Aim for FiveMacroeconomics

Required content

AP® Macroeconomics graphs

On the free-response section you'll draw graphs by hand, and points depend on getting the labels right. Here are all 8 graphs the course expects you to draw, in course order: what each one shows, how to label it, the shifts that come up most, and the mistakes that cost points. You'll also find 2 graphs you only need to read, not draw, marked as such.

You may also have to draw a bank's balance sheet (a T-account). It isn't a graph, so it's covered in the banking topic and on the must-know sheet instead. The same goes for the circular flow diagram, which you only need to read.

Unit 1: Basic Economic Concepts

Production possibilities curve (PPC)

Every combination of two goods an economy can make when it uses all its resources and today's technology. It shows trade-offs, opportunity cost, efficiency and economic growth.

Axes: Capital goods on the vertical axis, Consumer goods on the horizontal axis.

Production possibilities curve with efficient, inefficient and unattainable pointsCapital goods are on the vertical axis and consumer goods on the horizontal axis. The PPC is bowed out from the origin and touches both axes. Point A sits on the curve, so it is efficient. Point B sits inside the curve, so some resources are unemployed or wasted. Point C sits outside the curve, so the economy can't produce it with the resources and technology it has now.Consumer goodsCapital goodsPPCA: efficientB: inefficientC: unattainable
Production possibilities curve with efficient, inefficient and unattainable points
Economic growth shifts the PPC outCapital goods are on the vertical axis and consumer goods on the horizontal axis. The original curve, PPC₁, is bowed out from the origin. A second bowed-out curve, PPC₂, lies outside it at every point, and an arrow points outward from PPC₁ to PPC₂. More resources or better technology let the economy produce more of both goods.Consumer goodsCapital goodsPPC₁PPC₂
Economic growth shifts the PPC out

How to draw it

  1. Put one good on each axis and label them with the goods' names. The exam often uses capital goods and consumer goods.
  2. Draw the curve bowed out from the origin, touching both axes. Label it PPC (or PPC₁).
  3. Points on the curve are efficient. A point inside it means some resources are idle; a point outside it can't be reached right now.
  4. For growth, draw a second curve outside the first, label it PPC₂, and add an arrow pointing out.

Common shifts

More resources, better technology or more human capital
The whole curve shifts out. That's economic growth.
A new technology that helps make only one good
Only that good's end of the curve moves out; the other end stays put.
Resources are lost (a war, a natural disaster)
The curve shifts in.
Unemployment falls and idle resources go back to work
The curve doesn't move. The economy moves from a point inside the curve to a point on it.

Mistakes that cost points

  • Calling a move from inside the curve to the curve economic growth. Growth means the curve itself shifts out.
  • Drawing a straight line when the question describes increasing opportunity cost. Increasing cost means the curve bows out.

Learn it:Topic 1.2 Opportunity Cost and the Production Possibilities Curve (PPC)Topic 1.3 Comparative Advantage and Gains from TradeTopic 5.6 Economic GrowthTopic 5.7 Public Policy and Economic Growth

Supply and demand

How buyers and sellers in one market settle on a price and a quantity. Where the demand and supply curves cross is the equilibrium: the price where the amount people want to buy equals the amount sellers want to sell.

Axes: Price (P) on the vertical axis, Quantity (Q) on the horizontal axis.

Supply and demand with an increase in demandPrice is on the vertical axis and quantity on the horizontal axis. Demand D₁ slopes down and supply S slopes up; they cross at P₁ and Q₁. Demand shifts right to D₂, which crosses supply at a higher price P₂ and a larger quantity Q₂.Quantity (Q)Price (P)SD₁D₂Q₁P₁Q₂P₂
Supply and demand with an increase in demand

How to draw it

  1. Label the vertical axis Price (P) and the horizontal axis Quantity (Q).
  2. Draw demand (D) sloping down and supply (S) sloping up.
  3. Mark where they cross with dashed lines to both axes, and label the equilibrium price Pe and quantity Qe.
  4. For a shift, draw the new curve, label it (D₂), add an arrow, and mark the new price and quantity.

Common shifts

Demand increases (more income for a normal good, a substitute gets pricier)
D shifts right: price and quantity both rise.
Supply increases (cheaper inputs, better technology)
S shifts right: price falls and quantity rises.
Supply decreases (an input gets pricier)
S shifts left: price rises and quantity falls.
Both curves shift at once
One result is certain and the other depends on which shift is bigger, so it's indeterminate.

Mistakes that cost points

  • Calling a price change a shift in demand. A change in the good's own price moves you along the curve; it doesn't shift it.
  • Forgetting to mark the new equilibrium on both axes after a shift.

Learn it:Topic 1.4 DemandTopic 1.5 SupplyTopic 1.6 Market Equilibrium, Disequilibrium, and Changes in Equilibrium

Unit 2: Economic Indicators and the Business Cycle

Business cycleRead only: you won't draw it

How real GDP rises and falls around its long-run trend. You won't have to draw this one: it shows up only in multiple choice, where you read it and name the phases and turning points.

Axes: Real GDP on the vertical axis, Time on the horizontal axis.

The business cycleReal GDP is on the vertical axis and time on the horizontal axis. A dashed straight line slopes upward: potential real GDP, the long-run trend. Actual real GDP is a wave that rises above and dips below that line. A peak is marked at a high point and a trough at the next low point, each with a dashed line down to the time axis. The stretch from the peak to the trough is labelled recession, and the climb after the trough is labelled expansion.TimeReal GDPPotential real GDPActual real GDPPeakTroughRecessionExpansion
The business cycle

How to read it

  1. Real GDP is on the vertical axis and time is on the horizontal axis.
  2. The upward-sloping straight line is potential (full-employment) real GDP: the economy's long-run trend.
  3. The wave is actual real GDP. Its high points are peaks and its low points are troughs.
  4. Going from a trough up to a peak is an expansion; going from a peak down to a trough is a recession (contraction).
  5. Compare the wave with the trend line: above it, output is above full employment; below it, output is below full employment.

Common shifts

Actual real GDP is above the trend line
Output is above full employment: an inflationary (positive) output gap, with unemployment below the natural rate.
Actual real GDP is below the trend line
Output is below full employment: a recessionary (negative) output gap, with unemployment above the natural rate.
The economy grows over time
The trend line slopes up, because potential output keeps rising.

Mistakes that cost points

  • Calling the peak or the trough a phase. They're turning points; the two phases are expansion and recession.
  • Thinking potential output stays the same. The trend line slopes up because the economy's capacity grows over time.

Learn it:Topic 2.7 Business Cycles

Unit 3: National Income and Price Determination

Aggregate demand and aggregate supply (AD–AS)

The whole economy's output and price level. Where AD crosses SRAS is the short-run equilibrium; the vertical LRAS line shows full-employment output, so you can see whether the economy has a recessionary gap, an inflationary gap or neither.

Axes: Price level (PL) on the vertical axis, Real GDP (Y) on the horizontal axis.

AD–AS model in long-run equilibriumThe price level is on the vertical axis and real GDP on the horizontal axis. AD₁ slopes down, SRAS₁ slopes up, and LRAS is a vertical line at full-employment output, Yf. All three cross at one point, so the price level is PL₁ and real GDP Y₁ equals Yf: the economy is in long-run equilibrium with no output gap.Real GDP (Y)Price level (PL)LRASSRAS₁AD₁Y₁ = YfPL₁
AD–AS model in long-run equilibrium
AD–AS model with an increase in aggregate demandThe price level is on the vertical axis and real GDP on the horizontal axis. The economy starts in long-run equilibrium, where AD₁, SRAS₁ and the vertical LRAS line meet at PL₁ and Yf. AD shifts right to AD₂, which crosses SRAS₁ at a higher price level, PL₂, and higher real GDP, Y₂. Y₂ is to the right of LRAS, so in the short run the economy has an inflationary (positive) output gap.Real GDP (Y)Price level (PL)LRASSRAS₁AD₁AD₂YfPL₁Y₂PL₂
AD–AS model with an increase in aggregate demand
A recessionary gap closing through long-run self-adjustmentThe price level is on the vertical axis and real GDP on the horizontal axis. AD slopes down and crosses SRAS₁ at PL₁ and Y₁. The vertical LRAS line is to the right of Y₁, at full-employment output Yf, so the economy is in a recessionary (negative) output gap. Over time nominal wages fall and SRAS shifts right to SRAS₂, which crosses AD on the LRAS line. Real GDP returns to Yf and the price level falls to PL₂.Real GDP (Y)Price level (PL)LRASSRAS₁SRAS₂ADY₁PL₁YfPL₂
A recessionary gap closing through long-run self-adjustment

How to draw it

  1. Label the vertical axis Price level (PL) and the horizontal axis Real GDP (Y).
  2. Draw AD sloping down, SRAS sloping up, and LRAS as a vertical line. Label the full-employment output under LRAS as Yf.
  3. Mark the short-run equilibrium where AD crosses SRAS, with dashed lines to PL₁ and Y₁.
  4. Place LRAS to match the question: through the equilibrium for long-run equilibrium, to the right of Y₁ for a recessionary gap, to the left of Y₁ for an inflationary gap.
  5. For a shift, draw the new curve (AD₂ or SRAS₂), add an arrow, and mark PL₂ and Y₂.

Common shifts

AD increases (expansionary fiscal or monetary policy, more consumer confidence, more net exports)
AD shifts right: in the short run the price level and real GDP rise and unemployment falls.
AD decreases (contractionary policy, less consumer or business confidence)
AD shifts left: the price level and real GDP fall and unemployment rises.
A negative supply shock (higher oil prices or wages)
SRAS shifts left: the price level rises while real GDP falls. That's stagflation.
Long-run self-adjustment from a recessionary gap
Nominal wages and other input prices fall, SRAS shifts right, and output returns to Yf at a lower price level.
Economic growth (more capital, better technology, more human capital)
LRAS shifts right, and full-employment output rises.

Mistakes that cost points

  • Labelling the axes Price and Quantity. It's the price level and real GDP.
  • Leaving out LRAS or putting it on the wrong side of Y₁. If the economy is in a recession, LRAS goes to the right of Y₁.
  • Shifting LRAS when only AD or SRAS changes. LRAS moves only when the economy's capacity to produce changes.

Learn it:Topic 3.1 Aggregate Demand (AD)Topic 3.3 Short-Run Aggregate Supply (SRAS)Topic 3.4 Long-Run Aggregate Supply (LRAS)Topic 3.5 Equilibrium in the Aggregate Demand–Aggregate Supply (AD–AS) ModelTopic 3.6 Changes in the AD–AS Model in the Short RunTopic 3.7 Long-Run Self-AdjustmentTopic 3.8 Fiscal PolicyTopic 5.1 Fiscal and Monetary Policy Actions in the Short RunTopic 5.6 Economic Growth

Unit 4: Financial Sector

Money market

How the demand for money and the supply of money set the nominal interest rate. Use it for monetary policy in an economy with limited reserves, where changing the money supply moves the interest rate.

Axes: Nominal interest rate (i) on the vertical axis, Quantity of money on the horizontal axis.

The money marketThe nominal interest rate is on the vertical axis and the quantity of money on the horizontal axis. Money demand MD₁ slopes down. Money supply MS₁ is a vertical line. They cross at the equilibrium nominal interest rate i₁ and quantity of money Q₁.Quantity of moneyNominal interest rate (i)MS₁MD₁Q₁i₁
The money market
An increase in the money supplyThe nominal interest rate is on the vertical axis and the quantity of money on the horizontal axis. Money demand MD₁ slopes down. The central bank buys bonds, so the vertical money supply line shifts right from MS₁ to MS₂. The nominal interest rate falls from i₁ to i₂, and the quantity of money rises from Q₁ to Q₂.Quantity of moneyNominal interest rate (i)MS₁MS₂MD₁Q₁i₁Q₂i₂
An increase in the money supply
An increase in money demandThe nominal interest rate is on the vertical axis and the quantity of money on the horizontal axis. Money supply MS₁ is a vertical line at Q₁. A higher price level or higher real GDP shifts money demand right from MD₁ to MD₂. The quantity of money stays at Q₁, and the nominal interest rate rises from i₁ to i₂.Quantity of moneyNominal interest rate (i)MS₁MD₁MD₂Q₁i₁i₂
An increase in money demand

How to draw it

  1. Label the vertical axis Nominal interest rate (i) and the horizontal axis Quantity of money.
  2. Draw money demand (MD) sloping down and money supply (MS) as a vertical line, since the central bank sets it.
  3. Mark where they cross with dashed lines, and label the interest rate i₁ and the quantity Q₁.
  4. For a policy change, shift MS, label it MS₂, add an arrow, and mark the new interest rate i₂.

Common shifts

The central bank buys bonds (limited reserves)
MS shifts right and the nominal interest rate falls.
The central bank sells bonds or raises the reserve requirement (limited reserves)
MS shifts left and the nominal interest rate rises.
The price level or real GDP rises
People need more money for buying things, so MD shifts right and the nominal interest rate rises.

Mistakes that cost points

  • Drawing MS sloping up. It's vertical, because the central bank sets the money supply no matter the interest rate.
  • Labelling the vertical axis Real interest rate. The money market uses the nominal interest rate.
  • Shifting MD when the question is about monetary policy. Policy moves MS; MD moves with the price level and real GDP.

Learn it:Topic 4.5 The Money MarketTopic 4.6 Monetary PolicyTopic 5.1 Fiscal and Monetary Policy Actions in the Short Run

Reserve market

How the central bank sets its policy rate (in the U.S., the federal funds rate). With ample reserves, like the U.S. today, the supply of reserves crosses demand where demand is flat, so the central bank moves the rate by changing the interest it pays on reserves.

Axes: Policy rate (in the U.S., the federal funds rate) on the vertical axis, Quantity of reserves on the horizontal axis.

The reserve market with ample reservesThe policy rate is on the vertical axis and the quantity of reserves on the horizontal axis. Demand for reserves, DR₁, slopes down and then becomes flat at the interest rate paid on reserves. Supply of reserves, SR, is a vertical line that crosses DR₁ in its flat part, so the policy rate PR₁ equals the rate paid on reserves.Quantity of reservesPolicy rateSRDR₁PR₁
The reserve market with ample reserves
Lowering interest on reserves with ample reservesThe policy rate is on the vertical axis and the quantity of reserves on the horizontal axis. Supply of reserves, SR, is a vertical line in the flat part of demand. The central bank lowers the interest rate it pays on reserves, so demand for reserves shifts down from DR₁ to DR₂, and its flat part sits lower. SR stays put, and the policy rate falls from PR₁ to PR₂.Quantity of reservesPolicy rateSRDR₁DR₂PR₁PR₂
Lowering interest on reserves with ample reserves
Buying bonds with limited reservesThe policy rate is on the vertical axis and the quantity of reserves on the horizontal axis. Demand for reserves, DR, slopes down and then becomes flat. With limited reserves, supply of reserves SR₁ is a vertical line that crosses DR on its downward-sloping part, at PR₁. The central bank buys bonds, adding reserves, so supply shifts right to SR₂. It crosses DR lower on the sloped part, so the policy rate falls to PR₂.Quantity of reservesPolicy rateSR₁SR₂DRQ₁PR₁Q₂PR₂
Buying bonds with limited reserves

How to draw it

  1. Label the vertical axis Policy rate and the horizontal axis Quantity of reserves.
  2. Draw demand for reserves (DR) sloping down and then flattening out at the interest rate paid on reserves.
  3. Draw supply of reserves (SR) as a vertical line. For ample reserves, it must cross DR in the flat part.
  4. Label the policy rate PR₁ where the curves cross.
  5. To show a change in interest on reserves, shift DR down (or up) to DR₂, add an arrow, and label the new policy rate PR₂.

Common shifts

The central bank lowers the interest it pays on reserves (ample reserves)
The flat part of DR shifts down, so the policy rate falls from PR₁ to PR₂. SR doesn't move.
The central bank raises the interest it pays on reserves (ample reserves)
The flat part of DR shifts up, so the policy rate rises.
The central bank buys bonds with ample reserves
SR shifts right along the flat part of DR, so the policy rate barely changes.
The central bank buys bonds with limited reserves
SR crosses the sloped part of DR, so shifting SR right lowers the policy rate.

Mistakes that cost points

  • Drawing SR crossing DR on its sloped part when the question says ample reserves. It has to cross in the flat part.
  • Using open market operations to change the rate in an ample-reserves economy. The tool is the interest rate paid on reserves.
  • Forgetting to label the new policy rate after the shift.

Learn it:Topic 4.6 Monetary PolicyTopic 5.1 Fiscal and Monetary Policy Actions in the Short Run

Loanable funds market

How savers (supply) and borrowers (demand) set the real interest rate. Use it for government deficits, crowding out and flows of money between countries.

Axes: Real interest rate (r) on the vertical axis, Quantity of loanable funds on the horizontal axis.

The loanable funds marketThe real interest rate is on the vertical axis and the quantity of loanable funds on the horizontal axis. Demand for loanable funds, DLF₁, slopes down, and supply, SLF₁, slopes up. They cross at the equilibrium real interest rate r₁ and quantity Q₁.Quantity of loanable fundsReal interest rate (r)SLF₁DLF₁Q₁r₁
The loanable funds market
A government deficit raises the demand for loanable fundsThe real interest rate is on the vertical axis and the quantity of loanable funds on the horizontal axis. Supply SLF₁ slopes up. The government borrows to cover a deficit, so demand shifts right from DLF₁ to DLF₂. The real interest rate rises from r₁ to r₂ and the quantity of loanable funds rises from Q₁ to Q₂. The higher rate crowds out some private investment.Quantity of loanable fundsReal interest rate (r)SLF₁DLF₁DLF₂Q₁r₁Q₂r₂
A government deficit raises the demand for loanable funds

How to draw it

  1. Label the vertical axis Real interest rate (r) and the horizontal axis Quantity of loanable funds.
  2. Draw demand (DLF) sloping down and supply (SLF) sloping up.
  3. Mark where they cross with dashed lines, and label the real interest rate r₁ and the quantity Q₁.
  4. For a shift, draw the new curve, label it, add an arrow, and mark r₂ and Q₂.

Common shifts

The government runs a bigger deficit and borrows to cover it
DLF shifts right and the real interest rate rises, which crowds out private investment. (Showing SLF shifting left also earns credit.)
People save more, or the government runs a surplus
SLF shifts right and the real interest rate falls.
Foreign money flows in (a capital inflow)
SLF shifts right and the real interest rate falls.
Firms want to invest more (an investment tax credit, better expectations)
DLF shifts right and the real interest rate rises.

Mistakes that cost points

  • Labelling the vertical axis Nominal interest rate. Loanable funds uses the real interest rate.
  • Mixing up the curves: savers supply loanable funds and borrowers demand them.

Learn it:Topic 4.7 The Loanable Funds MarketTopic 5.5 Crowding OutTopic 6.6 Real Interest Rates and International Capital Flows

Unit 5: Long-Run Consequences of Stabilization Policies

Phillips curve

The short-run trade-off between inflation and unemployment, and why it goes away in the long run. It's the AD–AS story told with inflation and unemployment instead of the price level and real GDP.

Axes: Inflation rate (%) on the vertical axis, Unemployment rate (%) on the horizontal axis.

Short-run and long-run Phillips curves in long-run equilibriumThe inflation rate is on the vertical axis and the unemployment rate on the horizontal axis. The short-run Phillips curve, SRPC₁, slopes down and gets flatter to the right. The long-run Phillips curve, LRPC, is a vertical line at the natural rate of unemployment, labelled NRU. They cross at point A, the long-run equilibrium, where inflation is Inf₁.Unemployment rate (%)Inflation rate (%)LRPCSRPC₁ANRUInf₁
Short-run and long-run Phillips curves in long-run equilibrium
An increase in AD moves the economy along the SRPCThe inflation rate is on the vertical axis and the unemployment rate on the horizontal axis. SRPC₁ slopes down and the vertical LRPC sits at the natural rate of unemployment, NRU. The economy starts at point A, where the curves cross. AD increases, so the economy moves up and to the left along SRPC₁ to point B, with higher inflation, Inf₂, and lower unemployment, U₂. Point B is to the left of the LRPC, which means an inflationary (positive) output gap.Unemployment rate (%)Inflation rate (%)LRPCSRPC₁ANRUInf₁BU₂Inf₂
An increase in AD moves the economy along the SRPC
Higher expected inflation shifts the SRPC rightThe inflation rate is on the vertical axis and the unemployment rate on the horizontal axis. The vertical LRPC sits at the natural rate of unemployment, NRU. Expected inflation rises, so the short-run Phillips curve shifts right from SRPC₁ to SRPC₂. At the natural rate, inflation is now higher: point A on SRPC₁ at Inf₁ moves up to point C on SRPC₂ at Inf₂. A negative supply shock shifts the SRPC the same way.Unemployment rate (%)Inflation rate (%)LRPCSRPC₁SRPC₂ANRUInf₁CInf₂
Higher expected inflation shifts the SRPC right

How to draw it

  1. Label the vertical axis Inflation rate (%) and the horizontal axis Unemployment rate (%).
  2. Draw the short-run Phillips curve (SRPC) sloping down.
  3. Draw the long-run Phillips curve (LRPC) as a vertical line at the natural rate of unemployment, and label that rate on the axis (NRU is a common short form).
  4. Long-run equilibrium is where SRPC and LRPC cross. Label points exactly as the question asks.

Common shifts

AD increases
Move up and to the left along the SRPC: higher inflation, lower unemployment. The curve itself doesn't shift.
AD decreases
Move down and to the right along the SRPC: lower inflation, higher unemployment.
Expected inflation rises, or a negative supply shock (SRAS shifts left)
The SRPC shifts right (up): more inflation at every unemployment rate.
The natural rate of unemployment changes
The LRPC shifts. It's the only thing that moves it.

Mistakes that cost points

  • Shifting the SRPC when AD changes. A change in AD is a move along the SRPC.
  • Drawing the LRPC anywhere but at the natural rate of unemployment.
  • Swapping the axes. Inflation goes on the vertical axis and unemployment on the horizontal axis.

Learn it:Topic 5.2 The Phillips Curve

Aggregate production functionRead only: you won't draw it

How much real GDP an economy can make with a given number of workers, holding its capital (machines and workers' skills) and technology fixed. You won't have to draw this one: it shows up only in multiple choice.

Axes: Real GDP on the vertical axis, Employment on the horizontal axis.

Better technology shifts the aggregate production function upReal GDP is on the vertical axis and employment on the horizontal axis. The first curve starts at the origin, rises and flattens out. A second, higher curve starts at the same origin and lies above it everywhere, with an arrow pointing up. At the same level of employment, L₁, real GDP rises from Y₁ on the first curve to Y₂ on the second.EmploymentReal GDPAPF₁APF₂L₁Y₁Y₂
Better technology shifts the aggregate production function up

How to read it

  1. Real GDP is on the vertical axis and employment is on the horizontal axis.
  2. The curve starts at the origin, rises, and gets flatter: each added worker adds a bit less output.
  3. A higher curve means growth: the same number of workers can now make more real GDP.

Common shifts

Better technology, or more physical or human capital per worker
The whole curve shifts up: the same number of workers makes more real GDP.
More workers, with capital, skills and technology the same
A move along the curve to the right, not a shift.

Mistakes that cost points

  • Shifting the curve when only employment changes. More workers is a move along the curve.

Learn it:Topic 5.6 Economic GrowthTopic 5.7 Public Policy and Economic Growth

Unit 6: Open Economy—International Trade and Finance

Foreign exchange market

How the demand for and supply of a currency set its exchange rate: its price in another currency. Every exchange has a mirror image, so more demand for euros means more dollars supplied.

Axes: Dollars per euro on the vertical axis, Quantity of euros on the horizontal axis.

The foreign exchange market for eurosDollars per euro is on the vertical axis and the quantity of euros on the horizontal axis. Demand for euros, D₁, slopes down and supply of euros, S₁, slopes up. They cross at the equilibrium exchange rate e₁ and quantity Q₁.Quantity of eurosDollars per euroS₁D₁Q₁e₁
The foreign exchange market for euros
More demand for euros: the euro appreciatesDollars per euro is on the vertical axis and the quantity of euros on the horizontal axis. Supply of euros S₁ slopes up. Demand for euros shifts right from D₁ to D₂, for example because interest rates in Europe rose. The exchange rate rises from e₁ to e₂, so the euro appreciates and the dollar depreciates, and the quantity of euros traded rises from Q₁ to Q₂.Quantity of eurosDollars per euroS₁D₁D₂Q₁e₁Q₂e₂
More demand for euros: the euro appreciates
The mirror image: more dollars supplied, so the dollar depreciatesEuros per dollar is on the vertical axis and the quantity of dollars on the horizontal axis. Demand for dollars, D₁, slopes down. Americans want more euros, so they supply more dollars: supply shifts right from S₁ to S₂. The exchange rate falls from e₁ to e₂ euros per dollar, so the dollar depreciates, and the quantity of dollars traded rises from Q₁ to Q₂.Quantity of dollarsEuros per dollarS₁S₂D₁Q₁e₁Q₂e₂
The mirror image: more dollars supplied, so the dollar depreciates

How to draw it

  1. Name the currency you're graphing. For the euro, label the vertical axis Dollars per euro (the euro's price in the other currency) and the horizontal axis Quantity of euros.
  2. Draw demand for euros (D) sloping down and supply of euros (S) sloping up.
  3. Mark where they cross, and label the exchange rate e₁ and the quantity Q₁.
  4. For a shift, draw the new curve, add an arrow, and mark e₂. A higher e means the euro appreciated.

Common shifts

Interest rates in Europe rise compared with the U.S.
Investors want European assets, so demand for euros shifts right and the euro appreciates.
Europeans' incomes rise and they buy more imports
They supply more euros to buy foreign money, so supply shifts right and the euro depreciates.
Prices rise faster in Europe than abroad
European goods get pricier, so demand for euros falls, supply rises, and the euro depreciates.
Americans buy more European goods
Demand for euros rises (the euro appreciates). On a dollar graph, the supply of dollars rises (the dollar depreciates).

Mistakes that cost points

  • Putting the wrong currency on the vertical axis. On the euro graph, it's the euro's price: dollars per euro.
  • Shifting the wrong curve. People who want to buy a country's goods or assets demand its currency; that country's own people supply it.

Learn it:Topic 6.3 The Foreign Exchange MarketTopic 6.4 Effect of Changes in Policies and Economic Conditions on the Foreign Exchange MarketTopic 6.5 Changes in the Foreign Exchange Market and Net ExportsTopic 6.6 Real Interest Rates and International Capital Flows