COMMON MISTAKES ON THE AP MACRO EXAM

Compiled by:

John OstickMalvern Prep

Malvern, PA 19355

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

$54321

1020355580

D

Price of Corn

Quantity of Corn

CORN

10 20 30 40 50 60 70 80

What if

Demand

Increases?

GRAPHING DEMAND

P

Qo

$5

4

3

2

1

P QD

$54321

D

Price of Corn

Quantity of Corn

CORN

10 20 30 40 50 60 70 80

D’

Increase

in

Demand

Increase

in Quantity

Demanded1020355580

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 if

Supply

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’Increase

in

Supply

Increase

in Quantity

Supplied

GRAPHING SUPPLY

Mislabeling or NOT labeling graphs correctly

Pric

e Le

vel

Real Domestic Output, GDP

Q

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

Ca

pit

al G

oo

ds

Consumer Goods

Pri

ce

Lev

el

Real GDP

ASLR1 ASLR2

Q1 Q2

ECONOMIC GROWTH IN THEEXTENDED AD – AS MODEL

Pri

ce L

evel

Real GDP

o

P1

AS2

ASLR1

AD2

Q1

ASLR2

Q2

AD1

AS1

P2

Ra

te o

f in

tere

st,

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 Market

Increase Spending (AD)>>Increase Demand for Money>>Increase Interest Rate

Higher 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...

Pri

ce le

vel

AD3

Pri

ce 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

GDP

Nominal 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

INCOME

NOMINAL 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

WAGES

NOMINAL 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 TIPs

If 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

Ag

gre

gat

e E

xpen

dit

ure

s (b

illio

ns

of

do

llars

)

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

Ag

gre

gat

e E

xpen

dit

ure

s (b

illio

ns

of

do

llars

)

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

Pri

ce L

evel

Real domestic output

bP2

P3

AD2

AS2

c

Q2

COST-PUSH INFLATION

o

P1

AS1

ASLR

AD1

a

Q1

Pri

ce 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

Pri

ce 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

Pri

ce 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

Pri

ce 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

An

nu

al r

ate

of in

flat

ion

(per

cen

t)

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

rat

e (p

erce

nt)

0

100

m

l

THE LAFFER CURVE

Tax revenue (dollars)

Tax

rat

e (p

erce

nt)

0

100

m

n

l

THE LAFFER CURVE

Tax revenue (dollars)

Tax

rat

e (p

erce

nt)

0

100

m m

n

l

THE LAFFER CURVE

Tax revenue (dollars)

Tax

rat

e (p

erce

nt)

MaximumTax

Revenue