AP Macroeconomics Unit 4 Standards - Financial Sector

Disclaimer: This outline is sourced directly from the AP Macroeconomics Course Framework released by the College Board. This is a lightweight, web-friendly format for easy reference. Omninox does not take credit for this outline and is not affiliated with the College Board. AP is a reserved trademark of the College Board.

Unit 1 - Basic Economic Concepts
Unit 2 - Economic Indicators and the Business Cycle
Unit 3 - National Income and Price Determination
Unit 4 - Financial Sector (you are here)
Unit 5 - Long-Run Consequences of Stabilization Policies
Unit 6 - Open Economy– International Trade and Finance

TOPIC 4.1 - Financial Assets

MEA-3.A: a. Define the principal attributes—liquidity, rate of return, and risk— associated with various classes of financial assets, including money. b. Explain the relationship between the price of previously issued bonds and interest rates.

  • MEA-3.A.1: The most liquid forms of money are cash and demand deposits.
  • MEA-3.A.2: Other financial assets people can hold in place of the most liquid forms of money include bonds (interest-bearing assets) and stocks (equity).
  • MEA-3.A.3: The price of previously issued bonds and interest rates on bonds are inversely related.
  • MEA-3.A.4: The opportunity cost of holding money is the interest that could have been earned from holding other financial assets such as bonds.

TOPIC 4.2 - Nominal v. Real Interest Rates

MEA-3.B: a. Define the nominal and real interest rate. b. Explain the relationship between changes in nominal interest rates, expected inflation, and real interest rates. c. Calculate the nominal and real interest rate.

  • MEA-3.B.1: A nominal interest rate is the rate of interest paid for a loan, unadjusted for inflation.
  • MEA-3.B.2: Lenders and borrowers establish nominal interest rates as the sum of their expected real interest rate and expected inflation.
  • MEA-3.B.3: A real interest rate can be calculated in hindsight by subtracting the actual inflation rate from the nominal interest rate.

TOPIC 4.3 - Definition, Measurement, and Functions of Money

MEA-3.C: a. Define money and its functions. b. Calculate (using data as appropriate) measures of money.

  • MEA-3.C.1: Money is any asset that is accepted as a means of payment.
  • MEA-3.C.2: Money serves as a medium of exchange, unit of account, and store of value.
  • MEA-3.C.3: The money supply is measured using monetary aggregates designated as M1 and M2.
  • MEA-3.C.4: The monetary base (often labeled as M0 or MB) includes currency in circulation and bank reserves.

TOPIC 4.4 - Banking and the Expansion of the Money Supply

POL-2.A: a. Define key terms related to the banking system and the expansion of the money supply. b. Explain how the banking system creates and expands the money supply. c. Calculate (using data and balance sheets as appropriate) the effects of changes in the banking system.

  • POL-2.A.1: Depository institutions (such as commercial banks) organize their assets and liabilities on balance sheets.
  • POL-2.A.2: Depository institutions operate using fractional reserve banking.
  • POL-2.A.3: Banks’ reserves are divided into required reserves and excess reserves.
  • POL-2.A.4: Excess reserves are the basis of expansion of the money supply by the banking system.
  • POL-2.A.5: The money multiplier is the ratio of the money supply to the monetary base.
  • POL-2.A.6: The size of expansion of the money supply depends on the money multiplier.
  • POL-2.A.7: The maximum value of the money multiplier can be calculated as the reciprocal of the required reserve ratio.
  • POL-2.A.8: The amount predicted by the simple money multiplier may be overstated because it does not take into account a bank’s desire to hold excess reserves or the public holding more currency.

TOPIC 4.5 - The Money Market

MKT-3.A: a. Define (using graphs as appropriate) the money market, money demand, and money supply. b. Explain (using graphs as appropriate) the relationship between the nominal interest rate and the quantity of money demanded (supplied).

  • MKT-3.A.1: The demand for money shows the inverse relationship between the nominal interest rate and the quantity of money people want to hold.
  • MKT-3.A.2: Given a monetary base determined by a country’s central bank, money supply is independent of the nominal interest rate.

MKT-3.B: Define (using graphs as appropriate) equilibrium in the money market.

  • MKT-3.B.1: In the money market, equilibrium is achieved when the nominal interest rate is such that the quantities demanded and supplied of money are equal.

MKT-3.C: Explain (using graphs as appropriate) how nominal interest rates adjust to restore equilibrium in the money market.

  • MKT-3.C.1: Disequilibrium nominal interest rates create surpluses and shortages in the money market. Market forces drive nominal interest rates toward equilibrium.

MKT-3.D: a. Explain (using graphs as appropriate) the determinants of demand and supply in the money market. b. Explain (using graphs as appropriate) how changes in demand and supply in the money market affect the equilibrium nominal interest rate.

  • MKT-3.D.1: Factors that shift the demand for money, such as changes in the price level, and supply of money, such as monetary policy, change the equilibrium nominal interest rate.

TOPIC 4.6 - Monetary Policy

POL-1.D: a. Define monetary policy and related terms. b. Explain (using graphs as appropriate) the shortrun effects of a monetary policy action. c. Calculate (using data and balance sheets as appropriate) the effects of a monetary policy action.

  • POL-1.D.1: Central banks implement monetary policies to achieve macroeconomic goals, such as price stability.
  • POL-1.D.2: The tools of monetary policy include openmarket operations, the required reserve ratio, and the discount rate. The most frequently used monetary policy tool is openmarket operations.
  • POL-1.D.3: When the central bank conducts an openmarket purchase (sale), reserves increase (decrease), thereby increasing (decreasing) the monetary base.
  • POL-1.D.4: The effect of an open-market purchase (sale) on the money supply is greater than the effect on the monetary base because of the money multiplier.
  • POL-1.D.5: Many central banks carry out policy to hit a target range for an overnight interbank lending rate. (In the United States, this is the federal funds rate.)
  • POL-1.D.6: Central banks can influence the nominal interest rate in the short run by changing the money supply, which in turn will affect investment and consumption.
  • POL-1.D.7: Expansionary or contractionary monetary policies are used to restore full employment when the economy is in a negative (i.e., recessionary) or positive (i.e., inflationary) output gap.
  • POL-1.D.8: Monetary policy can influence aggregate demand, real output, the price level, and interest rates.
  • POL-1.D.9: A money market model and/or the AD–AS model are used to demonstrate the short-run effects of monetary policy.

POL-1.E: Define why there are lags to monetary policy.

  • POL-1.E.1: In reality, there are lags to monetary policy caused by the time it takes to recognize a problem in the economy and the time it takes the economy to adjust to the policy action.

TOPIC 4.7 - The Loanable Funds Market

MKT-4.A: a. Define (using graphs as appropriate) the loanable funds market, demand for loanable funds, and supply of loanable funds. b. Explain (using graphs as appropriate) the relationship between the real interest rate and the quantity of loanable funds demanded (supplied).

  • MKT-4.A.1: The loanable funds market describes the behavior of savers and borrowers.
  • MKT-4.A.2: The demand for loanable funds shows the inverse relationship between real interest rates and the quantity demanded of loanable funds.
  • MKT-4.A.3: The supply of loanable funds shows the positive relationship between real interest rates and the quantity supplied of loanable funds.

MKT-4.B: Define national savings in both a closed and an open economy

  • MKT-4.B.1: In the absence of international borrowing and lending, national savings is the sum of public savings and private savings.
  • MKT-4.B.2: For an open economy, investment equals national savings plus net capital inflow.

MKT-4.C: Define (using graphs as appropriate) equilibrium in the loanable funds market.

  • MKT-4.C.1: In the loanable funds market, equilibrium is achieved when the real interest rate is such that the quantities demanded and supplied of loanable funds are equal.

MKT-4.D: Explain (using graphs as appropriate) how real interest rates adjust to restore equilibrium in the loanable funds market.

  • MKT-4.D.1: Disequilibrium real interest rates create surpluses and shortages in the loanable funds market. Market forces drive real interest rates toward equilibrium.

MKT-4.E: a. Explain (using graphs as appropriate) the determinants of demand and supply in the loanable funds market. b. Explain (using graphs as appropriate) how changes in demand and supply in the loanable funds market affect the equilibrium real interest rate and equilibrium quantity of loanable funds.

  • MKT-4.E.1: The loanable funds market can be used to show the effects of government spending, taxes, and borrowing on interest rates.
  • MKT-4.E.2: Factors that shift the demand (such as an investment tax credit) and supply (such as changes in saving behavior) of loanable funds change the equilibrium interest rate and the equilibrium quantity of funds.