AP Macro Unit 2 Notes

I have attached my AP Macroeconomics Unit 2 Notes with helpful diagrams.

Hope they help you understand complicated yet interesting concepts of Macroeconomics!

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Money 

• A payment for a good or service or a productive resource 

• In the resource market, it represents the wages, interest, rent, and profits households receive as income for their resources 

• In the product market, it represents the expenditures households make for goods and services 

Stakeholders 

• Firms/ producers 

• Households/ consumers 

• Government? 

Firms demand resources from households 

Products demand products from firms 

Firms 

• The entrepreneurs and their firms are seeking to maximize profits in the Product Market, which they will do by minimizing their costs in the Resource Market 

• Therefore firms must try to acquire the land, labor, and capital at the lowest cost possible and then sell their goods and services for the highest price possible 

Households 

• Households are seeking to maximize their incomes in the resource market in order to maximize their consumption of goods and services in the product market 

• Therefore households holds try to sell their resources for the highest price possible and buy their products at the lowest price possible. 

Circular Flow Model Vocab 

• Private Sector: part of the economy that is run by individuals and businesses 

• Public Sector: part of the economy that is controlled by the government 

• Factor Payments: payment for the factors of production, namely rent, wages, interest, and profit 

• Transfer Payments: when the government redistributes income (welfare, social security, … ) 

• Subsidies: government payments to businesses 

<Three Macroeconomic Goals> 

• Promote economic growth 

• Low unemployment 

• Keep prices stable (limit inflation) 

<Gross Domestic Product (GDP)> 

• The market value of all final goods& services produced within a country in a given period of time (a year or a quarter) 

• Your income depends on GDP 

• Measures how well the country is doing financially 

• Includes final goods only (final goods already embody the value of the intermediate goods used in their production) 

  • Final Goods: intended for the end user 

  • Intermediate Goods: used as components or ingredients in the production of other goods 

  • **avoid double counting!!! 

• GDP includes tangible goods and intangible services (dry cleaning, concerts, …) 

• GDP includes currently produced goods, not goods produced in the past 

• GDP measures the value of production that occurs within a country's borders, whether done by its own citizens or by foreigners located there 

• **Not included in GDP 

  • Intermediate goods  

  • Nonproduction transactions (financial transactions- stocks, bonds, real estate)  

  • Used goods (old cars, used clothes) 

  • Nonmarket and illegal activities (household production- unpaid work, black markets, drugs)  

  • Transfer payment (welfare) 

  • Stocks and bonds 

• Using GDP 

  • Compare to previous years (is there growth?) 

  • Compare policy changes (did a new policy work?) 

  • Compare to other countries 

GDP Per Capita 

• = GDP divided by the population 

• Identifies on average how many products each person makes 

• The best measure of a nation's standard of living 

Why do some countries have higher GDPs? 

• Economic System: capitalism promotes innovation and provides incentives to improve productivity 

• Rule of Law: countries with solid institutions and political stability have historically had more economic growth 

• Capital Stock: countries that have more machines and tools are more productive 

  • Japan has few natural resources but a high GDP 

• Human Capital: countries that have better education and training are more productive 

• Natural Resources: in general, countries that have access to more natural resources are more productive 

Calculating GDP 

• Expenditures approach (add up all the spending on final goods and services produced in a given year) 

  • Consumer spending, business investment, government spending, net exports (exports [x]- imports[m]) 

  • Not the value, but the change 

  • GDP (Y)= C+ I+ G+ (NX= X-M) 

• Income approach (add up all the income earned from selling all final goods and services produced in a given year) 

  • Rent+ Wage+ Interest+ Profit 

• Value-added approach (add up the dollar value added at each stage of the production process) 

• Each of these methods should generate the same number 

Consumer Spending 

• Durable goods (washing machines, refrigerators, cars) 

• Non-durable goods (food, clothes, toilet paper) 

• Services (dental work, repairs, tutoring) 

Consumption (C) 

• = total spending by households on g& s 

• Note on housing costs: 

  • For renters, consumption includes rent payment 

  • For homeowners, consumption includes the imputed rental value of the house, but not the purchase price or mortgage payments 

Investment (I) 

• = total spending on goods that will be used in the future to produce more goods 

• Includes spending on 

  • capital equipment (machines tools) 

  • Structures (factories, office buildings, houses) 

  • Inventories (goods produced but not yet sold) 

• **when you sell inventory investment, you don't count it again (it's a double counting) 

• Investment= NOT when individuals buy assets like stocks and bonds, but when businesses buy capital goods like machines, resources, and tools 

• If the oven is purchases by a business, then it would be investment, but not when it's purchased by a home 

Government Purchases (G) 

• = all spending on the g&s purchased by government at the federal, state, and local levels. 

• Includes payments made by the government for goods and services (excluding the money spent on transfer payments or interest payments on national debt) 

• The government collects taxes from households and firms and makes transfer payments to households 

Net Exports (NX) 

• = exports- imports 

• Represents foreign spending on the economy's g&s 

Unemployment: Workers that are actively looking for a job in four w ㅌeeks but aren't working 

The Unemployment Rate: The percent of people in the labor force who want a job but are not working 

• Unemployment Rate= (# unemployed/ # in labor force) *100 

Labor Force 

• The total # of workers, including the employed and unemployed 

• 16+ years old 

• Able and willing to work 

• Not institutionalized (jails/ hospitals) 

• Not in military, school full time, or retired

Discouraged Workers are nonworking people who are capable of working but have given up looking for a job due to the state of the job market. (no hope) 

• Not in labor force 

Marginally attached workers would like to be employed and have looked for a job in the recent past but are not currently looking for work. (still wanting a job tho) more than four weeks ago 

• Not in labor force 

The underemployed are workers who would like to work more hours or who are overqualified for their jobs.  

<Criticisms of the Unemployment Rate> 

• The u-rate is not a perfect indicator of joblessness or the health of the labor market 

• The unemployment rate can misdiagnose the actual unemployment rate because of: 

  • It excludes discouraged workers—and marginally attached workers 

    • Some people are no longer looking for a job because they have given up 

    • Labor Force Participation Rate 

      • Percent of population in the labor force. If people leave labor force, the unemployment rate falls 

  • Unemployment Workers 

    • Someone who wants more hours but can’t get them is still considered employed. Does not distinguish between full-time and part-time work, or people working part time because full-time jobs not available 

  • Race/ Age Inequalities 

    • The overall unemployment rate doesn’t show disparity for minorities and teenagers. 

    • Also, some people misreport their work status in the BLS survey. 

<3 Types of Unemployment> 

• Frictional unemployment: temporary unemployment of being between jobs 

  • High school or college graduates looking for jobs 

  • Individuals that were fired or are looking for a better job 

  • Seasonal unemployment (due to time of year) 

• Structural unemployment: changes in the labor force make some skills obsolete 

  • VCR repairman, milkman 

  • The workers do not have transferable skills and these jobs will never come back. Workers must learn new skills to get a job 

  • The permanent loss of these jobs is called "creative destruction" 

  • Technological unemployment: type of structural unemployment where automation and machinery replace workers 

• Cyclical unemployment: unemployment caused by a recession; business cycle 

  • Steel workers laid off  during recessions, high unemployment during the Great Depression 

  • As demand for goods and services falls, demand for labor falls and workers are laid off 

  • This is sometimes called "demand deficient unemployment" 

<Natural Rate of Unemployment (NRU)> 

• Frictional and structural unemployment are present at all times because some people will always be between jobs or replaced by technology 

• So, the economy is doing great if there is only frictional and structural unemployment. 

• NRU= frictional plus structural unemployment 

  • Full Employment Output (Y): the real GDP created when there is no cyclical unemployment 

Minimum-Wage Laws 

• The minimum wage may exceed the equilibrium wage for the least skilled workers, causing structural unemployment 

Unions 

• A worker association that bargains with employers over wages, benefits, and working conditions 

• Exert their market power to negotiate higher wages for workers 

Efficiency Wages 

• Firms voluntarily pay above-equilibrium wages to boost worker productivity 

  • Worker health 

  • Worker turnover 

  • Worker quality  

  • Worker effort 

 Inflation 

• = overall increase in prices. Erodes the purchasing power of a given income 

• In general, high inflation is bad because banks don't lend and people don't save 

• This decreases investment and GDP 

Deflation 

• = overall decrease in prices. Strengthens the purchasing power of a given income 

• Bad, because people will hoard money and assets 

• Decreases consumer spending and GDP 

• Disinflation- prices increasing at slower rates 

How if inflation measured? 

• The government tracks the prices of specific "market baskets" that included the same goods and services 

• The inflation Rate: the percent change in prices from year to year 

• Price Indices: index numbers assigned to each year that show how prices have changed relative to a specific base year 

<Consumer Price Index (CPI)> 

• Measuring inflation rate 

• A measure of the average change over time in the prices paid by consumers for a FIXED "market basket" of goods and services 

• Market Basket 

  • Goods and services purchased by consumers 

• When the CPI rises, inflation is occurring 

**when calculating price of market basket (base year), use CURRENT prices and base year quantity. 

• Rate of Change (inflation rate)

Nominal Wage: wage measured by dollars rather than purchasing power 

Real Wage: wage adjusted for inflation  

<Real vs. Nominal Interest Rates> 

• Real interest rate: 

  • Corrected for inflation 

  • The rate of growth in purchasing power of a deposit of debt  

  • = nominal interest rate- inflation rate 

• Nominal interest rate 

  • Not corrected for inflation 

  • The rate of growth in the dollar value of a deposit or debt 

  • = real+ expected inflation rate 

<Nominal vs. Real> 

• Nominal 

  • Variables that have NOT been adjusted for inflation 

  • Nominal income, GDP, interest rate 

• Real 

  • Variables that have been adjusted for inflation 

    
    

<Limitations of CPI> 

• Substitution bias 

  • FIXED basket- market basket does not change to reflect consumer reaction to changes in relative prices 

  • Consumers substitute toward goods that have become relatively less expensive 

• New Products 

  • The market basket does not reflect the change in purchasing power brought on by the introduction of new products 

• Product Quality 

  • CPI ignores both improvements and decline in product quality 

• Problems of these limitations 

  • Many government programs use the CPI to adjust for changes in the overall level of prices (Cost-Of-Living-Adjustments, COLA) 

  • If the CPI overstates the inflation rate, then cost of living adjustments will be higher than they need to be 

 Rise in GDP deflator (increase in the overall price level of goods and services produced within an economy) or Rise in CPI= inflation  

If inflation is HIGHER than expected, the purchasing power of a given amount of money to be received in the future is LOWER than expected 

<Effects of Unanticipated Inflation> 

• Hurt by Inflation 

  • Leaders- people who lend money (at fixed interest rates) who will receive money 

  • Workers with fixed incomes 

  • Savers (since the value of the money is little) 

• Helped by Inflation 

  • Borrowers- people who borrow money 

  • A business where the price of the product increases faster than the price of resources 

<Cost of Inflation> 

• Menu Costs- costs money to change listed prices 

  • Businesses must update menus, signs, etc 

• Shoe Leather Costs- the costs of transactions increase 

  • People reduce their real money holdings so they must spend time and effort making additional trips to the bank 

• Unit of Account Costs- money doesn't reliably measure the value of goods/ services 

  • Leads to less efficient use of resources because of uncertainty caused by changes in currently value 

• Tax distortions- inflation  

  • Inflation makes nominal income grow faster than real income 

  • Because taxes are based on nominal income, inflation causes people to pay more taxes 

    
    

<Real vs. Nominal GDP> 

• Nominal GDP 

  • (PL* Y)= Pcurrent* Qcurrent  

  • Real GDP* (aggregate Price Level (PL)/ 100) 

  • GDP measured in current prices. 

  • A measure of how much is spent on output in a given period  

  • Does not account for inflation from year to year 

• Real GDP (Y) 

  • Pbase* Qcurrent  

  • (Nominal GDP/ aggregate Price Level)* 100 

  • Values output using the prices of a base year 

  • GDP expressed in constant (base year), or unchanging, dollars.  

  • Adjusts for inflation. 

  • The change in real GDP is the amount that GDP would change if prices were constant (if zero inflation) 

• Real GDP is better than nominal GDP for measuring actual growth 

<CPI vs. GDP Deflator> 

• GDP deflator measures the prices of all goods produced 

  • Monitor of the average level of prices in an economy 

  • Tells us aggregate Price Level 

  • = implicit price deflator 

<Business Cycle>

• Recession 

  • High unemployment, low output 

  • Growth/ recovery 

    • Unemployment decreases, output increases 

• Peak 

  • High output, low unemployment, price level increases 

• Depression 

  • High unemployment, low output 

• Potential output (point on PPC): linear 

• Actual output: curvy line 

• When actual output= potential output, then unemployment= natural unemployment rate.