Must-know sheet

Macroeconomics must-know sheet

The formulas, graphs and cause-and-effect chains you should know cold for AP Macroeconomics, with every graph described in words: its axes, curves, what shifts them and how to label equilibrium. The real exam gives you no formula sheet, so you need these formulas memorized; a four-function calculator (a handheld one or the one built into Bluebook) is allowed on both sections.

Drawing graphs on the free-response section

Units 1, 2, 3, 4, 5, 6

Label everything: Every graph needs both axes labeled, every curve named, the starting equilibrium marked (for example PL1 and Y1) and the new one marked after a shift (PL2 and Y2). An unlabeled curve or axis usually loses the point.
Show a shift clearly: Draw the new curve, give it a number (AD1 to AD2, MS1 to MS2) and show the direction of the shift with an arrow. Then mark the new equilibrium on both axes.
Use the right axis words: The AD–AS graph uses the price level and real GDP, not price and quantity. The money market uses the nominal interest rate; the loanable funds market uses the real interest rate. Mixing these up is a common way to lose points.
Explain with a chain: When a question says "explain," connect each step with cause and effect: policy → interest rate → investment → AD → real GDP and price level. Naming only the final result usually doesn't earn the explain point.
Calculations: Show the setup, not just the answer, and keep the units (dollars, percent, billions). A four-function calculator is allowed on both sections, but most numbers are chosen to be easy by hand.
Short run vs. long run: Watch which one the question asks about. In the short run, AD shifts change output and the price level; in the long run, output returns to full employment (YF) and only the price level ends up different.

Scarcity, the PPC and comparative advantage

Unit 1

Factors of production: Land (natural resources), labor (human work), capital (tools, machines and buildings used to make other goods) and entrepreneurship (risk-taking that combines the other three). Scarcity means these can't make everything people want, so every choice has a trade-off.
Opportunity cost: The value of the next-best thing you give up when you make a choice. On a PPC, the opportunity cost of one more unit of good X is how much of good Y you have to give up.
PPC graph: Good X on one axis, good Y on the other; the curve shows the most the economy can make of both with all its resources and today's technology. A point on the curve is efficient, a point inside means unemployed or wasted resources, and a point outside can't be reached right now.
PPC shape: Bowed out (concave to the origin) means increasing opportunity cost, because resources aren't equally good at making both goods. A straight line means constant opportunity cost. Bowed in (convex to the origin) means decreasing opportunity cost.
PPC shifts: The whole curve shifts out with more resources, better technology or more human capital (economic growth), and in when resources are lost. A change that helps only one good (like better technology for wheat) moves out only that good's end of the curve. Moving from inside the curve to a point on it is not growth; it's just using idle resources.
Capital goods and future growth: An economy that makes more capital goods today (giving up some consumer goods) tends to have a PPC that shifts out further in the future.
Absolute vs. comparative advantage: Absolute advantage: you can make more of a good with the same resources. Comparative advantage: you can make it at a lower opportunity cost. Trade is based on comparative advantage, not absolute advantage.
Opportunity cost from an output table: If a worker can make 10 wheat or 5 cloth, 1 cloth costs 10 ÷ 5 = 2 wheat and 1 wheat costs 5 ÷ 10 = ½ cloth. Divide the amount of the good you give up by the amount of the good you get.
Opportunity cost from an input table: If a table shows hours (or workers) needed to make one unit, the opportunity cost of a good is its input ÷ the other good's input. For example, if 1 cloth takes 4 hours and 1 wheat takes 2 hours, 1 cloth costs 4 ÷ 2 = 2 wheat.
Specialize and trade: Each side specializes in the good it makes at the lower opportunity cost. Both gain if the terms of trade (the price of one good in units of the other) falls between the two countries' opportunity costs, and both can then consume outside their own PPCs.

Supply and demand

Unit 1

The graph: Price on the vertical axis, quantity on the horizontal axis. Demand (D) slopes down, supply (S) slopes up, and they cross at the equilibrium price (Pe) and equilibrium quantity (Qe).
Law of demand and law of supply: When a good's price rises, quantity demanded falls and quantity supplied rises. A change in the good's own price moves you along the curve; it never shifts the curve.
What shifts demand: Income (normal goods: more income → more demand; inferior goods: more income → less demand), tastes, prices of substitutes (a substitute's price rises → demand rises) and complements (a complement's price rises → demand falls), expectations and the number of buyers. An increase shifts D right; a decrease shifts it left.
What shifts supply: Input prices, technology, taxes and subsidies, producers' expectations, prices of other goods the firm could make, and the number of sellers. Lower costs or better technology shift S right; higher costs shift it left.
Surplus and shortage: At a price above equilibrium, quantity supplied is greater than quantity demanded (a surplus), which pushes the price down. At a price below equilibrium, quantity demanded is greater (a shortage), which pushes the price up. The size of a surplus or shortage is the gap between the two quantities at that price.
One curve shifts: Demand up: price and quantity both rise. Demand down: both fall. Supply up: price falls, quantity rises. Supply down: price rises, quantity falls.
Both curves shift: One of the two results is indeterminate (can't be known without sizes). Both up: quantity rises, price indeterminate. Both down: quantity falls, price indeterminate. Demand up and supply down: price rises, quantity indeterminate. Demand down and supply up: price falls, quantity indeterminate.

GDP and measuring output

Unit 2

GDP: The market value of all final goods and services produced within a country in a given period, usually a year. "Within a country" means a foreign-owned factory in the U.S. counts in U.S. GDP.
GDP = C + I + G + Xn: The expenditure approach: consumer spending + investment + government purchases + net exports. Net exports (Xn) = exports − imports, so imports are subtracted.
Investment (I) in GDP: Business spending on capital goods (machines, factories), new home construction and changes in business inventories. Buying stocks or bonds is not investment in GDP; it's a financial transaction.
Income and value-added approaches: The income approach adds the incomes earned from making output (wages, rent, interest and profit, plus a few accounting adjustments). The value-added approach adds the value each stage of production adds (sale price − cost of inputs bought from other firms), which avoids counting intermediate goods twice.
Not counted in GDP: Intermediate goods (counted inside the final good), used goods, financial transactions like stocks and bonds, government transfer payments (Social Security, unemployment benefits), nonmarket work (cooking at home, volunteering) and the underground economy.
Limits of GDP: GDP leaves out leisure, nonmarket work, the underground economy, pollution and how income is shared, so higher GDP doesn't always mean people are better off. Real GDP per person is a better (still imperfect) measure of living standards.
Circular flow: Households sell land, labor, capital and entrepreneurship to firms in the factor (resource) market and get income (wages, rent, interest, profit); firms sell goods and services to households in the product market. The full version adds government (taxes in, purchases out), the rest of the world (exports and imports) and saving and investment. This graph is tested in multiple choice only.
Nominal vs. real GDP: Nominal GDP values output at that year's prices, so it can rise just because prices rose. Real GDP values output at constant base-year prices, so it measures how much is actually produced. In the base year they're equal.
GDP deflator = (nominal GDP ÷ real GDP) × 100: So real GDP = nominal GDP ÷ (deflator ÷ 100). Example: nominal GDP $12,000 and real GDP $10,000 give a deflator of 120.
Growth rate: Percent change = (new − old) ÷ old × 100. Economic growth is measured as the growth rate of real GDP per capita, where real GDP per capita = real GDP ÷ population.

Unemployment, price indexes and inflation

Unit 2

Labor force: Everyone who has a job (employed) or is actively looking for one (unemployed). People who aren't working and aren't looking, such as most retirees, full-time students without jobs and discouraged workers who stopped looking, are not in the labor force.
Unemployment rate = (unemployed ÷ labor force) × 100: Example: 10 million unemployed and 190 million employed make a 200 million labor force, so the rate is 5%. Don't divide by the whole population.
Labor force participation rate = (labor force ÷ adult population) × 100: Adult population here means people old enough to work (16 and older in the U.S.) who aren't in the military or an institution.
Why the rate can mislead: Discouraged workers aren't counted as unemployed, so the rate can understate joblessness. Part-time workers who want full-time jobs (underemployed) count as employed.
Types of unemployment: Frictional: between jobs or just entering the job market. Structural: skills or location don't match the jobs available, often from technology changes. Cyclical: caused by a recession (a fall in AD).
Natural rate of unemployment: Frictional + structural unemployment, with zero cyclical. When the economy is at full-employment output (YF), unemployment equals the natural rate; it is never zero. Cyclical unemployment = actual rate − natural rate. The natural rate can change slowly over time as the labor force changes.
CPI = (cost of the market basket this year ÷ cost in the base year) × 100: The base year's CPI is always 100. Example: a basket that cost $300 in the base year and $330 now gives a CPI of 110.
Inflation rate = (new index − old index) ÷ old index × 100: Example: CPI rising from 120 to 126 is (126 − 120) ÷ 120 × 100 = 5% inflation. You can use the CPI or the GDP deflator.
Real value = nominal value ÷ (price index ÷ 100): This works for wages, income and GDP. Example: a $50,000 salary when the CPI is 125 is $40,000 in base-year dollars.
CPI bias: The CPI tends to overstate inflation: its basket is fixed, so it misses people switching to cheaper substitutes (substitution bias), new products and quality improvements.
Deflation and disinflation: Deflation is a falling price level (a negative inflation rate). Disinflation is a slower rate of inflation, where prices still rise but more slowly.
Who wins and loses from unexpected inflation: Borrowers with fixed-rate loans gain, because they repay with dollars that buy less. Lenders, savers and people on fixed incomes lose. Unexpected deflation does the opposite; inflation that was fully expected is already built into interest rates and wage contracts.
Other costs of inflation: Menu costs (the cost of changing prices) and shoe-leather costs (time and effort spent avoiding holding cash). High inflation also makes it harder to plan.

Business cycle and the AD–AS model

Units 2, 3

Business cycle graph: Real GDP on the vertical axis and time on the horizontal axis. Output rises in an expansion to a peak, falls in a recession (contraction) to a trough, and swings around an upward-sloping trend line of potential (full-employment) output. This graph is tested in multiple choice only.
AD–AS graph: Price level (PL) on the vertical axis and real GDP (Y) on the horizontal axis. AD slopes down, SRAS slopes up, and LRAS is a vertical line at full-employment output (YF). Short-run equilibrium is where AD crosses SRAS (PL1, Y1).
Why AD slopes down: Real wealth effect: a lower price level makes money and savings buy more, so people spend more. Interest rate effect: a lower price level lowers interest rates, which raises borrowing and spending. Exchange rate effect: a lower price level makes the country's goods cheaper for foreigners, so net exports rise.
What shifts AD: Any change in C, I, G or Xn not caused by the price level: consumer confidence or wealth, taxes and transfers, interest rates, business expectations, government purchases, foreign income and the exchange rate. Increase → AD shifts right.
Why SRAS slopes up: Some wages and input prices are sticky (slow to change), so when the price level rises, producing more is profitable in the short run.
What shifts SRAS: Anything that changes production costs: input prices (wages, oil), productivity, business taxes and subsidies, regulation and expected inflation. Higher costs shift SRAS left; lower costs shift it right.
LRAS: Vertical at full-employment output (YF) because in the long run all wages and prices adjust. It shifts right only when the economy's capacity grows (more or better resources, more capital, better technology), the same things that shift a PPC out.
Long-run equilibrium: AD and SRAS cross on the LRAS line, so Y1 = YF and unemployment is at the natural rate.
Recessionary (negative) output gap: Y1 is less than YF (equilibrium to the left of LRAS). Unemployment is above the natural rate.
Inflationary (positive) output gap: Y1 is greater than YF (equilibrium to the right of LRAS). Unemployment is below the natural rate.
AD increases (demand-pull inflation): AD1 shifts right to AD2: in the short run the price level, real GDP and employment all rise, and unemployment falls. A decrease in AD does the opposite.
SRAS decreases (cost-push inflation): A negative supply shock, like a jump in oil prices, shifts SRAS1 left to SRAS2: the price level rises while real GDP falls and unemployment rises. Rising prices with falling output is stagflation. A positive supply shock shifts SRAS right: lower price level, higher output.
Long-run self-adjustment: With no policy, wages and input prices adjust. In a recessionary gap, nominal wages eventually fall, SRAS shifts right, and output returns to YF at a lower price level. In an inflationary gap, nominal wages rise, SRAS shifts left, and output returns to YF at a higher price level.

Multipliers and fiscal policy

Units 3, 5

MPC = change in consumption ÷ change in disposable income: The share of each extra dollar of disposable income that people spend. MPS = change in saving ÷ change in disposable income, and MPC + MPS = 1.
Spending multiplier = 1 ÷ MPS = 1 ÷ (1 − MPC): Change in real GDP = change in spending × spending multiplier. Example: MPC 0.8 gives a multiplier of 5, so a $10 billion rise in G can raise real GDP by up to $50 billion.
Tax multiplier = −MPC ÷ MPS: It's negative because a tax cut raises GDP. With MPC 0.8 it is −4, so a $10 billion tax cut can raise real GDP by up to $40 billion. A change in transfer payments works the same way with the sign flipped (MPC ÷ MPS).
Why spending beats an equal tax change: Government purchases add to AD in full right away, but people save part of a tax cut (the MPS share) before spending the rest. So the tax multiplier is always 1 smaller in size than the spending multiplier.
Balanced-budget multiplier = 1: If G and taxes both rise by the same amount, real GDP rises by that amount: 1 ÷ MPS + (−MPC ÷ MPS) = 1. Example: G and taxes each up $20 billion → real GDP up $20 billion.
Closing a gap: Needed change in G = output gap ÷ spending multiplier. Needed tax change = output gap ÷ tax multiplier. Example: a $200 billion recessionary gap with MPC 0.75 (multiplier 4) needs G to rise by $50 billion, or taxes to fall by about $66.7 billion (tax multiplier −3).
Fiscal policy: The government's use of spending, taxes and transfer payments. Expansionary (raise G, cut taxes, raise transfers) shifts AD right to close a recessionary gap; contractionary (the reverse) shifts AD left to close an inflationary gap. Congress and the President set it, not the central bank.
Automatic stabilizers: Taxes and transfers that change on their own with the economy, no new law needed. In a recession, tax collections fall and unemployment benefits rise, which supports spending; in a boom, the reverse cools spending.
Policy lags: Fiscal and monetary policy both take time: to recognize a problem, decide and act, and for the effects to work through the economy. Fiscal policy's lawmaking step is usually slower; monetary policy can be decided faster but still takes time to affect spending.

Money, banks and the money supply

Unit 4

Functions of money: Medium of exchange (used to buy things), unit of account (used to measure value) and store of value (holds value over time).
M1 and M2: M1 is the most liquid money: currency in circulation, checkable (demand) deposits and, under the Fed's definition since 2020, savings deposits. M2 is M1 plus less liquid near-monies such as small time deposits (like CDs) and retail money market funds. So moving money from checking into a CD lowers M1 but leaves M2 the same.
Monetary base: Currency in circulation plus banks' reserves (sometimes written MB or M0). The central bank controls it directly: an open market purchase adds reserves and raises the monetary base, and a sale lowers it.
Stocks and bonds: A stock is a share of ownership in a company; a bond is a loan to a company or government that pays interest. Assets trade off liquidity, risk and rate of return; riskier assets usually have to offer higher expected returns.
Bond prices and interest rates move in opposite directions: When market interest rates rise, existing bonds paying the old, lower rate are worth less, so their prices fall. When rates fall, existing bond prices rise.
T-account (bank balance sheet): Assets on the left (required reserves, excess reserves, loans, bonds) and liabilities on the right (demand deposits, plus owner's equity). The two sides must be equal.
Required reserves = demand deposits × required reserve ratio: Excess reserves = total reserves − required reserves. A single bank can lend out up to its excess reserves.
Money multiplier = money supply ÷ monetary base: Its maximum value is 1 ÷ required reserve ratio: 10 with a 10% ratio, 5 with 20%. Maximum change in the money supply = new excess reserves × that maximum multiplier. The real change is smaller if banks hold extra reserves or people keep more cash.
Someone deposits cash: Example with a 10% ratio and a $1,000 cash deposit: required reserves rise by $100 and excess reserves by $900. The most new money the banking system can create is $900 × 10 = $9,000, and demand deposits can rise by up to $1,000 × 10 = $10,000. The deposit itself doesn't change M1, because cash just became a checking deposit.
Central bank buys bonds from a bank: With limited reserves: if the central bank buys $1,000 of bonds from a bank, the bank's excess reserves rise by the full $1,000, so the money supply can grow by up to $1,000 × the money multiplier. If it buys from a member of the public instead, the seller's new $1,000 deposit is new money right away and the total can still reach $1,000 × the multiplier. Selling bonds does the reverse.

Interest rates and monetary policy

Unit 4

Money market graph: Nominal interest rate (i) on the vertical axis and quantity of money on the horizontal axis. Money demand (MD) slopes down because a higher interest rate raises the opportunity cost of holding cash; money supply (MS) is vertical because the central bank sets it. They cross at the equilibrium nominal interest rate (i1) and quantity of money (Q1).
What shifts MD: A higher price level or higher real GDP (more nominal GDP) means people need more money for transactions, so MD shifts right and the nominal interest rate rises.
What shifts MS: With limited reserves, the central bank shifts MS right (an open market purchase, a lower reserve ratio or a lower discount rate), which lowers the nominal interest rate. Shifting MS left raises it.
Nominal vs. real interest rate: Real interest rate = nominal interest rate − inflation. Example: 7% nominal with 3% inflation is a 4% real rate. When a loan is made, nominal rate ≈ the real rate the lender wants + expected inflation.
Limited-reserves tools (expansionary → contractionary): Open market operations: buying bonds adds reserves and lowers rates; selling bonds does the reverse. Required reserve ratio: lowering it frees up reserves. Discount rate (what the central bank charges banks for loans): lowering it makes borrowing reserves cheaper.
Ample reserves (the U.S. today): Banks hold so many reserves that small changes in their quantity don't move rates. The central bank moves its policy rate (the federal funds rate in the U.S.) by changing administered rates, mainly the interest rate it pays on reserves.
Reserve market graph: Policy rate (for example the federal funds rate) on the vertical axis and quantity of reserves on the horizontal axis. Demand for reserves (DR) slopes down and then flattens out at the rate paid on reserves; supply of reserves (SR) is vertical. With ample reserves, supply crosses demand in the flat part, so lowering the rate paid on reserves moves the flat part down and lowers the policy rate (PR1 to PR2). With limited reserves, supply crosses the sloped part, so shifting supply changes the rate.
Expansionary monetary policy: Used to fight a recession: lower interest rates → more investment and interest-sensitive consumer spending → AD shifts right → real GDP and the price level rise and unemployment falls.
Contractionary monetary policy: Used to fight inflation: higher interest rates → less investment and consumer borrowing → AD shifts left → the price level and real GDP fall.
Fed vs. fiscal policy: Monetary policy is set by the central bank (in the U.S., the Federal Reserve) and works through interest rates. Fiscal policy is set by the government through spending and taxes. Don't mix up who does what.

Loanable funds and crowding out

Units 4, 5

Loanable funds graph: Real interest rate (r) on the vertical axis and quantity of loanable funds on the horizontal axis. Supply (SLF) slopes up and comes from savers; demand (DLF) slopes down and comes from borrowers. They cross at r1 and Q1.
What shifts supply of loanable funds: More private saving, a government budget surplus or a foreign capital inflow shifts SLF right and lowers the real interest rate. Less saving or a capital outflow shifts it left.
What shifts demand for loanable funds: More borrowing shifts DLF right and raises the real interest rate: for example, firms responding to an investment tax credit or better business expectations, or a government borrowing to cover a deficit.
Government deficit on the graph: Show it as DLF shifting right (government borrows more) or as SLF shifting left (public saving falls). Either way the real interest rate rises; AP scoring has accepted both.
Crowding out: When government borrowing raises the real interest rate, firms and households borrow and invest less. Less private investment can mean a smaller capital stock and slower long-run growth.
National saving and investment: National saving = private saving + public saving (the government's budget balance). In an open economy, investment = national saving + net capital inflow, so a capital inflow lets a country invest more than it saves.
Money market vs. loanable funds: The money market is about holding money and uses the nominal interest rate; the loanable funds market is about saving and borrowing and uses the real interest rate. Use the market the question names.

Phillips curve and money growth

Unit 5

Phillips curve graph: Inflation rate (%) on the vertical axis and unemployment rate (%) on the horizontal axis. The short-run Phillips curve (SRPC) slopes down; the long-run Phillips curve (LRPC) is vertical at the natural rate of unemployment. Long-run equilibrium is where they cross.
Reading gaps on the Phillips curve: A point on the SRPC to the left of the LRPC (unemployment below natural) is an inflationary gap. A point to the right (unemployment above natural) is a recessionary gap.
AD changes move along the SRPC: More AD means higher inflation and lower unemployment: a move up and to the left along the SRPC. Less AD moves down and to the right.
What shifts the SRPC: Higher expected inflation or a negative supply shock (SRAS shifts left) shifts the SRPC right (up). Lower expected inflation or a positive supply shock shifts it left (down).
What shifts the LRPC: Only a change in the natural rate of unemployment, for example a change in frictional or structural unemployment. There's no long-run trade-off between inflation and unemployment.
Linking AD–AS and the Phillips curve: AD–AS short-run equilibrium left of LRAS = SRPC point right of LRPC (higher unemployment), and right of LRAS = left of LRPC. When SRAS shifts left in AD–AS, the SRPC shifts right.
Equation of exchange: M × V = P × Y: Money supply × velocity (how many times a dollar is spent per year) = price level × real output = nominal GDP. Example: M = $500 billion and V = 4 give nominal GDP of $2,000 billion.
Quantity theory of money: If velocity is stable and real output is set by full-employment capacity in the long run, faster money growth mainly raises the price level. In rate form, %ΔM + %ΔV ≈ %ΔP + %ΔY, so with V steady, inflation ≈ money growth − real output growth.

Deficits, debt and economic growth

Unit 5

Budget deficit and surplus: Deficit: in a given year, government spending plus transfers is more than tax revenue. Surplus: tax revenue is more. Budget balance = tax revenue − (government spending + transfers).
National debt: The total the government owes from all past borrowing. Each year's deficit adds to it and a surplus reduces it. Interest on the debt adds to future government spending and is money that can't go to other uses.
Mixing fiscal and monetary policy: Trace each policy's effect on AD, real GDP, the price level and interest rates. Expansionary fiscal policy tends to push interest rates up while expansionary monetary policy pushes them down, so with both the change in interest rates depends on which is bigger.
Long-run effect of AD policy: Policies that shift only AD can change output in the short run, but in the long run output returns to YF and only the price level stays different.
Economic growth: A sustained rise in real GDP per person. Show it as the PPC shifting out or LRAS shifting right (LRAS1 to LRAS2).
Sources of growth: Higher productivity (labor productivity = real output ÷ number of workers), which comes from more physical capital per worker, more human capital (education, skills, health) and better technology. The aggregate production function puts employment on the horizontal axis and real GDP on the vertical axis; more capital or better technology shifts it up (tested in multiple choice only).
Growth policy: Spending on education and job training, infrastructure, and research and development aims to raise productivity and shift LRAS right. Supply-side tax policies aim to strengthen incentives to work, save and invest. Economists disagree about how large these effects are, so on the exam focus on the direction the model predicts.

Balance of payments and exchange rates

Unit 6

Balance of payments: The record of all of a country's transactions with the rest of the world. Money coming in is a credit (+); money going out is a debit (−).
Current account (CA): Net exports of goods and services (the trade balance), plus net income from abroad and net transfers. Buying imports is a debit; selling exports is a credit.
Capital and financial account (CFA): Purchases and sales of assets such as stocks, bonds, land and factories. A foreigner buying a U.S. bond is a credit to the U.S. CFA (money flows in).
CA + CFA = 0: The two accounts balance (apart from measurement error). A current account deficit comes with a capital and financial account surplus of the same size, and vice versa.
Exchange rate: The price of one currency in terms of another, such as $1.25 per euro. Flip it to get the other price: $1.25 per euro = 1 ÷ 1.25 = 0.80 euros per dollar.
Converting a price: Price in dollars = price in euros × dollars per euro. Example: at $1.25 per euro, a €40 item costs $50.
Appreciation and depreciation: If it takes more dollars to buy a euro, the euro has appreciated and the dollar has depreciated. One currency rising always means the other is falling.
Foreign exchange graph: For the euro: price of a euro (dollars per euro) on the vertical axis and quantity of euros on the horizontal axis. Demand for euros slopes down (people wanting European goods, services and assets); supply of euros slopes up (Europeans buying things priced in other currencies). They cross at the equilibrium exchange rate (e1).
Mirror image: Americans demanding more euros means they're supplying more dollars. So if demand for euros rises, the euro appreciates and, on a dollar graph, the supply of dollars rises and the dollar depreciates.

What moves currencies and trade

Unit 6

What shifts currency demand and supply: Changes in relative tastes for a country's goods, relative incomes, relative price levels (inflation) and relative interest rates. Ask: does this make foreigners want more of this country's goods or assets (demand for its currency), or make its own people want more foreign things (supply of its currency)?
Higher relative interest rates: If U.S. real interest rates rise compared with other countries, foreigners want more U.S. assets: demand for dollars rises and the dollar appreciates. Financial capital flows in, which also adds to the U.S. supply of loanable funds.
Higher relative income at home: If U.S. incomes rise faster than abroad, Americans buy more imports, so they supply more dollars and the dollar depreciates.
Higher relative inflation at home: If U.S. prices rise faster than abroad, U.S. goods get relatively pricier: foreigners demand fewer dollars, Americans supply more, and the dollar depreciates.
Tariffs and quotas: A tariff or quota on imports means people buy fewer foreign goods, so they supply less of their own currency to buy foreign currency, and their currency appreciates.
Currency value and net exports: When a country's currency appreciates, its exports cost more abroad and imports cost less at home, so net exports fall and AD shifts left. When it depreciates, net exports rise and AD shifts right.
Monetary policy and the currency: Expansionary monetary policy lowers interest rates, so financial capital flows out, the currency depreciates, net exports rise and AD shifts further right. Contractionary policy does the reverse.
Fiscal policy and the currency: A larger government deficit can raise the real interest rate, draw in foreign capital and make the currency appreciate, which lowers net exports.

Cause-and-effect chains to know

Units 3, 4, 5, 6

Expansionary monetary policy (limited reserves): Central bank buys bonds → bank reserves rise → MS shifts right → nominal interest rate falls → investment and interest-sensitive spending rise → AD shifts right → real GDP and price level rise, unemployment falls. Also: lower rates → capital outflow → currency depreciates → net exports rise.
Expansionary monetary policy (ample reserves): Central bank lowers the rate it pays on reserves → policy rate falls → other interest rates fall → investment and consumer borrowing rise → AD shifts right → real GDP and price level rise.
Expansionary fiscal policy: G rises or taxes fall → AD shifts right (by the multiplier) → real GDP and price level rise, unemployment falls. If paid for by borrowing → DLF shifts right → real interest rate rises → private investment falls (crowding out).
Negative supply shock: Input costs jump → SRAS shifts left → price level rises, real GDP falls, unemployment rises (stagflation) → SRPC shifts right.
Recession with no policy: Real GDP below YF → unemployment above natural rate → nominal wages fall over time → SRAS shifts right → back to YF at a lower price level.
Capital inflow: Higher U.S. real interest rate → foreigners buy U.S. assets → demand for dollars rises → dollar appreciates → U.S. net exports fall; U.S. supply of loanable funds rises.
Key opposite-direction pairs: Interest rates and bond prices; interest rates and investment; the price level and the quantity of real output demanded (along AD); inflation and unemployment along the SRPC; a currency's value and its country's net exports.