AP Macroeconomics Review Guide: All 6 Units Explained

AP Macroeconomics feels overwhelming because it connects so many moving pieces (monetary policy, fiscal policy, inflation, unemployment, exchange rates). But the exam centers on two models: aggregate demand and aggregate supply (AD-AS), and the loanable funds market. Almost every question is a chain of effects through those two graphs.

This guide covers all 6 units, the five graphs you must know cold, and the policy chains (fiscal and monetary) the exam reuses. Master those, and Macro becomes systematic.

What the exam looks like

Exam structure and scoring

• Same format as AP Micro.
• 2 hours 10 minutes total.
• Section I: 60 multiple choice in 70 minutes. Worth 66 percent.
• Section II: 3 free response in 60 minutes (plus 10-minute reading period). Worth 33 percent.
• FRQ #1: long (10+ points), usually involves multiple graphs and policy chains.
• FRQs #2 and #3: shorter (5-6 points each).
• Calculator allowed. Math involves multipliers, GDP calculations, percent changes.

Unit 1: Basic Economic Concepts

Same as Micro Unit 1 (tested 5-10 percent)

• Scarcity, opportunity cost, production possibilities curve.
• Comparative advantage (LOWER opportunity cost = comparative advantage).
• Specialization and trade: countries should specialize where they have comparative advantage and trade.
• Economic systems: market, command, mixed.
• Factors of production: land, labor, capital, entrepreneurship.

Unit 2: Economic Indicators and the Business Cycle

What you need to know (12-17 percent)

GDP

• GDP: total market value of final goods and services produced within a country in a year.
• Expenditure approach: GDP = C + I + G + (X - M). Consumption, Investment, Government spending, eXports minus iMports.
• C (~68 percent): spending on goods and services.
• I (~16 percent): business investment in capital, residential investment, inventory changes.
• G (~17 percent): government spending (does NOT include transfer payments like Social Security).
• NX = (X - M): net exports. Often negative for US.
• Income approach: GDP = wages + rent + interest + profit. Same total as expenditure approach.
• GDP excludes: used goods, financial transactions, illegal/underground economy, non-market activities (household work, volunteer).
• Nominal GDP: at current prices. Real GDP: adjusted for inflation (uses constant prices). Real GDP = Nominal GDP / price index * 100.
• GDP per capita: GDP / population. Better measure of living standards.
• Real GDP measures economic output; nominal GDP includes price changes that can mask real changes.

Unemployment and inflation

• Labor force: people working + actively looking. Excludes retirees, students not working, discouraged workers.
• Unemployment rate: unemployed / labor force.
• Types: FRICTIONAL (between jobs, normal), STRUCTURAL (skills mismatch, obsolete jobs), CYCLICAL (recession, too little demand).
• Natural rate of unemployment: frictional + structural (typically 4-6 percent).
• Full employment: only frictional and structural unemployment, no cyclical.
• CPI (Consumer Price Index): measures price level using a basket of consumer goods.
• Inflation rate: percent change in CPI. (CPI_new - CPI_old) / CPI_old * 100.
• Types of inflation: demand-pull (too much spending chasing too few goods, AD shifts right), cost-push (supply shock raises costs, SRAS shifts left).
• Costs of inflation: menu costs, shoe leather costs, redistribution (debtors gain, creditors lose), uncertainty.
• Deflation and disinflation: deflation is falling prices (dangerous), disinflation is slowing rate of inflation.

Business cycle

• Phases: expansion, peak, contraction (recession), trough.
• Recession: two consecutive quarters of negative real GDP growth.
• Depression: severe, prolonged recession.

Unit 3: National Income and Price Determination

What you need to know (17-27 percent, the biggest unit)

AD-AS model

• Aggregate Demand (AD): total demand for all goods and services. Downward sloping (due to wealth effect, interest rate effect, international trade effect).
• Shifters of AD: Consumer confidence/wealth, Investment (interest rates, business confidence), Government spending, Net exports.
• Short-Run Aggregate Supply (SRAS): upward-sloping. Prices sticky, wages sticky.
• Shifters of SRAS: input prices (oil, wages), productivity, taxes/subsidies on businesses, inflation expectations.
• Long-Run Aggregate Supply (LRAS): VERTICAL at full-employment output (Yf). Represents economy's potential.
• Shifters of LRAS: labor force growth, capital accumulation, technology, productivity.
• Equilibrium: where AD and SRAS intersect. Also where they meet LRAS (for long-run equilibrium).
• Recessionary gap: actual Y below Yf. Unemployment above natural rate. AD shifts right (or SRAS shifts right) to close gap.
• Inflationary gap: actual Y above Yf. Unemployment below natural rate. Self-corrects as wages rise and SRAS shifts left.
• Self-correction: given time, the economy returns to LRAS. In recession, wages fall, SRAS shifts right. In inflation, wages rise, SRAS shifts left.

Fiscal policy

• Fiscal policy: government use of spending and taxes to influence economy.
• Expansionary fiscal policy (close recessionary gap): increase G or decrease T. Shifts AD right.
• Contractionary fiscal policy (close inflationary gap): decrease G or increase T. Shifts AD left.
• Spending multiplier = 1 / (1 - MPC) = 1 / MPS. MPC is marginal propensity to consume.
• Tax multiplier = -MPC / (1 - MPC) = -MPC / MPS. Smaller in absolute value than spending multiplier (negative because tax cuts INCREASE AD).
• Why is spending multiplier bigger? Spending goes DIRECTLY into GDP. Tax cut is partially spent, partially saved.
• Example: MPC = 0.8. Spending multiplier = 1/0.2 = 5. Tax multiplier = -0.8/0.2 = -4. A $100 increase in G raises GDP by $500; a $100 tax cut raises GDP by $400.
• Automatic stabilizers: built-in fiscal adjustments (progressive income tax, unemployment insurance) that stabilize without congressional action.

Unit 4: Financial Sector

What you need to know (18-23 percent)

Money and banking

• Money functions: medium of exchange, unit of account, store of value.
• M1: currency + checking deposits. M2: M1 + savings + small time deposits + money market funds.
• Fractional reserve banking: banks keep a fraction of deposits (reserve requirement), lend the rest.
• Money multiplier: 1 / required reserve ratio. If RR = 10 percent, multiplier is 10. $1000 deposit creates up to $10,000 in new money.
• Commercial banks vs central bank (Federal Reserve).

Money market and loanable funds

• Money market: interest rate (y-axis) vs quantity of money (x-axis). Money supply is VERTICAL (set by Fed). Money demand is downward-sloping (at high rates, people hold less money).
• Loanable funds market: interest rate (y-axis) vs quantity of loanable funds (x-axis). Supply from savings (upward sloping). Demand from investment (downward sloping).
• Government deficit increases demand for loanable funds, raises interest rates, crowds out private investment.
• Difference: money market shows nominal interest rate from Fed policy. Loanable funds shows real interest rate from savings/investment decisions.

Monetary policy

• Monetary policy: Federal Reserve adjusts money supply to influence economy.
• Expansionary monetary policy (close recessionary gap): increase money supply, lower interest rates, boost investment and consumption. AD shifts right.
• Contractionary monetary policy (close inflationary gap): decrease money supply, raise interest rates, reduce spending. AD shifts left.
• Tools: Open Market Operations (buy bonds = expansionary, sell bonds = contractionary). Reserve requirement (lower = expansionary). Discount rate (lower = expansionary). Interest on reserves (IOR, primary tool in new CED).
• In revised 2022+ CED: the Fed primarily uses the interest on reserves to target the federal funds rate. Buying/selling bonds has changed roles somewhat.

Unit 5: Long-Run Consequences of Stabilization Policies

What you need to know (20-30 percent)

• Phillips curve: inverse relationship between inflation and unemployment. Short-run is downward sloping. Long-run is VERTICAL at natural rate of unemployment.
• Shifts SRPC: inflation expectations, supply shocks. Stagflation: SRPC shifts right (higher inflation AND higher unemployment simultaneously).
• Crowding out: expansionary fiscal policy (deficit spending) raises interest rates (loanable funds demand up), reduces private investment. Partially offsets stimulus.
• Long-run economic growth: shifts LRAS right. Sources: labor force growth, capital accumulation, technology, productivity improvements, education.
• Real vs nominal interest rate: Fisher equation. Nominal = Real + Expected Inflation.
• Government debt: accumulation of deficits over time. Sustained high debt can crowd out private investment, raise future tax burden.
• Ricardian equivalence: people save in anticipation of future tax increases from current deficits. Limits effectiveness of debt-financed stimulus. Debated.

Unit 6: Open Economy (International Trade and Finance)

What you need to know (10-13 percent)

Balance of payments

• Current account: trade of goods and services (net exports) + net investment income + net transfers.
• Financial (capital) account: net financial flows (foreign purchases of US assets minus US purchases of foreign assets).
• Current account + Financial account = 0 (by definition).
• US runs current account DEFICIT (imports more than exports) balanced by financial account SURPLUS (foreigners buy US assets).

Foreign exchange market

• FX market: price of currency (exchange rate) vs quantity.
• For US dollar market: x-axis quantity of dollars, y-axis price (in foreign currency, like pesos per dollar).
• Supply of dollars: from Americans buying foreign goods/assets (high dollar price = fewer dollars supplied).
• Demand for dollars: from foreigners buying US goods/assets (high price = fewer dollars demanded).
• Appreciation: dollar becomes more valuable (takes more foreign currency to buy a dollar). Causes: higher US interest rates, expected dollar appreciation, higher US demand for foreign assets (less).
• Depreciation: dollar becomes less valuable.
• Weaker dollar: US exports cheaper to foreigners (net exports rise), imports more expensive (net exports rise). AD shifts right.
• Stronger dollar: opposite. Hurts US exports, cheapens imports. AD shifts left.
• Higher US interest rates (monetary policy) attract foreign capital, appreciate dollar, reduce net exports. Partial offset of monetary policy in open economy.

Policy chains the exam loves

Expansionary fiscal policy (e.g., increase G)

• AD shifts right -> output rises, unemployment falls, price level rises.
• Loanable funds demand rises (government borrows more) -> interest rate rises -> investment falls (crowding out).
• In open economy: higher US interest rates attract capital -> dollar appreciates -> exports fall, imports rise -> net exports fall (partial offset).
• Money market: higher income raises money demand -> interest rate rises in money market too.
• Long-run: if at full employment, wages rise, SRAS shifts left, output returns to Yf but price level higher.

Expansionary monetary policy (e.g., Fed buys bonds)

• Money supply rises -> interest rate falls -> investment and consumption rise -> AD shifts right.
• Output rises, unemployment falls, price level rises.
• Lower US interest rates: capital flows out -> dollar depreciates -> net exports rise -> AD amplified.
• Long-run: same as fiscal, Y returns to Yf, price level higher.

The five graphs you need cold

1. AD-AS: short-run AS (upward), long-run AS (vertical), AD (downward). Show recessionary gap (Y below Yf) and inflationary gap (Y above Yf).
2. Money market: vertical MS, downward MD. Shift MS with monetary policy.
3. Loanable funds: upward supply (savings), downward demand (investment). Shift demand with government borrowing.
4. Phillips curve: short-run (downward sloping), long-run (vertical at natural rate).
5. Foreign exchange (FX) market: downward demand, upward supply. Shift with interest rates, income, expectations.

How to score a 5 on AP Macro

1. Master the five graphs. You will use them on every FRQ. Draw them cleanly, label axes and curves, show shifts.
2. Practice the policy chains. Fiscal: change in G or T -> AD shifts -> output/price/unemployment change -> interest rate and FX effects.
3. Learn the multipliers. Spending: 1/(1-MPC) = 1/MPS. Tax: -MPC/(1-MPC). Memorize.
4. Know the difference between money market and loanable funds. Both have interest rate on y-axis, but show different things.
5. Understand long-run adjustment. Even without policy, economy returns to LRAS. In recession, wages fall. In inflation, wages rise.
6. On FRQs, show the graph changes AND explain the reasoning. Graders want both.

Common mistakes

• Shifting AS when you should shift AD, and vice versa. Taxes on consumers shift AD (they change C). Supply shocks (oil prices, wages) shift SRAS.
• Mislabeling axes. Money market: interest rate vs quantity of money. Loanable funds: interest rate vs quantity of loanable funds. They look similar but are different markets.
• Forgetting the long-run Phillips curve is VERTICAL at the natural rate of unemployment. In the long run, no trade-off between inflation and unemployment.
• Using wrong direction for exchange rate changes. STRONGER dollar = takes MORE foreign currency to buy a dollar = US goods EXPENSIVE to foreigners = net exports FALL.
• Confusing nominal and real variables. Nominal GDP includes price changes; real GDP does not. Real interest rate = nominal - expected inflation.
• Forgetting crowding out. Expansionary fiscal policy raises interest rates, reducing private investment. Partial offset of the stimulus.
• Not writing the direction clearly on FRQ graphs. Draw arrows showing the shift direction. Graders need to see it.
• Using tax multiplier magnitude when you need its sign. Tax multiplier is NEGATIVE (tax cut is expansionary). If cutting taxes, use |tax multiplier|.

Master AD-AS and loanable funds. Memorize the five graphs. Practice the policy chains until they are automatic. That is AP Macro.