A.P. Economics Final Exam Study Guide

I. TERMS AND CONCEPTS

1. Marginal analysis The comparison of marginal (“extra” or “additional”) benefits and marginal costs, usually for decision making. 2. Ceteris paribus assumption (other-things-equal assumption) The assumption that factors other than those being considered are held constant. 3. Built-in stability with set tax rates and spending policies, a rise in domestic income will reduce a budget deficit or produce a budget surplus while a decline will result in a deficit or a smaller surplus 4. Capital, entrepreneurial ability, land, and labor (CELL) The economic resources that are used in the production of goods and services; productive agents; factors of production. 5. Factors of production Economic resources: capital, entrepreneurial ability, land, and labor 6. Production possibilities table A table that lists the different combinations of two products that can be produced with a specific set of resources (and with full employment and productive efficiency). 7. Production possibilities curve 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. 8. Opportunity cost The amount of other products that must be forgone or sacrificed to produce a unit of a product. 9. Consumer sovereignty the power held by the consumer in the market place which helps maintain competition and prevent abuses. (dollar votes) 10. Scarcity Resources can only be used for one purpose at a time. Scarcity requires that choices be made. The relative scarcity of money compared to goods and services will allow money to retain its purchasing power. This is the fundamental economic problem. 11. Circular flow model The flow of resources from households to firms and of products from firms to households. These flows are accompanied by reverse flows of money from firms to households and from households to firms. Be able to distinguish among the various flow types. 12. 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. 13. 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. 14. Diminishing marginal utility The decrease in added satisfaction that results as one consumes additional units of a good or service, i.e., the second “Big Mac” yields less extra satisfaction (or utility) than the first. 15. Substitute goods Products or services that can be used in place of each other. When the price of one falls, the demand for the other product falls; conversely, when the price of one product rises, the demand for the other product rises. 16. Complementary goods Products and services that are used together. When the price of one falls, the demand for the other increases (and conversely). 17. Surplus The amount by which the quantity supplied of a product exceeds the quantity demanded at a specific (above-equilibrium) price. 18. Shortage The amount by which the quantity demanded of a product exceeds the quantity supplied at a particular (below-equilibrium) price. 19. Sole proprietorship An unincorporated firm owned and operated by one person. 20. Partnership An unincorporated firm owned and operated by two or more persons. 21. Corporation A legal entity (“person”) chartered by a state or the Federal government that is distinct and separate from the individuals who own it. 22. Spillover cost A cost imposed without compensation on third parties by the production or consumption of sellers or buyers. Example: A manufacturer dumps toxic chemicals into a river, killing the fish sought by sport fishers. 23. Double taxation The taxation of both corporate net income (profits) and the dividends paid from this net income when they become the personal income of households. 24. Investment Demand Curve Economic model which illustrates the inverse relationship between the real rate of interest and the level of investment spending 25. Gross domestic product (GDP) The total market value of all final goods and services produced annually within the boundaries of the United States, whether by U.S. or foreign- supplied resources 26. Nominal GDP The GDP measured in terms of the price level at the time of measurement (unadjusted for inflation). 27. Real GDP Gross domestic product adjusted for inflation; gross domestic product in a year divided by the GDP price index for that year, expressed as a decimal. 28. Consumer price index (CPI) An index that measures the prices of a fixed “market basket” of some 300 goods and services bought by a “typical” consumer 29. Business cycle Recurring increases and decreases in the level of economic activity over periods of years; consists of peak, recession, trough, and recovery phases. 30. Frictional unemployment A type of unemployment caused by workers voluntarily changing jobs and by temporary layoffs; unemployed workers between jobs. 31. Structural unemployment Unemployment of workers whose skills are not demanded by employers, who lack sufficient skill to obtain employment, or who cannot easily move to locations where jobs are available. 32. Cyclical unemployment A type of unemployment caused by insufficient total spending (or by insufficient aggregate demand). 33. Price index An index number that shows how the weighted-average price of a “market basket” of goods changes over time. 34. Measurement of inflation To measure inflation, subtract last year’s price index from this year’s price index and divide by last year’s index; then multiply by 100 to express as a percentage. 35. Demand-pull inflation Increases in the price level (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand. 36. Cost-push inflation Increases in the price level (inflation) resulting from an increase in resource costs (for example, raw-material prices) and hence in per-unit production costs; inflation caused by reductions in aggregate supply. 37. Okun’s law For every point that the unemployment rate exceeds the natural rate of unemployment, GDP will decline by 2 points annually 38. Who is hurt by inflation? Fixed-income groups, savers, lenders. Workers who are paid on salary with progressively cheaper money, thereby lowering their purchasing power. Farmers 39. Who benefits from inflation? Borrowers, people who buy on credit, people who rent out property 40. Shifts in Investment Demand Shifts in investment demand occur when any determinant apart from the interest rate changes. Greater expected returns create more investment demand; shift curve to right. The reverse causes a leftward shift. a. Acquisition, maintenance, and operating costs of capital goods may change. b. Business taxes may change. c. Technology may change. d. Stock of capital goods on hand will affect new investment. e. Expectations can change the view of expected profits. 41. Multiplier effect The effect on equilibrium GDP of a change in aggregate expenditures or aggregate demand (caused by a change in the consumption schedule, investment, government purchases, or net exports). 42. Aggregate demand A schedule or curve that shows the total quantity of goods and services demanded (purchased) at different price levels. 43. Aggregate supply A schedule or curve showing the total quantity of goods and services supplied (produced) at different price levels. 44. Real-balances effect The tendency for increases in the 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 GDP, and conversely for decreases in the price level. 45. Interest-rate effect The tendency for increases in the price level to increase the demand for money, raise interest rates, and, as a result, reduce total spending and real output in the economy (and the reverse for price-level decreases) 46. Determinants of aggregate demand (AD) Factors such as consumption spending, investment, government spending, and net exports that, if they change, shift the aggregate demand curve. 47. Determinants of aggregate supply (AS) Factors such as input prices, productivity, and the legal-institutional environment that, if they change, shift the aggregate supply curve. 48. Expansionary fiscal policy An increase in government purchases for goods and services, a decrease in net taxes, or some combination of the two for the purpose of increasing aggregate demand and expanding real output. 49. Contractionary fiscal policy A decrease in government purchases for goods and services, and increase in net taxes, or some combination of the two, for the purpose of decreasing aggregate demand and thus controlling inflation. 50. Monetary policy A central bank’s changing of the money supply to influence interest rates and assist the economy in achieving price stability, full employment, and economic growth. 51. Supply-side fiscal policy Tax reductions will shift the aggregate supply curve to the right, negating the inflation and increasing economic growth. 52. Money Any item that is generally acceptable to sellers in exchange for goods and services. 53. M1 The most narrowly defined money supply, equal to currency in the hands of the public and the checkable deposits of commercial banks and thrift institutions. 54. M2 All of M1 plus + savings deposits + money market mutual funds or deposit accounts + small time deposits (less than 100,000K) 55. Federal Reserve System (the “Fed”) Established by Congress in 1913 and holds power over the money and banking system. The Board of Governors of the Fed directs the activities of the 12 Federal Reserve Banks, which in turn control the lending activity of the nation’s banks and thrift institutions. 56. Federal Open Market Committee (FOMC) The 12-member group that determines the purchase and sale policies of the Federal Reserve Banks in the market for U.S. government securities. 57. Open-market operations The buying and selling of U.S. government securities by the Federal Reserve Banks for purposes of carrying out monetary policy. 58. Discount rate The interest rate that the Federal Reserve Banks Charge on the loans they make to commercial banks and thrift institutions. 59. Federal funds rate overnight rate at which banks loan money to other banks for reserve purposes 60. Reserve requirement The specified minimum percentage of its checkable deposits that a bank or thrift must keep on deposit at the Federal Reserve Bank in its district or hold as vault cash. 61. Easy money policy Federal Reserve System actions to increase the money supply to lower interest rates and expand real GDP. 62. Tight money policy Federal Reserve System actions that contract, or restrict, the growth of the nation’s money supply for the purpose of reducing or eliminating inflation. 63. Supply shocks Rapid and significant increases in resource costs that may occur with unexpected increases in the price of raw materials. The stagflation of the 1970s and early 1980s may have been caused by a series of adverse aggregate supply shocks. 64. Comparative advantage A lower relative or comparative cost than that of another producer. – Be able to calculate production ratios when given a variety of techniques. 65. Absolute advantage Occurs when a country or region can create more of a product with the same factor inputs. 66. Trade barriers/controls Tariffs, export subsidies, import quotas, and other means a nation may employ to reduce imports and expand exports. Trade barriers in the 1930s contributed to the Great Depression. 67. Tariff A tax imposed by a nation on an imported good. 68. Protective tariff A tariff designed to shield domestic producers of a good or service from the competition of foreign producers. 69. Import quota A limit imposed by a nation on the quantity (or total value) of a good that may be imported during some period of time. 70. Economic impact of tariffs Direct impacts include the decline in consumption, increased domestic production, decline in imports, and tariff revenue. Indirect impacts include fewer U.S. exports and the contraction of relatively efficient industries that do have a comparative advantage. 71. Dollar Votes = Consumer Sovereignty 72. Mixed Economy The combination of both the public and private sectors in an economy 73. Vertical Integration A group of plants engaged in different stages of production owned by a single firm 74. Horizontal Integration A group of plants engaged in the same stage of production owned by a single firm 75. Invisible Hand The tendency of firms to seek their own self-interests in competitive markets to also promote the interest of society 76. Transaction Demand for Money – Money demanded for purposes of exchange, direct relationship with nominal GDP. 77. Asset Demand for Money – Money demanded for purposes of holding as an asset, functioning as a store of value 78. F.O.M.C. – Federal Open Market Committee, Part of the Federal Reserve engaged in the purchase or sale of bonds to the public. Understand specifically how the sale or purchase bonds affects the money supply and under what conditions each option is used.

II. FORMULAS & SYMBOLS

1. GDP = C + Ig + G + Xn 2. APC + APC = 1 3. MPC + MPS = 1 4. GDP (SPENDING) MULTIPLIER = 1/MPS 5. MONETARY MULTIPLIER = 1/RESERVE RATIO 6. NOMINAL INTEREST RATE = REAL INTEREST RATE + INFLATION PREMIUM (%) 7. C = CONSUMPTION (Injection) 8. Ig = INVESTEMENT (Gross Private Domestic Investment) (Injection) 9. G = GOVERNMNET PURCHASES (Spending) (Injection) 10. Xn = EXPORTS (Injection) 11. Sa = SAVINGS (Leakage) 12. M = IMPORTS (Leakage) 13. T = TAXES (Leakage) 14. Injections = Leakages at Equilibrium GDP 15. Consumption of Fixed Capital (Depreciation) = GDP – NDP II. ECONOMIC MODELS

1. Consumption Schedule

2. Money Market

3. Production Possibilities Curve 4. Aggregate Demand & Aggregate Supply (Long run and Short Run)