Kingsley's AP Macroeconomics Blog

The  balance of payments  is the measure of money inflows and outflows between the United States and the Rest of the World (ROW).  Inflows  are referred to as  credits  and  outflows  are referred to as  debits . The balance of payments is divided into three accounts:  current account ,  capital/financial account , and  official reserves account . Current Account Balance of trade or net exports exports of goods/services - import of goods/services exports  create a  credit  to the  balance of payments imports  create a  debit  to the  balance of payments Net foreign income income earned by U.S. owned foreign assets - income paid to foreign-held U.S. assets ex: interest payments on U.S. owned Brazilian bonds - interest payments on German-owned U.S. Treasury bonds Net transfers (tend to be unilateral) foreign aid -> a debit to the current account ex: Mexican migrant wo...

Monetary policy is always conducted by the Fed and only affects AD through investment spending . In open market operations , the Fed can either buy bonds, which increases the money supply, or sell bonds, which decreases the money supply. The discount rate is used when FDIC member banks and other eligible institutions may borrow short-term loans from the Fed (banks borrow from the Fed). The federal funds rate is used when FDIC member banks loan each other overnight funds (banks borrow from each other). Reserve requirement is a certain amount of reserves that banks must keep in the vault. The prime rate is the interest rate that banks charge to do their most creditworthy customers. If the Fed wants to fight a recession , it will enact expansionary monetary policy to increase the money supply by using one or more of the following tools: Buying bonds in open market operations when the Fed buys bonds, a demand deposit (DD) is created banks can make mo...

The loanable funds market is where savers and borrowers exchange funds ( Q LF ) at the real interest rate (r%). The demand for loanable funds , or borrowing , comes from households, firms, government, and the foreign sector. The demand for loanable funds is, in fact, the supply of bonds . The supply of loanable funds , or savings , comes from households, firms, government, and the foreign sector. The supply of loanable funds is also the demand for bonds . Remember that demand for loanable funds = borrowing (i.e. supplying bonds) . Changes in the demand for loanable funds occur when there is: More borrowing = more demand for loanable funds (->) Example: Government deficit spending = more borrowing = more demand for loanable funds, therefore  D LF  -> and r% increases Less borrowing = less demand for loanable funds (<-) Example: Less investment demand = less borrowing = less demand for loanable funds, therefore D LF  <- and r% decreases Re...

The money market is where the Federal Reserve and the users of money interact, thus determining the nominal interest rate (i%). It is composed of two parts: Money demand (MD) comes from households, firms, government, and the foreign sector. Money supply (MS) is determined only by the Federal Reserve. Money demand is further divided into three parts: Transaction demand is the demand for money as a medium of exchange (independent of interest rate). Asset demand is the demand for money as a store of value (dependent of the interest rate). Total money demand MD is downward sloping because at high interest rates people are less inclined to hold money and more inclined to hold stocks and bonds At lower interest rates people sacrifice less when they hold money Money supply is determined by the Federal Reserve because the Federal Reserve has monopoly control over the supply of money. For more information, please refer to these videos on Khan Academy: Demand ...

There are three functions of money : medium of exchange, store of value, and unit of account. Medium of Exchange it serves to trade one product for another Store of Value where money holds its value over a period of time Unit of Account establishes economic worth There are three types of money : commodity money, representative money, and fiat money. Commodity Money gets its value from the type of material from which it is made examples are gold and silver in products Representative Money paper money backed by something tangible that gives it value examples are gold-or-silver-backed money and IOUs Fiat Money money because the government says so There are seven characteristics of money : Durability Portability Divisibility Uniformity Scarcity Acceptability Limited Supply Money supply consists of M1 money, M2 money, and M3 money. M1 Money consists of currency in circulation, which can be: currency , which consists of cash and c...

Fiscal policy is the changes in the expenditures or tax revenues of the federal government. It is enacted to promote our nation's economic goals: full employment, price stability, and economic growth. There are two tools of fiscal policy : Taxes --government can increase or decrease taxes Spending --government can increase or decrease spending Here is some information about deficits, surpluses, and debt : Balanced budget Revenues = Expenditures Budget deficit Revenues < Expenditures Budget surplus Revenues > Expenditures Government debt Sum of all deficits - Sum of all surpluses The government must borrow money when it runs a budget deficit The government borrows from: Individuals Corporations Financial institutions Foreign entities or foreign governments There are two options for fiscal policy : Discretionary fiscal policy (action) Expansionary fiscal policy -- think deficit Contractionary fiscal policy -- think surpl...

Disposable income (DI) is income after taxes or net income. With disposable income, households have two choices. They can: Consume (spend money on goods and services) Save (not spend money on goods and services) Consumption (C) is household spending. Households consume if DI = 0 through autonomous consumption and dissaving. The ability to consume is constrained by: The amount of DI The propensity to save Saving (S) is when the household is NOT spending. Households do NOT save if DI = 0. The ability to save is constrained by: The amount of DI The propensity to consume Here are some formulas and information about average propensity to consume (APC) and average propensity to save (APS) : APC + APS = 1 1 - APC = APS 1 - APS = APC APC > 1 (dissaving) -APS (dissaving) The marginal propensity to consume (MPC) is the percentage of every extra dollar earned that is spent. It is also the fraction of any change in DI that is consumed. Its equations a...

Investment is money spent or expenditures on the following: New plants (factories) Capital equipment (machinery) Technology (hardware and software) New homes Inventories (goods sold by producers) Businesses make investment decisions using cost/benefit analysis . Businesses determine these benefits using expected rates of return . They count the costs using interest costs . Businesses determine the amount of investment they should undertake by comparing the expected rate of return to the interest cost . If the expected return is greater than the interest cost, then they should invest . If the expected rate of return is less than the interest cost, then they shouldn't invest . The nominal interest rate (i%) is the observable rate of interest. Real interest rate (r%) subtracts out the inflation rate ( π%)  and is only known ex post facto. The real interest rate determines the cost of an investment decision. The equation is as follows: r% = i% -  π% The...

The AS/AD model shows that the equilibrium of AS and AD determines the current output (real GDP) and the price level. Full employment equilibrium exists where AD intersects SRAS and LRAS at the same point. A recessionary gap exists when equilibrium occurs below full-employment output AD <- SRAS <- An inflationary gap exists when equilibrium occurs beyond full employment output. AD -> SRAS -> There are three ranges of SRAS : Keynesian or horizontal range , intermediate range , and classical or vertical range . Keynesian or horizontal range occurs when we are in a recession or depression, not fully using all of our resources, and below full employment. Intermediate-range occurs when resources are getting closer to full employment levels, which creates upward pressure on wages and prices. Classical or vertical range occurs when real GDP is at a level below the full employment level where any increase in demand will result only in an inc...

Aggregate supply , or AS , is the level of real GDP that firms will produce at each price level. Long-run is the period of time where input prices are completely flexible and adjust to changes in the price level. In the long-run, the level of real GDP supplied is independent of the price level. Short-run is the period of time where input prices are sticky and don't adjust to changes in the price level. In the short-run, the level of real GDP supplied is directly related to the price level. There are two types of aggregate supply: long-run aggregate supply (LRAS) and short-run aggregate supply (SRAS) . Long-run aggregate supply (LRAS) marks the level of full employment in the economy (analogous to production possibilities chart, or PPC). Because input prices are completely flexible in the long-run, changes in price level don't change firms' real profits and therefore don't change firms' level of output. This means that the LRAS is vertical at the...

Aggregate demand , or AD , shows the amount of real GDP that the private, public, and foreign sector collectively desire to purchase at each possible price level. In other words, it is the demand by consumers, businesses, government, and foreign countries. Changes in price level cause a move along the curve, not a shift of the curve. The relationship between the price level and the level of real GDP is inverse. The formula for aggregate demand is as follows: AD = C + Ig + G + Xn There are 3 reasons why aggregate demand is downward sloping , which are wealth effect , interest-rate effect , and foreign trade effect . Wealth Effect Higher prices reduce purchasing power of money This decreases the quantity of expenditures Lower price levels increase purchasing power and increase expenditures Interest-Rate Effect As price level increases, lenders need to charge higher interest rates to get a REAL return on their loans Higher interest rates discourage consumer spending and b...