AP Macroeconomics - Ultimate Review Flashcards
absolute advantage
a situation in which a person or country can produce more of a particular product from a specific quantity of resources than some other person or country
capital
human-made resources (buildings, machinery, and equipment) used to produce goods and services; goods that do not directly satisfy human wants; also called capital goods
ceteris paribus
The assumption that factors other than those being considered are held constant
comparative advantage
a situation in which a person or country can produce a specific product at a lower opportunity cost than some other person or country; the basis for specialization and trade
complements
products and services that are used together. When the price of one falls, the demand for the other increases (and conversely)
economic growth
An increase in the capacity of an economy to produce goods and services, compared from one period of time to another
factors of production
Economic resources: land, capital, labor, and entrepreneurial ability
fallacy of composition
The false notion that what is true for the individual (or part) is necessarily true for the group (or whole)
inferior goods
A good or service whose consumption declines as income rises, prices held constant
law of demand
The principle that, other things equal, an increase in a product’s price will reduce the quantity of it demanded, and conversely for a decrease in price
law of supply
The principle that, other things equal, an increase in the price of a product will increase the quantity of it supplied, and conversely for a price decrease
macroeconomics
The part of economics concerned with the economy as a whole; with such major aggregates as the household, business, and government sectors, and with measures of the total economy
microeconomics
The part of economics concerned with decision making by individual units such as a household, a firm, or an industry and with individual markets, specific goods and services, and product and resource prices
normal goods
A good or service whose consumption increases when income increases and falls when income decreases, price remaining constant
normative economics
The part of economics involving value judgments about what the economy should be like; focused on which economics goals and policies should be implemented; policy economics
opportunity cost
The amount of other products that must be forgone or sacrificed to produce a unit of a product
positive economics
The analysis of facts or data to establish scientific generalizations about economic behavior
production possibilities
A curve showing the different combinations of two goods or services that can be produced in a full employment, full production economy where the available supplies of resources and technology are fixed
scarcity
The ease of which you can obtain a certain good or product
substitutes
An alternate good of another good or a competitor
terms of trade
The rate at which units of one product can be changed for units of another product; the price of a good or service the amount of one good or service that must be given up to obtain 1 unit of another good or service
gross domestic product (GDP)
the total market value of all final goods and services produced annually within a country (eg. USA)
final goods
products purchased for final use and not for resale
intermediate goods
products purchased for resale or further manufacturing; not counted in the spending method of calculating GDP because it would cause double counting.
double (multiple) counting
wrongly including the value of intermediate goods in GDP
nominal (GDP, income, interest rate)
unadjusted for inflation: measured at current price levels
price index
the number which shows how the weighted average of selected goods changes throughout time
consumer price index (CPI)
the number which measures the prices of a fixed “market basket” of 300+ goods and services bought by a typical consumer
frictional unemployment
type of unemployment caused by temporary layoffs and workers voluntarily changing jobs
structural unemployment
unemployment of workers whose skills are not in demand, who lack skills to obtain employment or are unable to move to places where jobs are available
cyclical unemployment
a type of unemployment caused by insufficient total spending or insufficient aggregate demand
rule of 70
the number of year it will take for some measure to double, i.e for price level doubling, divide 70 by annual inflation rate
demand-pull inflation
inflation caused by there being more demand than there is output at the existing price levels
cost-push (supply) inflation
inflation resulting from an increase in resource costs and in per unit production costs
cost-of-living-adjustment (COLA)
automatic increase in the income of workers or pensions when inflation occurs
deflation
reduction in an economy’s price level; may occur during a recession
resource market
households sell and firms buy resources or services
product market
products are sold by firms and bought by households
economic growth
outward shift in the PPC; increase in real output (GDP) or real GDP per capita; caused by increasing quantity or quality or resources, technology, and productivity
calculating nominal vs real GDP
current production in current year prices vs. current production in base year prices
human capital
improvement in labor created by education and knowledge
current account
Part of the balance of payments which consists of trade in goods and services - net exports, investment income(dividends and interest) and net transfers.
financial account
Part of the balance of payments which consists of purchases and sales of international assets such as stocks, bonds, factories, buildings, and currency by a central bank
Expenditure Approach for calculating GDP
Adds together Consumption + Investment + Government Spending + Exports - Imports (C+I+G+X-M)
Income Approach for calculating GDP
Add together Wages + Profits + Interest + Rent (W+P+I+R)
GDP Deflator (Price Index)
a measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100
Non-discretionary Fiscal Policy
Automatic Stabilizers (permanent laws, wellfare, unemployment, income tax)
Discretionary Fiscal Policy
Congress creates a bill that is designed to change AD through gov spending or taxation (lag time is an issue)
Stagflation
Slow growth, high unemployment rate, high inflation (SRAS shifts left)
Crowding Out
The decrease in private expenditures that occurs as a consequence of increased government spending or the financing needs of a budget deficit
Discretionary Demand-Side Fiscal Policy
Deliberate changes of government expenditures and/or taxes to achieve particular economic goals
Expansionary Demand-Side Fiscal Policy
Increases in government expenditures and/or decreases in taxes to achieve particular economic goals
Fiscal Policy
Changes in government expenditures and/or taxes to achieve economic efficiency
Interest Rate Effect
The changes in household and business buying as the interest rate changes
International Trade Effect (Net Export Effect)
The change in foreign sector spending as the price level changes.
Marginal Propensity to Consume (MPC)
The fraction of any change in income spent on domestically produced goods and services; equal to the change in consumption divided by the change in disposable income.
Marginal Propensity to Save (MPS)
The fraction of any change in income that is saved; equal to the change in savings divided by the change in disposable income.
MPC + MPS = 1
The fraction of an increase in disposable income that is spent (MPC) plus the fraction that is saved (MPS) must equal 1.
Multiplier Effect
The increase in total spending in an economy resulting from an initial injection of new spending. The size of the multiplier effect depends upon the spending multiplier. An effect in economics in which an increase in spending produces an increase in national income and consumption greater than the initial amount spent.
Spending multiplier
= 1/(1-MPC) or 1/MPS. This tells you how much total spending an initial interjection of spending in the economy will generate. For example, if the MPC = .8 and the government spends $100 million, then the total increase in spending in the economy = $100 x 5 = $500 million.
Sticky wage and price model
The short-run Aggregate-Supply Curve is sometimes referred to as the “sticky wage and price model,” because workers’ wage demands take time to adjust to changes in the overall price level, and therefore, in the short-run an economy may produce well below or beyond its full employment level of output.
Real Balances Effect = Wealth Effect
One of the reasons the aggregate demand curve slopes downward: The tendency for increases in price level to lower the real value (or purchasing power) of financial assets with fixed money value and, as a result, to reduce total spending and real output. The idea that any wealth that you may have in the form of a cushion or securities becomes less valuable as prices rises because higher prices reduce real spending power, prices and output are negatively related.
2 Tools of Fiscal Policy
Federal Government engages in fiscal policy. Tool # 1 = Government Spending. Tool # 2 = Personal Income Taxes.
Classical Economic Theory
The view that an economy will self-correct from periods of economic shock if left alone. Also known as “laissez-faire” and derived from the thinking of Adam Smith, Thomas Malthus, and David Ricardo. Neoclassical theories are up-to-date versions of similar belief systems. Key idea that price levels and wages are fully flexible both upwards and downwards.
Transfer Payment
A payment made when no good or service is exchanged. Allowances are private transfer payments; social security checks are governmental transfer payments. Transfer payments are NOT included in GDP because they do NOT represent production.
factors of production
resources; includes land, labor, capital, and entrepreneurship.
marginal utility
extra usefulness a person gets from consuming one more unit of a product.
diminishing marginal utility
the more you consume of a product, the less satisfaction you receive from it.
movement along the demand curve
change in quantity demanded, caused only by a change in price
price ceiling
a cap on a price/maximum price allowed for a product; if set below equilibrium price, will cause a shortage.
price floor
minimum price allowed for a product; if set above equilibrium, will result in a surplus.
National accounts
keep track of the flows of money between different sectors of the economy
Firm
an organization that uses resources to produce a product, which it then sells
fiat money
currency whose value derives entirely from its official status as a means of exchange
commodity money
objects that have value in themselves and that are also used as money
3 functions of money
- medium of exchange (easily buy goods)
- unit of account (measures the value of goods)
- store of value (money allows you to store purchasing power for the future)
Types of Money
- M1 (high liquidity)- Coins/cash/checkable deposits The Money Supply
2.M2 (Medium liquidity)- M1 plus savings deposits/time deposits/ mutual funds below $100 K
M1 money supply
the most narrowly defined money supply, equal to currency in the hands of the public, time deposits & checkable deposits (demand deposits)
checkable deposits (demand deposits)
any deposit in a commercial bank or thrift institution against which a check may be written (a checking account)
M2 Money Supply
Includes all of M1 money supply plus most savings accounts, money market accounts, and certificates of deposit.
Monetary Base
the sum of currency in circulation and bank reserves
financial intermediaries
financial institutions through which savers can indirectly provide funds to borrowers. Example: Banks hold your savings, then loan it out to others
bank reserves
the money deposits held in banks or at the FED
reserve ratio
the fraction of deposits that banks hold as reserves
reserve requirement
the percentage of deposits that banking institutions must legally hold in reserve
excess reserves
a bank’s reserves over and above its required reserves
Total Reserves
required reserves + excess reserves
monetary policy
Government policy that attempts to manage the economy by controlling the money supply and thus interest rates.
Tools of Monetary Policy
reserve requirement, discount rate, open market operations (bonds)
federal funds rate
the interest rate at which banks make overnight loans to one another
discount rate
Interest rate the Federal Reserve charges for loans to commercial banks
open market operations
the buying and selling of government securities (bonds) to alter the supply of money. Buying bonds = bigger bucks, Selling bonds = smaller bucks
medium of exchange
Any item generally accepted to pay for a good or service; money; a convenient means of exchanging goods and services without engaging in barter.
unit of account
A standard unit in which prices can be stated and the value of goods and services can be compared
store of value
an asset that serves as a means of holding wealth
Money Supply Curve
shows the relationship between the quantity of money supplied and the interest rate. This curve is vertical and can only shift because of monetary policy
Money Demand Curve
a graphical representation of the negative relationship between the quantity of money demanded and the interest rate; the money demand curve slopes down because, other things equal, a higher interest rate increases the opportunity cost of holding money
Opportunity Cost of holding on to your money
Potential interest earned
demand for money
how much money people would like to hold in their “pockets” - access to liquid assets
expansionary monetary policy
Federal Reserve system actions to increase the money supply, lower interest rates, and expand real GDP
contractionary monetary policy
the federal reserve’s decreasing the money supply to increase interest rates to reduce inflation and real GDP
loanable funds market
The market in which the demand for private investment (loans) and the supply of household savings intersect to determine the equilibrium real interest rate.
demand for loanable funds
inverse relationship between real interest rate and quantity of loans demanded. How much money firms, individuals & governments what to borrow
supply for loanable funds
Direct relationship between real interest rate and loanable funds supplied. People will invest more at higher interest rates. The amount of savings made available to be loaned out
National Savings (Closed Economy)
Total amount of private and public savings. Closed economy means there is no trade occurring.
National Savings (Open Economy)
Total amount of private and public savings, plus net capital inflows (money coming in to country - money going out of the country). Open economy means trade is occurring.
equation for government savings
government savings = taxes - government spending - transfers
budget surplus/positive budget balance
tax revenue > g + tax
budget deficit/negative budget balance
tax revenue < g + tax
cyclically adjusted budget balance
an estimate of what the budget balance would be in real GDP were if it was exactly equal to potential output
(it separates the two effects of automatic stabilizers and discretionary fiscal policy)
national debt
the accumulation of all past budget deficits + all past budget surpluses
budget deficit
increase government demand for loanable funds and increases the real interest rate (then decreases C + I) called CROWDING OUT
debt to GDP ratio
the government’s debt as a percentage of GDP
implicit liabilities
spending promises made by governments that are effectively a debt, despite the fact that they are not included in the usual debt statistic
why does monetary policy work?
bc the money multiplier!
velocity of money
measures the number of times that the average dollar bill is spent in a year, the ratio of nominal GDP to the money supply
what do the letters stand for in M x V = P x Y
m = money supply, v = velocity of money, p = price, y = real gdp
money neutrality
changes in the money supply have no real effects in the economy
(in the LR, the only effect of the increase in the money supply is an increase in APL)
assumption about fixed income
people on fixed incomes will lose if there is high inflation (because APL goes up and their income does not change with it)
assumption about banks making fixed loans
banks who make loans on fixed interest rates will lose if there is high inflation
assumption about inflation rates and saving
when inflation rates are high, people will hold less money
fisher effect
in the LR, increases in future inflation will drive up the nominal interest rate, leaving the real interest unchanged
seigniorage
the government’s right to print money
liquidity trap
if we get into a situation when monetary policy is ineffective because interest rates are zero-bound
phillips curve
shows the relationship between the inflation and unemployment rate
mvmt along SRPC
when AD shifts, what happens to phillips curve?
shift of SRPC
when AS shifts, what happens to the phillips curve?
NAIRU stands for…
non-accelerating inflation rate of unemployment
inflation targeting
when the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that rate
classical model of the APL
the real quantity of money is always at LR equilibrium
short-run phillips curve
the negative short-run relationship between unemployment rate and inflation rate
NAIRU
the unemployment rate at which inflation does not change over time
long-run phillips curve
shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience
debt deflation
the reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation
Keynesian theory
-emphasized the short-run effects instead of long-run
-SRAS is upward sloping, not vertical
-shifts in STAS affect GDP AND APL
monetarism
GDP will grow steadily if money supply grows steadily
quantity theory of money
M x V = P x Y
Balance of payments accounts
national accounts that track both payments to and receipts from foreigners
balance of payments on current account
balance of payments on goods and services plus net international transfer payments and factor income
Balance of Payments on goods and services
the difference between its exports and its imports during a given period
Balance of payments on financial account
the difference between its sales of assets to foreigners and its purchases of assets from foreigners during a given period
Foreign Exchange Market
a market in which currencies of different countries are bought and sold
exchange rates
a measurement of the value of one nation’s currency relative to the currency of other nations
appreciation
An increase in the value of a currency
Equilibrium exchange rate
the exchange rate at which the quantity of a currency demanded in the foreign exchange market is equal to the quantity supplied
Real exchange rate
the rate at which a person can trade the goods and services of one country for the goods and services of another
Purchasing power parity
A monetary measurement of development that takes into account what money buys in different countries.
fixed exchange rate
An exchange rate policy under which a government commits itself to keep its currency at or around a specific value in terms of another currency or a commodity, such as gold.
floating exchange rate
an exchange rate policy under which a government permits its currency to be traded on the open market without direct government control or intervention
exchange market intervention
government purchases or sales of currency in the foreign exchange market
foreign exchange reserves
stocks of foreign currency that governments maintain to buy their own currency on the foreign exchange market
foreign exchange controls
licensing systems that limit the right of individuals to buy foreign currency
devaluation
lowering the value of a nation’s currency relative to other currencies
revaluation
an increase in the value of a currency that is set under a fixed exchange rate regime
trade balance
the value of a nation’s exports minus the value of its imports; also called net exports
trade surplus
when a country exports more than it imports
trade deficit
An excess of imports over exports
nominal exchange rate
the rate at which a person can trade the currency of one country for the currency of another
