rates of change being the inflation rate as well and you can use algebra to rearrange this formula to get whichever variable you're missing bank balance sheets have two sides assets and liabilities now on the liability side those are the things that the Bank owes we have demand deposits that's often called checkable deposits that's checkbook money or checking accounts we also have savings deposits and other liabilities now of these three liabilities only demand deposits have a reserve requirement set by the Federal Reserve over on the asset side we have total reserves that's all of the money the bank has that money can be divided into two categories required reserves that's the percentage of checkable deposits set by the Federal Reserve that the bank cannot loan out and what's left is excess reserves that's the money the bank can loan out next we have loans that's the money the bank has already given out to Consumers and the bank has a promise to pay in their possession that is worth the value of the loan and then we have other assets the bank has and that can include the building or bonds or Securities of other sorts now assets are always going to equal liabilities these two sides will always balance out the things the bank owns will equal the things the Bank owes now the money multiplier tells us how many dollars worth of new loans deposits and money can be created from excess reserves in order to find that you take one and divide it by the reserve requirement set by the Federal Reserve so you're going to take that money multiplier and multiply it by excess reserves and that's how many dollars worth of new money loans and deposits that can be created from that excess reserves now depending on the question that's being asked you may need to add in the original amount as well the question asked for new money created and the original amount was new money you add it back in if the original amount was not brand new money like if it was a cash deposit well then it wouldn't be counted and so you leave it at the money multiplier times the excess reserves now the money multiplier only tells you the maximum amount of new loans deposits and money that can be created with with new excess reserves but the reality is the number is going to be smaller because Banks hold excess reserves and consumers hold currency next Let's Talk About The Money Market the money market is comprised of two curves a supply curve and a demand curve the demand curve is downward sloping and it shows the inverse relationship between the nominal interest rate and the quantity of money demanded that nominal interest rate is the opportunity cost of holding your wealth as money the demand for money actually comes from two things the asset demand for money and that's the desire to hold your wealth as money and the transaction demand for money which is all the transactions of gross domestic product C plus I plus G Plus xn and the price level if there's an increase in the demand for money it shifts to the right and it shifts to the left if there's a decrease the money supply curve is determined by the Central Bank in a economy that has scarce reserves as well as the lending within the banking system if there's an increase in the money supply we're going to see a rightward shift and if there's a decrease in the money supply we will see a leftward shift when we put the money supply and money demand curve on the same graph where the two curves intersect we see the nominal interest rate abbreviated as I little e and an increase in the money supply will decrease that nominal interest rate we could also shift that demand curve and if we shift it to the right that will give us a higher nominal interest rate now when it comes to monetary policy we have two systems the scarce Reserve System and the ample Reserve System the United States uses ample reserves today but you still need to know scarce reserves on the AP exam countries that have a scarce Reserve System their central banks will use open market operations that's buying bonds when they're trying to increase the money supply or sell bonds when they're trying to decrease the money supply they can also change the discount rate that's the interest rate that banks are charged by the central bank they can increase it to decrease the money supply and decrease it to increase the money supply and the third tool they can use is the reserve requirement that's the percentage of checkable deposits that cannot be loaned out by Banks they can increase the reserve requirement to decrease the money supply and decrease the reserve requirement to increase the money supply and central banks with scarce reserves use those tools to Target their policy rate expansionary monetary policy is used to fight unemployment and when there are scarce reserves that will mean buying bonds lowering the discount rate or lowering the reserve requirement that's going to shift our money supply curve to the right decreasing the nominal interest rate if the central bank with scarce reserves is trying to fight inflation on the other hand they are going to use contractionary monetary policy that means selling bonds raising the discount rate or raising the reserve requirement that will decrease the supply of money in the money market and that will increase the nominal interest rate now in the United States we have an ample Reserve System that means that the Federal Reserve does not use the money market to Target the federal funds rate which is what the policy rate is called in the united states in the United States they use the reserves Market graph we have a demand for reserves with an upper Trend that is flat at the discount rate we have a downward sloping demand curve as well and at the lower end we have another flat portion that moves with interest on reserves interest on reserves is the interest that banks are paid by the Federal Reserve on their reserves and when we add that supply of reserves Market we get our equilibrium policy rate where the two curves cross as long as that supply curve is intersecting the demand curve in that lower end where it's flat then we have ample reserves if that supply curve was intersecting the downward sloping portion of the demand curve that would be scarce reserves ample reserves has two main policy tools the first one is open market operations under ample reserves though that isn't used to Target the policy rate it is used to maintain the ample reserves when the Federal Reserve buys Bonds on the open market it shifts the supply of reserves to the right keeping us in that lower end of the demand curve central banks with ample reserves also have administered rates they can change the discount rate move the upper end of that demand curve and most importantly the interest on reserves rate moves the lower end of that demand curve and that is the key policy tool for ample reserves because it's the shift of that lower end of the demand curve up or down that actually changes the policy rate so it doesn't matter if we have ample reserves or scarce reserves either way central banks are going to use expansionary monetary policy to fight unemployment here we have a recessionary gap which means we will have high levels of unemployment in order to restore long-run equilibrium the central bank is going to take action if we have scarce reserves expansionary policy means buying bonds lowering the discount rate or lowering the reserve requirement that will lower interest and with that we will have more gross investment if the economy has ample reserves they will decrease the interest on reserves rate or they can decrease administered rates which will move both the upper and lower portion of the demand curve either way we see a lower policy rate which increases gross investment and when we see that increasing gross investment that's going to shift our aggregate demand curve to the right closing that recessionary Gap if on the other hand we have an inflationary Gap that means the central bank is going to use contractionary monetary policy to close that Gap if there's a scarce Reserve System that means the central bank will sell bonds raise the discount rate or raise the reserve requirement which will shift that money supply curve to the left meaning higher interest and lower gross investment if the economy has an ample reserves banking system then they will increase the interest on reserves rate which increases the policy rate or they could also increase the administered rates which is both the discount rate and interest on reserves which would move both the upper and lower portion of that demand curve either way we see an increase in the policy rate which is going to decrease gross investment the other Financial Market you need to know for this unit is the loanable funds Market first we have the demand curve that's the investment demand curve at higher interest rates businesses demand less Investments and at lower interest rates businesses buy more Investments and of course investment is purchases of physical capital here that investment demand curve will shift for anything that will change the potential profit of future Investments That Could Be changes in economic Outlook or investment tax credits but rightward shift is an increase a leftward shift is a decrease the savings Supply is the money saved within an economy that is made available for loans the savings Supply changes with disposable income the economic Outlook and foreign investment a rightward shift is an increase a leftward shift is a decrease put these two curves together and it gives us the equilibrium real interest rate and the equilibrium quantity of loanable funds now we're on to unit five that's the long run consequences of economic policies first we're taking a look at the interaction between monetary policy and fiscal policy if monetary policy and fiscal policy are both expansionary both of those policies will shift the aggregate demand curve to the right which means that our price level is for sure going to increase and our real output is for sure going to increase as well but in regards to interest rates the nominal interest rate is going to decrease and thanks to crowding out we'll get to that in a little bit the real interest rate in the loanable funds Market is going to increase the net impact is indeterminate because in one market they're increasing in the other Market they're decreasing if monetary policy and fiscal policy go in opposite directions then the aggregate demand curve is Shifting to the right and to the left so in the Asad model our price level is indeterminate and our quantity of real output is indeterminate but in regards to interest rates that will be determined here we have contractionary monetary policy and expansionary fiscal policy both of those actions are going to increase interest rates and so interest rates are for sure sure going to increase here we have the long run impact of an increase in the money supply in the short run we're going to see a rightward shift of the aggregate demand curve but that causes price levels to go up and in the long run wages are going to increase causing the short run aggregate supply curve to shift to the left in the long run the real output is unchanged and the price level is higher here we have the monetary equation of exchange m is the money supply V is the velocity of money P is the price level and Y is real output both M times V and P times y equal nominal GDP you can use algebra with this formula to solve for whatever variable is missing next let's talk about the budget deficit and the national debt the national debt is the accumulation of all previous deficits and surpluses added together budget deficit occurs when taxes are less than government spending a budget surplus occurs when taxes are greater than government spending when there is an increase in the budget deficit interest rates are going to increase that means there's a decrease in Gross investment that leads to less Capital formation and that decreases economic growth we call that crowding out if we have a budget surplus that would decrease interest rates which would increase gross investment causing more Capital formation and with that we would have greater amounts of economic growth and we can see that change of interest rates in the loanable funds Market when it comes to the loanable funds Market you can shift either curve you can either increase the demand for loanable funds because the government is demanding loans alongside other businesses which drives up the interest rate or some textbooks will look at it another way and decrease the supply of loanable funds essentially the government has taken money out of the loanable funds Market because they are deficit spending and as a result there's less loanable funds supplied in the private markets either shift is fine use the one your teacher prefers best now the opposite occurs when there's a decrease in the budget deficit that will decrease the demand for loanable funds or increase the supply of loanable funds But whichever curve you shift that real interest rate is going to decrease next let's talk about economic growth economic growth is an increase in in potential GDP or per capita GDP which is GDP divided by population so again it's not an increase in GDP but potential GDP in order to have higher rates of economic growth we need an increase in the quantity of resources or the quality of resources when we talk about increases in the quality of workers we're talking about productivity that's the output divided by worker hours you can see increases in productivity through specialization Capital per worker human capital which is the skills and knowledge of workers or increases in technology investment gross investment which is physical capital is one of the key components because that changes the capital per worker along with education programs that change human capital on the graphs we see economic growth as a rightward shift of the long run aggregate supply curve or a shift outward of the production possibilities curve the government can use economic policies like government-funded research and development investment tax credits jobs trainings programs or other supply side policies like reducing government regulations or corporate tax cuts those are some of the policies that can shift that long-runner supply curve to the right more quickly now the Phillips curve shows us the relationship between the unemployment rate and the inflation rate in the short run the relationship is inverse when unemployment is high inflation is low and vice versa that gives us that short run Phillips curve but in the long run there is no relationship between the inflation rate and the unemployment rate in the long run we get the natural rate of unemployment and that is the long run Phillips curve that lines up with the natural rate of unemployment if we have an inflationary Gap then we're up high on that Phillips curve if we have a recessionary gap we're down low on that Phillips curve changes within the Phillips curve model are mirrored By changes in the aggregate supply aggregate demand model if we have a shift of aggregate demand that will be shown as an opposite direction shift as movement up or down the short run Phillips curve in the Phillips curve model if we have a shift of the short run aggregate supply curve that will be shown as an opposite direction shift of the short run Phillips curve a rightward shift of the short Niagara supply curve will be a leftward shift of the Phillips curve and vice versa now that long run Phillips curve is going to move with changes in the natural rate of unemployment which can change with changes in the frictional rate or the structural rate onto the last unit and that is foreign exchange markets first of all we have the balance of payments and that's an accounting of transactions between countries we have two components it's the current account and the financial and capital account in the current account we track transactions between countries for goods Services investment income and money transfers in the capital and financial account we track purchases of assets assets can include stocks currency bonds and other assets when it comes to the balance of payments money going into an economy is counted as a credit or an inflow money going out of an economy is a debit or an outflow now the sum of the current account and capital and financial account will always equal zero that means when one is in a surplus the other isn't a deficit and vice versa now one portion of the current account is the balance on trade that's exports minus Imports if exports are greater than Imports that is a trade surplus and if exports are less than Imports that's a trade deficit and that is just one part of the current account exchange rates are the price of one currency in terms of another currency if an exchange rate increases we say that the currency has appreciated if an exchange rate decreases that currency has depreciated the demand for a currency is downward sloping the demand for a currency will shift because of the demand for a country's exports interest rates within a country or expected exchange rates and those ones in the green box there are affected by monetary and fiscal policy Foreign Exchange Market supply curve is upward sloping showing the direct relationship between the exchange rate and the quantity of the currency the supply shifters are very similar to the demand shifters its demand for imports this time as well as the interest rates and the future expected exchange rate and once again those ones in the green box there are affected by monetary and fiscal policy when you put the supply curve and the demand curve together it gives us the equilibrium exchange rate and the equilibrium quantity of the currency demanded and supplied if United States national income decreases then we are going to buy fewer things from other countries that's going to decrease the supply of our dollars in increasing the equilibrium exchange rate now if our national income decreases then the places where we are no longer buying as much stuff will see a decrease in the demand for their currency in this case the Mexican peso sees a decrease in the demand for the peso because we're buying fewer mexican-made products now if our price level decreases we're going to see a double shift foreign made goods are now cheaper so we're going to import more and Export less that's going to be a increase in the supply of our dollars as we buy more foreign made goods and we're going to see a decrease in the demand for our dollars as foreigners buy less of our stuff if you get a question like this usually you can shift either curve or shift the one that is asked for so far they haven't required you to shift both if the United States sees an increase in interest rates that's also going to be a double shift so for other countries like Mexico in this market Mexican investors are going to withdraw their money from Mexican Banks and put their money in U.S banks that's going to increase the supply of Mexican pesos in their International markets and the low interest rate means that foreign investors will be less likely to put their money in Mexican Banks and that will decrease the demand for Mexican pesos both of those shifts will cause the depreciation of the Mexican peso now exchange rates impact net exports if a currency appreciates that means Imports are going to be cheaper and exports are going to be more expensive for foreign people that's going to mean exports decrease Imports increase that decreases our net exports and shifts our accurate demand curve to the left if a currency depreciates on the other hand that means Imports are going to be more expensive exports are going to be relatively cheaper for foreign people and that means exports are going to increase Imports are going to decrease net exports will increase as a result and that will shift our aggregate demand curve to the right whoa there you have it that is the bulk of what we can expect to show up on this year's AP macroeconomics exam if you got it all you are on your way to getting a five on that exam if you still need a little more help head over to review econ.com where there's lots of games and activities to help you practice the skill skills you need to Ace that macroeconomics exam that's all for now I'll see you all next time

hi everybody Jacob Reed here from revieweecon.com today we&#39;re going to be going over everything you need to know for your AP macroeconomics exam in this video I&#39;m going to be flying through all the macroeconomics you need to know without a lot of explanations or examples this video is really designed for people who already have a good sense of macroeconomics but just need a quick review before the exam if you need a more in-depth review I suggest you start off with the macroeconomics summary review videos if after watching this video you still need a little more help head over to review econ.com and pick up the total review booklet it has practice sets practice exams answers and explanations a formulas cheat sheet a graphs cheat sheet and exclusive online games if you want to pick up yourself a copy head over to the link up there now let&#39;s get into the content first up we&#39;ve got unit one basic economic Concepts if you already watched the microeconomics review video you can go ahead and Skip to unit 2 because this part is all repeat first up we&#39;ve got unit one basic concepts number one concept is scarcity scarcity is the inability of limited resources to satisfy our wants there&#39;s less of an item than is wanted of that item the item is scarce it will have a positive price and you have to give up something to get it the reason why goods and services are scarce is because factors of production are scarce factors of production are land labor capital and Entrepreneurship we have two different types of economic systems that you need to know on the AP microeconomics exam the first one is market-based economies those emphasize private property rights and they use prices to distribute scarce resources and goods and services the other type of economy is a command economy command economies government bureaucrats allocate the resources and the goods and services that means that the economy is run by Central planners basic concept in economics is that every choice has a cost we call that cost opportunity cost that is the value of the next best alternative not chosen it&#39;s what you give up when you make a choice here we have a production possibilities curve it shows all combinations of two goods that can be produced with fixed resources this linear production possibilities curve shows constant opportunity costs and that&#39;s because the resources that are made to make one good are perfectly adaptable to produce the other good if we have a bowed out curve like this it means that we have increasing opportunity costs as you produce more and more of one of these Goods the opportunity costs in terms of the other Good Will consistently increase and that&#39;s because the resources that are used to produce these goods are not perfectly adaptable any point of production on a production possibilities curve means that the economy is productively efficient any point of production within the curve is inefficient and it means some resources are sitting idle and not being used in a macro economy it means we have a recession and we have high levels of unemployment points of production outside the curve are impossible because of scarce resources we can&#39;t have an unlimited amount of both corn and robots in this example if we have a greater quality or quantity of resources or greater productivity of those resources we call that economic growth and that is shown as an outward shift of the production possibilities curve if on the other hand we have a decrease in the quality or quantity of resources we are going to see a shift inward of the production possibilities curve and now the economy can&#39;t produce as many of those two goods next we have absolute advantage that&#39;s the ability to produce more of something or the same amount of something using fewer resources here with this chart we have an output problem and that means more production is better and Henry has the absolute advantage in the production of both strawberries and zucchini because he can produce more of both here we have an input problem for these numbers and that means lower quantities of inputs mean you have an absolute advantage in this case Amy has the absolute advantage in doing brake jobs and painting cars now comparative advantage is even more important than absolute advantage and that&#39;s the ability to produce something at a lower opportunity cost if you have an output problem meaning the numbers in the table are finished products like we have here strawberries and zucchini are finished products we will use the other over formula that means the opportunity cost of producing good a will be the numbers we have for the other one good B divided by good a in this example here Henry has the comparative advantage in the production of zucchini while Jason has the comparative advantage in the production of strawberries because that&#39;s where their lower opportunity costs are found if we get an input problem then the opportunity cost can be calculated with the it over formula that means the opportunity cost of producing one unit of a will be the numbers we have for that item a divided by B in this example Amy has the comparative advantage in the production of brake jobs well Eric has the comparative advantage in the production of painted cars now mutually beneficial terms of trade will fall between the two countries or in this case people&#39;s opportunity cost so with the opportunity cost we have here one painted car will be worth between four and six brake jobs if it&#39;s going to benefit both Amy and Eric if it falls outside that range one person is benefiting while the other is worse off the law of demand tells us that ceterus paribus consumers will buy more of a good at low prices and fewer units of a good at high prices that law of demand gives us a downward sloping demand curve and a change in price is going to cause movement along that curve price does not change Demand only quantity demanded here are our demand shifters we&#39;ve got tastes and preferences Market size more consumers means more demand prices of related Goods substitutes have a direct relationship for the price of one good and the demand for the other good compliments have an inverse relationship the price of one good demand for the other good and then we have changes in income for normal goods and increase in income will cause an increase in the demand and for inferior Goods an increase in income will cause a decrease in the demand for the product and the last one is expectations for the future any of those changes happen and it&#39;s going to shift the actual demand curve this is a change in demand not just a change in quantity demanded it&#39;s something besides price that&#39;s changed remember is an increase and left is a decrease when it comes to the law of supply we have a direct relationship between price and quantity at higher prices producers will sell more of a good and at lower prices producers will sell less and when you graph out that relationship it gives us an upward sloping supply curve and again price does not change Supply it&#39;s only quantity Supply that changes and the change in price is Illustrated as movement along that curve those Supply shifters we have are input prices there&#39;s an inverse relationship between the price of resources and the supply curve government tools that&#39;s taxes subsidies and regulations the number of sellers an increase in the number of sellers will shift that supply curve to the right technology will increase Supply and the prices of other Goods that these producers can produce and then of course producer expectations is our last one if any of those things change it&#39;s going to shift our supply curve to the right if it&#39;s an increase or to the left if it&#39;s a decrease now if we graph supply and demand together where the two curves intersect that is the price where the quantity demanded equals the quantity supplied that is equilibrium it&#39;s the price that clears the market and markets are going to seek that equilibrium if price is above equilibrium we have a surplus meaning the quantity supplied is greater than the quantity demanded and prices will fall towards equilibrium if the price is below equilibrium prices are going to rise because we will have a shortage that means the quantity demanded is greater than the quantity supplied causing prices to go up towards that equilibrium if we have an increase in the demand within the market that&#39;s going to cause the equilibrium price to go up and the equilibrium quantity to also go up if we have a decrease in demand both equilibrium price and quantity will decrease if we have an increase in Supply then the price will fall and the quantity will increase and with a decrease in Supply price is going to increase and quantity is going to decrease if you get a double shift graph it out and see which of the axes conflict if we have a decrease in Supply with an increase in the demand that equilibrium quantity is going to be indeterminate because one shift will increase it and the other one will decrease it and it will depend on how big the shifts are as to whether or not the quantity is increasing or decreasing in the end but the price here both shifts are going to increase the price and that means the price is definitely going to increase here&#39;s another example with the supply curve increasing and the demand curve also increasing now it&#39;s that price axis that&#39;s indeterminate because one shift increases it while the other decreases it but both are going to increase the quantity so the quantity is determined as an increase next on to unit 2 that&#39;s macroeconomic indicators first off we have the circular flow diagram we have two economic actors in the circular flow diagram households and businesses households provide land labor and capital in the factor markets and they buy goods and services in the product Market businesses on the other hand buy land labor and capital in the factor market and they Supply goods and services in the product Market in a capitalist economy the government is also in the mix they are buying goods and services in the product market and also buying resources in the factor market they also provide public goods to both households and businesses now we measure the economic activity within that circular flow model with gross domestic product that&#39;s the total value of all final goods and services produced within a country during a calendar year one way of calculating GDP is with the value-added approach the value-added approach takes the added value each company within a country adds to the final product value another way of calculating GDP is through the income approach through the factor market there we&#39;re going to take rent wages interest and Prof profit add them together with some adjustments and that gives us the income approach to GDP now the method of calculating GDP you&#39;re going to see most on the AP macroeconomics exam is the output expenditure model here we are calculating the payments for goods and services within the economy we have sea consumption that&#39;s the things that consumers are buying IG that&#39;s gross investment those are the things that businesses are buying along with changes in inventory G is government purchases and xn is net exports those are the things that foreign people are buying from our country here are some things that are not counted in GDP used items intermediate goods and financial transactions now if you take GDP and divide it by the population that gives you per capita GDP and while that number is often used as an indicator of a country&#39;s standard of living it isn&#39;t perfect it has some drawbacks first of all it doesn&#39;t count the underground economy also non-market activity like home production is not counted so if you clean your own house the value of that clean house is not part of GDP when bad things happen the cleanup of the pollution for example is counted as a positive if on GDP and the last thing is that the gross domestic product does not count for income distribution next up is unemployment in order to be considered unemployed you have to be not working and actively looking for work if you&#39;re not actively looking for work you are not considered unemployed even if you don&#39;t have a job now the unemployment rate is the number of unemployed people divided by the labor force times 100 the labor force that we&#39;re dividing by is the number of people who are unemployed those actively looking for work without work and the people who are employed as well add those two together that&#39;s the labor force the labor force participation rate is the labor force divided by the civilian working age population times 100. we have three types of unemployment that you need to know first of all we have frictional unemployment that&#39;s just movement between jobs or finding your first job next we have structural unemployment that means the economy has changed and the job is no longer needed or robots are doing the job now or we have a skills mismatch between the jobs that are available and the skills the unemployed workers have the third type of unemployment is cyclical unemployment that&#39;s unemployment caused by the business side and when we have cyclical unemployment that means we have a recession the natural rate of unemployment is the rate of unemployment we will have when we&#39;re at long run equilibrium in the Asad model that&#39;s frictional unemployment plus structural unemployment add those two together that is our natural rate of unemployment it means cyclical unemployment is zero now our next economic indicator is the inflation rate the inflation rate is a general increase in prices within an economy we can measure that with a CPI which tracks changes in the prices of a market basket of goods or we can use the GDP deflator which tracks price changes for all Goods now you can calculate GDP using nominal or real nominal GDP is GDP that has not been adjusted for inflation in order to calculate that you take the value of the current Goods that are being produced times it by the current Year&#39;s prices so for the 2020 nominal GDP we would use 2020 quantities and 2020 prices now real GDP on the other hand is calculating the value of the current Year&#39;s goods and services but using the base years prices so 2020&#39;s real GDP will use 20 20s quantities but 2010s the base years prices we can calculate the GDP deflator by taking the nominal GDP dividing by the real GDP and then times seen by 100 that will give us an index number that is the GDP deflator you can also take nominal values and convert them to real values by using the GDP deflator you take the nominal value in the current year divided by the GDP deflator times 100 and that will give you the real value instead of a GDP deflator you could calculate a CPI which is a consumer price index or CPI you&#39;re calculating the value of a market basket of goods the CPI you&#39;re first going to take the value of that Market Basket in the current Year&#39;s prices then you&#39;re going to calculate the value of that Market Basket using the base years prices then times it by 100 and that will give you the CPI for the current year if you want to calculate the amount of inflation between two different years and you&#39;re given either a GDP deflator or a CPI you can find that by taking the new CPI minus the old CPI divided by the old CPI times 100. now the reason reason we track inflation is because it impacts people within the economy some people are helped and some people are hurt unexpected inflation helps borrowers because they pay back fewer real dollars thanks to the higher than expected inflation on the other hand unexpected inflation hurts Banks because they are paid back fewer real dollars and it hurts Savers because their savings are worth fewer real dollars as a result of the inflation now those economic indicators help us understand where we are within the business cycle when output is increasing we call that an expansion when output is decreasing we call that a contraction if the contraction lasts more than six months or two consecutive quarters it&#39;s usually called a recession and we have a high point called a peak a low Point called a trough and when our current output is greater than our long run potential output we call that an inflationary Gap and when current output is below our long run potential output we call that a recessionary gap and there we have cyclical unemployment and when that long-run potential output increases over time we call that economic growth on to unit 3 that&#39;s the Asad model and fiscal policy now when consumers earn income the government&#39;s going to take their share and what&#39;s left is called disposable income so disposable income is income minus taxes and with disposable income you can only do two things with it spend it or save it the marginal propensity to consume is the amount of new money that consumers are likely to spend it&#39;s expressed as a decimal so if I spend eighty percent of new money my marginal propensity to consume is 0.8 the marginal propensity to save is the percentage of new income that I would be likely to save so in that example 20 or 0.2 is my marginal propensity to save we can use the MPC and the MPS to calculate the simple spending multiplier that&#39;s one divided by the MPS or 1 divided by one minus the MPC any new consumer spending business investment government spending or net exports will be impacted by this multiplier and it will Ripple through the economy and increase GDP the tax multiplier on the other hand is the negative NPC divided by the MPS or the negative NPC divided by 1 minus the NPC the tax multiplier also has an absolute value one less than the government spending multiplier and that&#39;s because when there&#39;s a reduction in Government taxes consumers disposable income increases by the amount of the taxes but some of that money will be saved rather than spent the aggregate demand curve is a downward sloping curve that shows an inverse relationship between the price level and real GDP and that demand curve represents the demand for all goods and services within the economy now the aggregate demand curve will shift with any change in any component of the output expenditure model for GDP so if there&#39;s a change in consumption gross investment government purchases or net exports it will shift that aggregate demand curve to the right if there&#39;s an increase or to the left if there&#39;s a decrease when it comes to aggregate supply we have two curves the short run aggregate supply shows a direct relationship between real GDP and the price level it is the supply of all goods and services within the economy and it is upward sloping in the show run because wages are sticky in the short run the short run aggregate supply curve will shift because of prices of resources mostly wages productivity changes inflation expectations there&#39;s an inverse relationship increase in inflation expectations will shift that aggregate supply curve to the left and vice versa business taxes will shift it to the left or shift it to the right if they&#39;re decreased and last business regulations will decrease Supply if they&#39;re increased a shift to the left is a decrease a shift to the right is an increase now in the long run the economy will always be at full employment and that&#39;s because wages are flexible in the long run so the long run aggregate supply curve is vertical at YF that&#39;s the Full Employment level of output and at any price level we&#39;re going to get YF the long run aggregate supply curve shifters are the quantity of resources quality of resources productivity of those resources and Technology essentially anything that shifts the production possibilities curve inward will shift the long run aggregate supply curve to the left and anything that would shift the production possibilities curve outward will shift the LR as to the right that long run your supply curve is long run potential output now if we put the aggregate demand curve and the short run aggregate supply curve together it gives us short run equilibrium where those two curves intersect is the current price level and the current amount of real GDP real output also called national income if we add in the long run aggregate supply curve we can see where we are in relationship to our long run potential here we have an inflationary Gap because the current level of output is greater than the long run potential output that means unemployment is low and we&#39;re likely to see higher rates of inflation if the current level of output is less than the Full Employment output then that is a recessionary gap that means national income is lower than the long run potential output and that means the rate of unemployment is higher than the natural rate and when all three curves line up like we have here that means we are at long run equilibrium the current level of output equals the long run potential output and now the actual unemployment rate matches the natural rate if we have a positive demand shock to the economy the price level is going to increase and real output is also are going to increase we call that demand pull inflation if we have a negative demand shock to the economy the price level is going to fall and real output is going to fall that means national income is lower and unemployment has increased employment has decreased if we have a positive Supply shock that is a rightward shift of the supply curve that causes price levels to fall real output to increase and now we have an inflationary Gap that means national income has increased and unemployment has decreased if we have a negative Supply shock to the economy prices are going to rise and real output is going to fall we call this cost push inflation also known as stagflation we have higher prices and higher unemployment at the same time if we have a recessionary gap and there is no government action taken to close that recessionary Gap wages are eventually going to fall that is going to mean lower input costs for businesses and that will be a rightward shift of the short run aggregate supply curve bringing us back to long-run equilibrium in the long run thanks to flexible wages if on the other hand we have an inflationary Gap in the long run wage are going to rise those higher wages will mean higher input costs for businesses that will shift the short run aggregate supply curve to the left bringing us back to the Full Employment output in the long run thanks to flexible wages now if we don&#39;t want to wait for wages to change to bring us back to Long Run equilibrium the government could use fiscal policy to close the output Gap if we have a recessionary gap the government could use expansionary fiscal policy to fight unemployment that would be increasing government spending and or decreasing taxes that&#39;s going to increase the deficit or decrease the Surplus but it can bring us back to long-run equilibrium more quickly on the graph that expansionary fiscal policy will shift to aggregate demand curve to the right thanks to the increase in government spending or decrease in taxes which increases disposable income increasing with it consumption and that shifts the aggro demand curve to the right restoring long run equilibrium if we have a positive GDP Gap or an inflationary Gap the government could fight inflation by decreasing government spending or increasing taxes that would also decrease the budget deficit or increase the Surplus as well on the graph the contractionary fiscal policy is going to shift that aggregate demand curve to the left restoring long-run equilibrium now if the government doesn&#39;t take any discretionary action the business cycle will still be smoothed out somewhat by automatic stabilizers automatic stabilizers caused the budget deficit to decrease during expansions and increase during contractions taxes are one of those automatic stabilizers since they are based on people&#39;s income taxes are automatically going to increase during expansions and decrease during contractions transfer payments like unemployment compensation and welfare payments are also automatic stabilizers transfer payments decrease during expansions and increase during contractions next up we&#39;ve got unit 4 financial markets first let&#39;s talk about money what is money well money has three functions it is a medium of exchange most importantly it&#39;s a unit of account that means it&#39;s a yardstick or measuring tool and third it&#39;s a store of value now when it comes to the money supply we have three measures of the money supply the first one is the monetary base that includes Bank Reserves which are not actually money but it does include currency paper and coins which is money the second measure of money is the M1 money supply that includes currency checkable deposits and savings accounts the third measure of money is the M2 money supply it&#39;s the most broad definition of money it includes all of the money that is in M1 along with small time deposits and money market mutual funds the Fisher formula shows us the difference between real interest rates and nominal interest rates is the inflation rate little I is the nominal interest rate Pi is the inflation rate take nominal interest rate minus the inflation rate and that will approximately give you little r the a real interest rate this formula can also be used to calculate the difference between nominal rates of change and real rates of change being the inflation rate as well and you can use algebra to rearrange this formula to get whichever variable you&#39;re missing bank balance sheets have two sides assets and liabilities now on the liability side those are the things that the Bank owes we have demand deposits that&#39;s often called checkable deposits that&#39;s checkbook money or checking accounts we also have savings deposits and other liabilities now of these three liabilities only demand deposits have a reserve requirement set by the Federal Reserve over on the asset side we have total reserves that&#39;s all of the money the bank has that money can be divided into two categories required reserves that&#39;s the percentage of checkable deposits set by the Federal Reserve that the bank cannot loan out and what&#39;s left is excess reserves that&#39;s the money the bank can loan out next we have loans that&#39;s the money the bank has already given out to Consumers and the bank has a promise to pay in their possession that is worth the value of the loan and then we have other assets the bank has and that can include the building or bonds or Securities of other sorts now assets are always going to equal liabilities these two sides will always balance out the things the bank owns will equal the things the Bank owes now the money multiplier tells us how many dollars worth of new loans deposits and money can be created from excess reserves in order to find that you take one and divide it by the reserve requirement set by the Federal Reserve so you&#39;re going to take that money multiplier and multiply it by excess reserves and that&#39;s how many dollars worth of new money loans and deposits that can be created from that excess reserves now depending on the question that&#39;s being asked you may need to add in the original amount as well the question asked for new money created and the original amount was new money you add it back in if the original amount was not brand new money like if it was a cash deposit well then it wouldn&#39;t be counted and so you leave it at the money multiplier times the excess reserves now the money multiplier only tells you the maximum amount of new loans deposits and money that can be created with with new excess reserves but the reality is the number is going to be smaller because Banks hold excess reserves and consumers hold currency next Let&#39;s Talk About The Money Market the money market is comprised of two curves a supply curve and a demand curve the demand curve is downward sloping and it shows the inverse relationship between the nominal interest rate and the quantity of money demanded that nominal interest rate is the opportunity cost of holding your wealth as money the demand for money actually comes from two things the asset demand for money and that&#39;s the desire to hold your wealth as money and the transaction demand for money which is all the transactions of gross domestic product C plus I plus G Plus xn and the price level if there&#39;s an increase in the demand for money it shifts to the right and it shifts to the left if there&#39;s a decrease the money supply curve is determined by the Central Bank in a economy that has scarce reserves as well as the lending within the banking system if there&#39;s an increase in the money supply we&#39;re going to see a rightward shift and if there&#39;s a decrease in the money supply we will see a leftward shift when we put the money supply and money demand curve on the same graph where the two curves intersect we see the nominal interest rate abbreviated as I little e and an increase in the money supply will decrease that nominal interest rate we could also shift that demand curve and if we shift it to the right that will give us a higher nominal interest rate now when it comes to monetary policy we have two systems the scarce Reserve System and the ample Reserve System the United States uses ample reserves today but you still need to know scarce reserves on the AP exam countries that have a scarce Reserve System their central banks will use open market operations that&#39;s buying bonds when they&#39;re trying to increase the money supply or sell bonds when they&#39;re trying to decrease the money supply they can also change the discount rate that&#39;s the interest rate that banks are charged by the central bank they can increase it to decrease the money supply and decrease it to increase the money supply and the third tool they can use is the reserve requirement that&#39;s the percentage of checkable deposits that cannot be loaned out by Banks they can increase the reserve requirement to decrease the money supply and decrease the reserve requirement to increase the money supply and central banks with scarce reserves use those tools to Target their policy rate expansionary monetary policy is used to fight unemployment and when there are scarce reserves that will mean buying bonds lowering the discount rate or lowering the reserve requirement that&#39;s going to shift our money supply curve to the right decreasing the nominal interest rate if the central bank with scarce reserves is trying to fight inflation on the other hand they are going to use contractionary monetary policy that means selling bonds raising the discount rate or raising the reserve requirement that will decrease the supply of money in the money market and that will increase the nominal interest rate now in the United States we have an ample Reserve System that means that the Federal Reserve does not use the money market to Target the federal funds rate which is what the policy rate is called in the united states in the United States they use the reserves Market graph we have a demand for reserves with an upper Trend that is flat at the discount rate we have a downward sloping demand curve as well and at the lower end we have another flat portion that moves with interest on reserves interest on reserves is the interest that banks are paid by the Federal Reserve on their reserves and when we add that supply of reserves Market we get our equilibrium policy rate where the two curves cross as long as that supply curve is intersecting the demand curve in that lower end where it&#39;s flat then we have ample reserves if that supply curve was intersecting the downward sloping portion of the demand curve that would be scarce reserves ample reserves has two main policy tools the first one is open market operations under ample reserves though that isn&#39;t used to Target the policy rate it is used to maintain the ample reserves when the Federal Reserve buys Bonds on the open market it shifts the supply of reserves to the right keeping us in that lower end of the demand curve central banks with ample reserves also have administered rates they can change the discount rate move the upper end of that demand curve and most importantly the interest on reserves rate moves the lower end of that demand curve and that is the key policy tool for ample reserves because it&#39;s the shift of that lower end of the demand curve up or down that actually changes the policy rate so it doesn&#39;t matter if we have ample reserves or scarce reserves either way central banks are going to use expansionary monetary policy to fight unemployment here we have a recessionary gap which means we will have high levels of unemployment in order to restore long-run equilibrium the central bank is going to take action if we have scarce reserves expansionary policy means buying bonds lowering the discount rate or lowering the reserve requirement that will lower interest and with that we will have more gross investment if the economy has ample reserves they will decrease the interest on reserves rate or they can decrease administered rates which will move both the upper and lower portion of the demand curve either way we see a lower policy rate which increases gross investment and when we see that increasing gross investment that&#39;s going to shift our aggregate demand curve to the right closing that recessionary Gap if on the other hand we have an inflationary Gap that means the central bank is going to use contractionary monetary policy to close that Gap if there&#39;s a scarce Reserve System that means the central bank will sell bonds raise the discount rate or raise the reserve requirement which will shift that money supply curve to the left meaning higher interest and lower gross investment if the economy has an ample reserves banking system then they will increase the interest on reserves rate which increases the policy rate or they could also increase the administered rates which is both the discount rate and interest on reserves which would move both the upper and lower portion of that demand curve either way we see an increase in the policy rate which is going to decrease gross investment the other Financial Market you need to know for this unit is the loanable funds Market first we have the demand curve that&#39;s the investment demand curve at higher interest rates businesses demand less Investments and at lower interest rates businesses buy more Investments and of course investment is purchases of physical capital here that investment demand curve will shift for anything that will change the potential profit of future Investments That Could Be changes in economic Outlook or investment tax credits but rightward shift is an increase a leftward shift is a decrease the savings Supply is the money saved within an economy that is made available for loans the savings Supply changes with disposable income the economic Outlook and foreign investment a rightward shift is an increase a leftward shift is a decrease put these two curves together and it gives us the equilibrium real interest rate and the equilibrium quantity of loanable funds now we&#39;re on to unit five that&#39;s the long run consequences of economic policies first we&#39;re taking a look at the interaction between monetary policy and fiscal policy if monetary policy and fiscal policy are both expansionary both of those policies will shift the aggregate demand curve to the right which means that our price level is for sure going to increase and our real output is for sure going to increase as well but in regards to interest rates the nominal interest rate is going to decrease and thanks to crowding out we&#39;ll get to that in a little bit the real interest rate in the loanable funds Market is going to increase the net impact is indeterminate because in one market they&#39;re increasing in the other Market they&#39;re decreasing if monetary policy and fiscal policy go in opposite directions then the aggregate demand curve is Shifting to the right and to the left so in the Asad model our price level is indeterminate and our quantity of real output is indeterminate but in regards to interest rates that will be determined here we have contractionary monetary policy and expansionary fiscal policy both of those actions are going to increase interest rates and so interest rates are for sure sure going to increase here we have the long run impact of an increase in the money supply in the short run we&#39;re going to see a rightward shift of the aggregate demand curve but that causes price levels to go up and in the long run wages are going to increase causing the short run aggregate supply curve to shift to the left in the long run the real output is unchanged and the price level is higher here we have the monetary equation of exchange m is the money supply V is the velocity of money P is the price level and Y is real output both M times V and P times y equal nominal GDP you can use algebra with this formula to solve for whatever variable is missing next let&#39;s talk about the budget deficit and the national debt the national debt is the accumulation of all previous deficits and surpluses added together budget deficit occurs when taxes are less than government spending a budget surplus occurs when taxes are greater than government spending when there is an increase in the budget deficit interest rates are going to increase that means there&#39;s a decrease in Gross investment that leads to less Capital formation and that decreases economic growth we call that crowding out if we have a budget surplus that would decrease interest rates which would increase gross investment causing more Capital formation and with that we would have greater amounts of economic growth and we can see that change of interest rates in the loanable funds Market when it comes to the loanable funds Market you can shift either curve you can either increase the demand for loanable funds because the government is demanding loans alongside other businesses which drives up the interest rate or some textbooks will look at it another way and decrease the supply of loanable funds essentially the government has taken money out of the loanable funds Market because they are deficit spending and as a result there&#39;s less loanable funds supplied in the private markets either shift is fine use the one your teacher prefers best now the opposite occurs when there&#39;s a decrease in the budget deficit that will decrease the demand for loanable funds or increase the supply of loanable funds But whichever curve you shift that real interest rate is going to decrease next let&#39;s talk about economic growth economic growth is an increase in in potential GDP or per capita GDP which is GDP divided by population so again it&#39;s not an increase in GDP but potential GDP in order to have higher rates of economic growth we need an increase in the quantity of resources or the quality of resources when we talk about increases in the quality of workers we&#39;re talking about productivity that&#39;s the output divided by worker hours you can see increases in productivity through specialization Capital per worker human capital which is the skills and knowledge of workers or increases in technology investment gross investment which is physical capital is one of the key components because that changes the capital per worker along with education programs that change human capital on the graphs we see economic growth as a rightward shift of the long run aggregate supply curve or a shift outward of the production possibilities curve the government can use economic policies like government-funded research and development investment tax credits jobs trainings programs or other supply side policies like reducing government regulations or corporate tax cuts those are some of the policies that can shift that long-runner supply curve to the right more quickly now the Phillips curve shows us the relationship between the unemployment rate and the inflation rate in the short run the relationship is inverse when unemployment is high inflation is low and vice versa that gives us that short run Phillips curve but in the long run there is no relationship between the inflation rate and the unemployment rate in the long run we get the natural rate of unemployment and that is the long run Phillips curve that lines up with the natural rate of unemployment if we have an inflationary Gap then we&#39;re up high on that Phillips curve if we have a recessionary gap we&#39;re down low on that Phillips curve changes within the Phillips curve model are mirrored By changes in the aggregate supply aggregate demand model if we have a shift of aggregate demand that will be shown as an opposite direction shift as movement up or down the short run Phillips curve in the Phillips curve model if we have a shift of the short run aggregate supply curve that will be shown as an opposite direction shift of the short run Phillips curve a rightward shift of the short Niagara supply curve will be a leftward shift of the Phillips curve and vice versa now that long run Phillips curve is going to move with changes in the natural rate of unemployment which can change with changes in the frictional rate or the structural rate onto the last unit and that is foreign exchange markets first of all we have the balance of payments and that&#39;s an accounting of transactions between countries we have two components it&#39;s the current account and the financial and capital account in the current account we track transactions between countries for goods Services investment income and money transfers in the capital and financial account we track purchases of assets assets can include stocks currency bonds and other assets when it comes to the balance of payments money going into an economy is counted as a credit or an inflow money going out of an economy is a debit or an outflow now the sum of the current account and capital and financial account will always equal zero that means when one is in a surplus the other isn&#39;t a deficit and vice versa now one portion of the current account is the balance on trade that&#39;s exports minus Imports if exports are greater than Imports that is a trade surplus and if exports are less than Imports that&#39;s a trade deficit and that is just one part of the current account exchange rates are the price of one currency in terms of another currency if an exchange rate increases we say that the currency has appreciated if an exchange rate decreases that currency has depreciated the demand for a currency is downward sloping the demand for a currency will shift because of the demand for a country&#39;s exports interest rates within a country or expected exchange rates and those ones in the green box there are affected by monetary and fiscal policy Foreign Exchange Market supply curve is upward sloping showing the direct relationship between the exchange rate and the quantity of the currency the supply shifters are very similar to the demand shifters its demand for imports this time as well as the interest rates and the future expected exchange rate and once again those ones in the green box there are affected by monetary and fiscal policy when you put the supply curve and the demand curve together it gives us the equilibrium exchange rate and the equilibrium quantity of the currency demanded and supplied if United States national income decreases then we are going to buy fewer things from other countries that&#39;s going to decrease the supply of our dollars in increasing the equilibrium exchange rate now if our national income decreases then the places where we are no longer buying as much stuff will see a decrease in the demand for their currency in this case the Mexican peso sees a decrease in the demand for the peso because we&#39;re buying fewer mexican-made products now if our price level decreases we&#39;re going to see a double shift foreign made goods are now cheaper so we&#39;re going to import more and Export less that&#39;s going to be a increase in the supply of our dollars as we buy more foreign made goods and we&#39;re going to see a decrease in the demand for our dollars as foreigners buy less of our stuff if you get a question like this usually you can shift either curve or shift the one that is asked for so far they haven&#39;t required you to shift both if the United States sees an increase in interest rates that&#39;s also going to be a double shift so for other countries like Mexico in this market Mexican investors are going to withdraw their money from Mexican Banks and put their money in U.S banks that&#39;s going to increase the supply of Mexican pesos in their International markets and the low interest rate means that foreign investors will be less likely to put their money in Mexican Banks and that will decrease the demand for Mexican pesos both of those shifts will cause the depreciation of the Mexican peso now exchange rates impact net exports if a currency appreciates that means Imports are going to be cheaper and exports are going to be more expensive for foreign people that&#39;s going to mean exports decrease Imports increase that decreases our net exports and shifts our accurate demand curve to the left if a currency depreciates on the other hand that means Imports are going to be more expensive exports are going to be relatively cheaper for foreign people and that means exports are going to increase Imports are going to decrease net exports will increase as a result and that will shift our aggregate demand curve to the right whoa there you have it that is the bulk of what we can expect to show up on this year&#39;s AP macroeconomics exam if you got it all you are on your way to getting a five on that exam if you still need a little more help head over to review econ.com where there&#39;s lots of games and activities to help you practice the skill skills you need to Ace that macroeconomics exam that&#39;s all for now I&#39;ll see you all next time

Transcript for:AP Macroeconomics Exam Review

Transcript for:
AP Macroeconomics Exam Review