COMMON MISTAKES ON THE AP MACRO EXAM

Compiled by:

John OstickMalvern Prep

The difference between a change in demand and the resultant movement along

a demand curve

vs.

Shifting of the demand curve

P

Qo

$5

4

3

2

1

P QD$5

4321

1020355580

D

Price of Corn

Quantity of Corn

CORN

10 20 30 40 50 60 70 80

What ifDemand

Increases?

GRAPHING DEMAND

P

Qo

$5

4

3

2

1

P QD$5

4321

D

Price of Corn

Quantity of Corn

CORN

10 20 30 40 50 60 70 80

D’Increase

inDemand

Increasein QuantityDemanded10

20355580

30406080 +

GRAPHING DEMAND

The difference between a change in supply and the resultant movement along

a supply curve

vs.

Shifting of the supply curve

SP

Qo

$5

4

3

2

1

10 20 30 40 50 60 70 80

$54321

60503520 5

P QS

Price of Corn

Quantity of Corn

CORN

What ifSupply

Increases?

GRAPHING SUPPLY

SP

Qo

$5

4

3

2

1

10 20 30 40 50 60 70 80

Price of Corn

Quantity of Corn

$54321

60503520 5

P QS

CORN

8070604530

S’Increasein

Supply

Increasein QuantitySupplied

GRAPHING SUPPLY

Mislabeling or NOT labeling graphs correctly

Pric

e Le

vel

Real Domestic Output, GDPQ

P AS

AD

Equilibrium in theIntermediate Range

QeQ1 Q2

EQUILIBRIUM: REAL OUTPUTAND THE PRICE LEVEL

P1

Pe

GROWTH IN THE AD-AS MODEL

A

B

C

D

Cap

ital G

oods

Consumer Goods

Pric

e Le

vel

Real GDP

ASLR1 ASLR2

Q1 Q2

ECONOMIC GROWTH IN THEEXTENDED AD – AS MODEL

Pric

e L

evel

Real GDPo

P1

AS2

ASLR1

AD2

Q1

ASLR2

Q2

AD1

AS1

P2

Rat

e of

inte

rest

, i (p

erce

nt)

Amount of money demanded(billions of dollars)

0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ie

Sm

A temporary shortageof money will requirethe sale of some assetsto meet the need.

Sm1

THE MONEY MARKET

Net effects of Monetary Policy and/or Fiscal Policy

onInterest Rate (I%)

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION

Pric

e le

vel

Real GDP (billions)

AS

AD2

$495 $515

P1

AD1

Fiscal PolicyAnd Inflation

$505

Expansionary Fiscal Policy >> Interest Rate

INCREASEDraw Money MarketIncrease Spending (AD)>>Increase Demand for Money>>Increase Interest RateHigher Price Level>>Increase Demand for Money>>Increase Interest Rate

Expansionary Monetary Policy>> Interest Rate

DECREASE

Real domestic output, GDP

Dm

InvestmentDemand

Rea

l rat

e of

inte

rest

, i

10

8

6

0Quantity of money demanded and supplied Amount of investment, i

MONETARY POLICY AND EQUILIBRIUM GDPSm1

AS

AD1P1

10

8

6

0

Sm2

AD2

P2

Money Supply Increases

Interest Rate Decreases

Investment Increases

AD & GDP Increaseswith slight inflation

If the moneysupply increasesto stimulate the

economy...

Pric

e le

vel

AD3

Pric

e le

vel

Real domestic output, GDP

Dm

InvestmentDemand

Rea

l rat

e of

inte

rest

, i

10

8

6

0Quantity of money demanded and supplied Amount of investment, i

MONETARY POLICY AND EQUILIBRIUM GDPSm1

AS

AD1P1

10

8

6

0

Sm2

AD2

P2

More Money Supply

Lower Interest Rates

More Investment

Still higher AD & GDPwith significant inflation

Sm3

P3 If the moneysupply increases

again…

MULTIPLIER(S) CONFUSION

Income (Spending) Multiplier

Multiplier = 1/ 1 – MPC or 1/ MPS

Initial Change in Spending X MULTIPLIER = Change in Output

MONEY MULTIPLIER 1 / Required Reserve Ratio

Maximum Multiple $$$ Money Expansion

MULTIPLE DEPOSIT EXPANSION PROCESS

BankAcquired reserves

and depositsRequiredreserves

Excessreserves

Amount bankcan lend - Newmoney created

ABCDEFGHIJKLMNOther banks

$100.00 80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 21.97

$20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40

$80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57

$80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57

$400.00Total amount of money created by the banking system

Balanced Budget Multiplier

= 1

(Net Result on GDP)

Remembering the difference between the

Amount of Money Created

and theChange in the Money

Supplywhen dealing with the Money Multiplier and

Money Creation

New reserves$800

ExcessReserves

$4000Bank System Lending

FEDERAL RESERVEPURCHASE OF BONDS

Purchase of a$1000 bondfrom a bank...

$200Requiredreserves

$1000Initial

Deposit

Total Increase in Money Supply ($5000)

Confusing Comparative Advantage

Calculations

Remembering the difference between

Real and

Nominal

Nominal:with Inflation

Real:without Inflation

GDPNominal GDP: GDP measured in terms of current Price Level at the time of measurement. (Unadjusted for inflation)

Real GDP: GDP adjusted for inflation; GDP in a year divided by a GDP deflator (Price Index) for that year

INCOMENOMINAL INCOME: number of dollars received by an individual or group for its resources during some period of time

REAL INCOME: amount of goods and services which can be purchased with nominal income during some period of time; nominal income adjusted for inflation

INTEREST RATE (I%)NOMINAL I%: interest rate expressed in terms of annual amounts currently charged for interest; not adjusted for inflation

REAL I%: interest rate expressed in dollars of constant value (adjusted for Inflation) and equal to the NOMINAL I% minus the EXPECTED RATE OF INFLATION

NominalInterest

Rate

RealInterest

Rate

InflationPremium

=11%

5%

6%+

ANTICIPATED INFLATION

WAGESNOMINAL WAGES: amount of money received by a worker per unit of time (hour, day, etc.); Money Wage

REAL WAGES: amount of goods and sevices a worker can purchase with their NOMINAL WAGE; purchasing power of the nominal wage.(Real = Nominal – Inflation rate)

NOMINAL/REAL TIPsIf nominal rates INCREASE and Price Level INCREASE, the CHANGE in Real is “indeterminable.”If nominal Wage rates do NOT change and Price Level fall. REAL WAGES increase.NOMINAL RATES “PIGGY-BACK” REAL RATES & NOT VICE VERSA.

Confusing calculationsusing

MPC / MPSto determine changes necessary to correct

Recessionary andInflationary Gaps

FULL-EMPLOYMENT GDP

Agg

rega

te E

xpen

ditu

res

(bill

ions

of d

olla

rs)

o45 o

Real domestic product, GDP (billions of dollars)

490 510 530

AE0

Recessionary Gap

AE1

530

510

490

Recessionary Gap= $5 Billion

Full Employment

FULL-EMPLOYMENT GDP

Agg

rega

te E

xpen

ditu

res

(bill

ions

of d

olla

rs)

o45 o

Real domestic product, GDP (billions of dollars)

490 510 530

AE0

Inflationary Gap

AE2

530

510

490

Inflationary Gap= $5 Billion

Full Employment

Demand-Pull Inflation

vs.

Cost-Push Inflation

DEMAND-PULL INFLATION

o

P1

AS1

ASLR

AD1

a

Q1

Pric

e L

evel

Real domestic output

bP2

P3

AD2

AS2

c

Q2

COST-PUSH INFLATION

o

P1

AS1

ASLR

AD1

a

Q1

Pric

e L

evel

Real domestic output

bP2

AS2

Occurs when short-run AS shifts left

Q2

COST-PUSH INFLATION

o

P1

AS1

ASLR

AD1

a

Q1

Pric

e L

evel

Real domestic output

bP2

P3

AD2

AS2

Government response with increased AD

c

Evenhigherpricelevels

COST-PUSH INFLATION

o

P1

AS1

ASLR

AD1

a

Q1

Pric

e L

evel

Real domestic output

bP2

AS2

If government allows a recession to occur

Q2

Q2

COST-PUSH INFLATION

o

P1

AS1

ASLR

AD1

a

Q1

Pric

e L

evel

Real domestic output

bP2

AS2

If government allows a recession to occur

Nominal wages fall &AS returns

to its originallocation

Phillips Curve

vs.

Laffer Curve

Ann

ual r

ate

of in

flatio

n(p

erce

nt)

Unemployment rate (percent)

7

6

5

4

3

2

1

01 2 3 4 5 6 7

As inflation declines...

THE PHILLIPS CURVE CONCEPT

Unemploymentincreases

0

100

l

THE LAFFER CURVE

Tax revenue (dollars)

Tax

rate

(per

cent

)

0

100

m

l

THE LAFFER CURVE

Tax revenue (dollars)

Tax

rate

(per

cent

)

0

100

m

n

l

THE LAFFER CURVE

Tax revenue (dollars)

Tax

rate

(per

cent

)

0

100

m m

n

l

THE LAFFER CURVE

Tax revenue (dollars)

Tax

rate

(per

cent

)

MaximumTax

Revenue