Economics Chapter on GDP and Unemployment

AP Macroeconomics Review Material

• This document is a review guide for AP Macroeconomics.
• It was created by Qiu Jinyue and Qiao Yijia.
• The document is reviewed by Wang Qing.
• The document is divided into 25 pages.

Circular Flow Diagram

• A simplified model showing the flow of goods, services, and resources in an economy.
• Represents the interaction between households and businesses in the resource and product markets.
• Illustrates the flow of money and resources between households and businesses.

Production Possibility Frontier (PPF)

• Shows the maximum possible combinations of goods that can be produced with given resources and technology.
• The shape of the PPF (bowed outward) indicates increasing opportunity costs. This is because resources are not equally productive in all areas of production.
• A shift outward of the PPF indicates economic growth, either through improvements in technology, or an increase in resources.

Trade

• Trade allows both countries to benefit by specializing in the production of goods in which they have a comparative advantage.
• Absolute advantage is when a country can produce a good using fewer inputs.
• Comparative advantage is when a country can produce a good at a lower opportunity cost.

Financial Investment / Economic Investment

• Financial investment encompasses the purchase of assets like stocks, bonds, and real estate to gain financial returns.
• Economic investment refers to spending on the production and acquisition of newly created capital goods.

Interest Rate-Investment Relationship

• Investment decisions depend on the marginal benefit (expected rate of return) and marginal cost (interest rates).
• Businesses will borrow when their expected rate of return exceeds the interest rate.

Shift Factors of Investment Demand

• Acquisition, maintenance, and operating costs, business taxes, technological change, stock of capital goods on hand, planned inventory changes, and expectations all influence investment demand.

Measuring Economic Activity (GDP)

• GDP (Gross Domestic Product) is the total market value of all final goods and services produced within a country in a year.
• Intermediate goods are not included in GDP to avoid double counting.
• GDP can be calculated using the expenditure approach (Y = C + I + G + NX) or the income approach.
• where Y = GDP = output, C = consumption, I = investment, G = government spending, NX = net exports.

Other Accounts

• Net Domestic Product (NDP) = GDP - depreciation
• National Income (NI) = NDP + net foreign factor income

Inflation

• Inflation is a rise in the general level of prices.
• Demand-pull inflation occurs when an increase in demand outpaces the economy's ability to supply goods.
• Cost-push inflation results from a decrease in the supply of goods or an increase in input costs (e.g., energy)
• Inflation can cause a redistribution of income and wealth.

Consumer Price Index (CPI)

• CPI measures the overall cost of a basket of goods and services purchased by a typical consumer.
• It is used to track inflation and adjust for its impact on purchasing power.
• It has some biases (substitution bias, new goods, quality change).

Production and Growth

• Economic growth is defined as an increase in real GDP or real GDP per capita over a period of time.
• Factors determining growth include, increasing the quantity and quality of natural resources, increasing the quantity and quality of human resources, increasing the stock of capital goods, and technological progress.

Supply Factors

• Increases in the quantity and quality of natural resources, human resources, and capital goods are supply-side factors that increase potential GDP.
• Technological improvements also contribute to increased potential GDP.

Demand Factors

• Increases in total spending drive economic growth.

Efficiency Factors

• Economic efficiency and full employment are necessary to achieve the full production potential of an economy

Business Cycle

• Recessions and expansions are normal economic fluctuations. The economy often dips into a recession, and then, recovers.

Unemployment

• Unemployment rates fluctuate with the business cycle.
• Unemployment arises during recessions because businesses reduce production and cut back on hiring.
• Types of unemployment include frictional, structural, and cyclical.

GDP Gap

• GDP gap describes the difference between actual GDP and potential GDP.
• A negative GDP gap indicates unemployment exceeding the natural rate.
• A positive GDP gap indicates that the actual rate of unemployment is below the natural rate.

Aggregate Demand (AD)

• Aggregate Demand (AD) is the total quantity of goods and services demanded at various price levels in a given time period.
• AD curve slopes downward because of the real-balance effect, the interest-rate effect, and the exchange-rate effect, meaning they all react inversely to inflation.
• Factors affecting AD include changes in consumption (C), investment (I), government purchases (G), and net exports (NX).

Aggregate Supply (AS)

• Short-run aggregate supply (SRAS) is upward sloping because input prices are fixed in the short-run.
• Long-run aggregate supply (LRAS) is vertical because input prices are flexible in the long run. Input prices will adjust to changing price levels so that the economy always operates at full employment.

Fiscal Policy

• Fiscal policy includes changes in government spending or taxes.
• An increase in government spending or decreases in net taxes will increase aggregate demand. Conversely, a decrease in government spending or an increase in net taxes will decrease aggregate demand.

Automatic Stabilizers

• Automatic stabilizers reduce the severity of economic fluctuations.
• The progressive income tax system and transfer payments are examples of automatic stabilizers.

Money

• Money functions as a medium of exchange, a unit of account, and a store of value.
• Types of money include currency, demand deposits, and other checkable deposits.

Banking System

• Fractional-reserve banking allows banks to create money.
• When banks only hold a fraction of deposits as reserves, the money supply can increase by a multiple of the initial deposit.

Monetary Policy

• Monetary policy includes changing the money supply to affect interest rates and macroeconomic aggregates like investment, consumption, employment, GDP, and Price Level to manage the economy.
• Policy tools include open market operations, changes to the reserve requirement, and the discount rate.
• During a recession, expansionary monetary policy is used and during inflation, restrictive monetary policy is used.

Phillips Curve

• The trade-off between inflation and unemployment is illustrated by the Phillips Curve.
• The short-run Phillips curve (SRPC) shows an inverse relationship between inflation and unemployment.
• The long-run Phillips curve (LRPC) is vertical at the natural rate of unemployment.

Balance of Payments

• A nation's current account and capital account are in balance.
• The current account reflects the flow of goods, services, and investment income across borders.
• The capital account records international purchases and sales of assets.