Commonly Missed Concepts of AP Macroeconomics

Alright, let’s review for AP Drawing Graphs and go over some of the most commonly missed (and least taught) concepts on the AP exam.

First off, C + I + G + NX = Y, which means consumption (by households aka the public) plus investment (by companies) plus gov’t spending plus net exports (which is exports minus imports) is equal to real GDP.

Crowding Out

Crowding out occurs when the government is deficit spending (or spending more than it’s making in revenue) and the government takes out loans to cover that extra spending. This phenomenon can be seen in the loanable funds market graph, which, in its original form, looks like this:

Loanable_funds_market
r is the interest rate, LF is the number of loanable funds available/offered

Since the government takes loans from the same supply of loans as the rest of us, deficit spending actually shifts the demand curve to the right and thus, reduces the number of loanable funds available to the rest of us and raises the interest level.

The resulting graph would look like this:

loanablefunds

*As a side note, government spending isn’t affected by the interest rate. While businesses and households (C and I) decrease spending when interest rates are higher (making it more expensive to take out loans), the government still has to spend what it has to spend so G isn’t affected by how high or low the interest rate on loans are.*

When the AP exam tests you on this, they won’t say straight out that the question is about crowding out so you’ll have to figure it out yourself. There are only usually one or two questions about crowding out though, so you’ll be fine.

Bond Prices

When a person buys gov’t bonds, they are basically buying gov’t debt. In exchange for buying the bond, they get a certain amount of money paid to them by the US gov’t as interest. What to keep in mind here is that interest rates and bond prices have an inverse relationship. When interest rates rise, previous bonds that were bought at a lower interest rate aren’t worth as much because you’re not getting as much money back with a bond that has a lower interest rate. The same is true of the reverse where lowering interest rates make the higher-interest bonds more valuable.

Quantity Theory of Money

The quantity theory of money states that MV = PQ: money supply times velocity of money is equal to the average price level times the number of goods/services produced. Basically, what this equation says is that there is a direct relationship between the money supply and how much things cost, which helps explain why Venezuela is experiencing massive inflation as the gov’t keeps pumping more currency into the system when there’s no real economic growth(and also why financing national debt doesn’t work).  Here’s an ACDC video that explains this concept:

Here’s the link to his channel. I promise his videos will be a huge help during the class. If you guys need help reviewing for AP Microeconomics, he has videos for that too.

 

Nominal vs Real Interest Rates

The thing to keep in mind about questions about nominal vs real interest rates is that the real interest rate doesn’t change because the banks won’t give up profit in order to offer lower interest loans so whatever effect inflation has on loans, it’s the nominal interest rates that will change to accommodate it.

For example, if the original nominal interest rate is 4% and inflation was 2% but is now 4%, the math would look like this:

Nominal = Real + Inflation

Originally: 4% = real + 2% so the real interest rate was 2%

After 2% increase in inflation:  nominal = 2% + 4% so the nominal interest rate would be 6% now.


That’s all I can think of for now. I’ll be uploading more AP Macro material on Outlet so if y’all need help with specific concepts, leave a comment or lemme know with the contact form. Remember to share the love and knowledge with your friends.

This is LtDemonLord and I’ll talk to y’all later.

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