Ap Macroeconomics Graphs Cheat Sheet

AP Macroeconomics Graphs Cheat Sheet: A Comprehensive Guide

Understanding graphs is crucial for success in AP Macroeconomics. This cheat sheet provides a comprehensive overview of the key graphs, their components, and how they relate to core macroeconomic concepts. Mastering these visuals will significantly enhance your understanding of supply and demand, economic growth, inflation, unemployment, and fiscal and monetary policies. This guide goes beyond simple identification; we'll explore the why behind each curve shift and the implications of these changes.

I. Supply and Demand: The Foundation

The most fundamental graph in economics, the supply and demand model, underpins many macroeconomic concepts.

1. Basic Supply and Demand Graph:

• X-axis: Quantity (Q) – the amount of a good or service offered or demanded.
• Y-axis: Price (P) – the cost of the good or service.
• Demand Curve (D): Downward sloping. Reflects the law of demand: as price increases, quantity demanded decreases (and vice-versa). This is because of the substitution effect (consumers switch to cheaper alternatives) and the income effect (higher prices reduce purchasing power).
• Supply Curve (S): Upward sloping. Reflects the law of supply: as price increases, quantity supplied increases (and vice-versa). This is because higher prices incentivize producers to offer more goods.
• Equilibrium Point: Where supply and demand intersect. This represents the market-clearing price and quantity – the price at which the quantity demanded equals the quantity supplied.

2. Shifts in Supply and Demand:

Changes in factors other than price cause shifts in the entire curve.

• Demand Shifts:

  • Rightward Shift (Increase in Demand): Caused by factors like increased consumer income, changes in tastes and preferences (increased demand for a product), prices of related goods (substitutes becoming more expensive or complements becoming cheaper), consumer expectations (expecting future price increases), and increased number of buyers.
  • Leftward Shift (Decrease in Demand): Caused by the opposite of the above factors.

• Supply Shifts:

  • Rightward Shift (Increase in Supply): Caused by factors like technological advancements, lower input costs (raw materials, labor), favorable government policies (subsidies), increased number of sellers, and improved expectations about future prices.
  • Leftward Shift (Decrease in Supply): Caused by the opposite of the above factors (e.g., natural disasters, increased input costs).

3. Understanding the Impact of Shifts:

When either supply or demand shifts, the equilibrium price and quantity change. Analyzing these changes is key to understanding market dynamics. For example, a rightward shift in demand leads to a higher equilibrium price and quantity, while a leftward shift in supply leads to a higher equilibrium price and a lower equilibrium quantity.

II. Aggregate Demand and Aggregate Supply: The Macroeconomic View

The aggregate demand-aggregate supply (AD-AS) model is the cornerstone of macroeconomic analysis.

1. The AD-AS Graph:

• X-axis: Real GDP (Output) – the total value of goods and services produced in an economy adjusted for inflation.
• Y-axis: Price Level – a measure of the average prices of goods and services in the economy (e.g., CPI or GDP deflator).
• Aggregate Demand (AD) Curve: Downward sloping. Reflects the inverse relationship between the overall price level and the quantity of real GDP demanded. This inverse relationship is due to the wealth effect (higher prices reduce real wealth, decreasing consumption), the interest rate effect (higher prices lead to higher interest rates, reducing investment), and the international trade effect (higher prices make domestic goods more expensive, reducing net exports).
• Aggregate Supply (AS) Curve: The shape of the AS curve depends on the time horizon considered.
  • Short-Run Aggregate Supply (SRAS): Upward sloping. In the short run, firms can increase output by increasing production even if prices rise.
  • Long-Run Aggregate Supply (LRAS): Vertical. In the long run, the economy operates at its potential output, which is determined by factors like technology, capital stock, and labor force. Changes in these factors shift the LRAS curve.

2. Shifts in AD and AS:

Shifts in AD and AS curves reflect changes in various macroeconomic factors.

• AD Shifts: Factors that shift AD include changes in consumer confidence, investment spending, government spending, net exports, and expectations about future economic conditions. An increase in AD shifts the curve to the right, and a decrease shifts it to the left.

• AS Shifts: Factors that shift the SRAS curve include changes in input prices (e.g., wages, raw materials), productivity, supply shocks (e.g., natural disasters), and government regulations. Factors that shift the LRAS curve include technological advancements, changes in the capital stock, and changes in the size of the labor force. An increase in AS shifts the curve to the right, and a decrease shifts it to the left.

3. Macroeconomic Equilibrium:

The intersection of the AD and SRAS curves determines the short-run equilibrium price level and real GDP. The long-run equilibrium occurs where AD, SRAS, and LRAS intersect. This point represents the economy operating at its potential output.

4. Analyzing Shifts and their Impact:

Analyzing the shifts of AD and AS curves is crucial to understand the impacts of macroeconomic policies and shocks. For instance, an increase in AD (e.g., due to expansionary fiscal policy) leads to higher output and prices in the short run, but only higher prices in the long run once the economy returns to its potential output. A negative supply shock (e.g., oil price spike) will lead to stagflation - higher prices and lower output.

III. Money Market and the Federal Reserve

The money market graph illustrates the interaction between the supply and demand for money.

1. The Money Market Graph:

• X-axis: Quantity of Money (M)
• Y-axis: Nominal Interest Rate (i) – the opportunity cost of holding money.
• Money Demand (MD) Curve: Downward sloping. Reflects the inverse relationship between the interest rate and the quantity of money demanded. Higher interest rates make it more expensive to hold money, so people demand less.
• Money Supply (MS) Curve: Vertical. The Federal Reserve (the central bank) controls the money supply directly through monetary policy tools.

2. Shifts in Money Market Curves:

• MD Shifts: Changes in the price level, real GDP, and technology can shift the MD curve. An increase in the price level or real GDP will shift the MD curve to the right.

• MS Shifts: The Federal Reserve shifts the MS curve through its monetary policy tools:

  • Open Market Operations (OMO): Buying government bonds increases the money supply (shifts MS right); selling bonds decreases it (shifts MS left).
  • Reserve Requirement: Lowering the reserve requirement increases the money supply; raising it decreases it.
  • Discount Rate: Lowering the discount rate (the interest rate at which banks borrow from the Fed) increases the money supply; raising it decreases it.

3. Equilibrium Interest Rate:

The intersection of the MD and MS curves determines the equilibrium interest rate. Changes in monetary policy affect this equilibrium rate and, consequently, investment, consumption, and aggregate demand.

IV. Loanable Funds Market

The loanable funds market illustrates the interaction between savers (suppliers of funds) and borrowers (demanders of funds).

1. Loanable Funds Market Graph:

• X-axis: Quantity of Loanable Funds
• Y-axis: Real Interest Rate (r) – the real return on saving and borrowing.
• Supply of Loanable Funds (SLF): Upward sloping. Reflects the positive relationship between the real interest rate and the quantity of loanable funds supplied. Higher interest rates incentivize saving.
• Demand for Loanable Funds (DLF): Downward sloping. Reflects the inverse relationship between the real interest rate and the quantity of loanable funds demanded. Higher interest rates make borrowing more expensive, reducing investment.

2. Shifts in Loanable Funds Market Curves:

• SLF Shifts: Changes in factors like household saving behavior, government budget surplus or deficit, and foreign investment can shift the SLF curve. A budget surplus increases the supply, while a budget deficit decreases it.

• DLF Shifts: Changes in business investment opportunities, government borrowing, and expected future profits can shift the DLF curve. Increased business optimism will shift the curve to the right.

3. Equilibrium Real Interest Rate:

The intersection of the SLF and DLF curves determines the equilibrium real interest rate. This rate affects investment and economic growth. Government policies impacting saving and borrowing will alter this rate.

V. Foreign Exchange Market

The foreign exchange market determines the exchange rate between currencies.

1. Foreign Exchange Market Graph:

• X-axis: Quantity of a Currency (e.g., USD)
• Y-axis: Exchange Rate – the price of one currency in terms of another (e.g., USD/EUR). A higher exchange rate means the domestic currency is appreciating (becoming stronger).
• Demand for a Currency (e.g., USD): Downward sloping. Reflects that as the value of the USD increases (appreciation), demand for the USD falls because foreign goods become cheaper and US goods become more expensive.
• Supply of a Currency (e.g., USD): Upward sloping. Reflects that as the value of the USD increases, the supply of the USD increases because foreigners demand more USD to buy US goods, and Americans supply more USD to buy foreign goods.

2. Shifts in Foreign Exchange Market Curves:

Several factors shift supply and demand for a currency, including:

• Changes in Relative Interest Rates: Higher interest rates in a country attract foreign investment, increasing demand for its currency.
• Changes in Relative Income Levels: Higher income levels in a country increase demand for imports and thus increase the supply of its currency.
• Changes in Expectations about Future Exchange Rates: Expectations of currency appreciation or depreciation can significantly impact demand and supply.

3. Equilibrium Exchange Rate:

The intersection of supply and demand for a currency determines its equilibrium exchange rate. This rate affects net exports and overall economic activity.

VI. Phillips Curve

The Phillips curve illustrates the short-run relationship between inflation and unemployment.

1. The Phillips Curve Graph:

• X-axis: Unemployment Rate
• Y-axis: Inflation Rate
• Short-Run Phillips Curve (SRPC): Downward sloping. In the short run, there's a trade-off between inflation and unemployment: lower unemployment is associated with higher inflation, and vice-versa. This is because increased aggregate demand leads to both higher employment and higher prices.

2. Shifts in the Short-Run Phillips Curve:

The SRPC shifts due to changes in inflationary expectations. If people expect higher inflation, they'll demand higher wages, leading to a shift of the SRPC to the right (higher inflation for any given unemployment rate).

3. Long-Run Phillips Curve (LRPC):

The LRPC is vertical at the natural rate of unemployment (NAIRU) - the unemployment rate consistent with long-run equilibrium. In the long run, there is no trade-off between inflation and unemployment; attempts to reduce unemployment below the NAIRU through expansionary policies lead only to higher inflation.

VII. Production Possibilities Frontier (PPF)

The PPF illustrates the trade-offs an economy faces when allocating resources between different goods.

1. The PPF Graph:

• X-axis: Quantity of one good
• Y-axis: Quantity of another good
• PPF Curve: A bowed-out curve representing the maximum combination of goods that an economy can produce with its available resources and technology.

2. Points on and off the PPF:

• Points on the curve: Represent efficient production – all resources are fully utilized.
• Points inside the curve: Represent inefficient production – resources are underutilized.
• Points outside the curve: Represent unattainable production levels with current resources and technology.

3. Shifts in the PPF:

The PPF shifts outward due to factors like technological advancements, increased capital stock, or increased labor force. This signifies economic growth, as the economy can now produce more of both goods.

Conclusion: Mastering the Graphs

This cheat sheet provides a foundational understanding of the key graphs used in AP Macroeconomics. Remember that the true power of these graphs lies not just in memorizing their shapes but in understanding the economic principles they represent and the implications of shifts in curves. Through consistent practice and application, you'll confidently analyze macroeconomic scenarios and ace your AP exam. Practice drawing these graphs repeatedly, and work through numerous examples to solidify your comprehension. Good luck!