AP Macroeconomics

Economics 经济学 begins with scarcity 稀缺性: people's wants are unlimited, but the resources 资源 to satisfy them are limited. The resources – the factors of production 生产要素 – are land, labor 劳动, capital 资本, and entrepreneurship 企业家才能. Scarcity forces every society to choose what, how, and for whom to produce, and it makes trade-offs 权衡 unavoidable.

Every choice has an opportunity cost 机会成本 – the value of the next-best alternative given up. The production possibilities curve (PPC) 生产可能性曲线 shows the maximum combinations of two goods an economy can make when resources are fully and efficiently used.

A straight PPC means constant opportunity cost; a bowed one means increasing cost

• Points on the curve are efficient; inside, inefficient (unemployed resources); outside, unattainable.
• The downward slope shows opportunity cost; a bowed-out curve shows increasing opportunity cost.
• More resources or better technology cause economic growth 经济增长, shifting the PPC outward.

A production possibilities curve; investing in capital goods shifts it outward

A producer has an absolute advantage 绝对优势 in a good if it can make more of it. It has a comparative advantage 比较优势 if it has the lower opportunity cost. Nations should specialize in their comparative-advantage goods and trade – both gain if the terms of trade 贸易条件 lie between the two opportunity costs. Trade lets a country consume beyond its own PPC.

Worked example. Country A can make $10$ wheat or $5$ cloth per day; Country B can make $8$ wheat or $8$ cloth. For A, one cloth costs $\tfrac{10}{5}=2$ wheat; for B it costs $\tfrac{8}{8}=1$ wheat. B's opportunity cost of cloth is lower, so B specializes in cloth. Checking wheat: A gives up $0.5$ cloth per wheat and B gives up $1$, so A specializes in wheat. Trading at any rate between the two costs, both consume beyond their own PPC.

Comparative advantage comes from differently-sloped production possibilities curves

Demand 需求 relates price to the quantity buyers will buy. The law of demand 需求定律 makes the curve slope downward. A change in the good's own price is a movement along the curve; the determinants (income, tastes, prices of substitutes 替代品 and complements 互补品, number of buyers, expectations) shift the whole curve.

The demand curve slopes down; income, tastes, and related prices shift it

The law of demand slopes the curve downward; a determinant shifts the whole curve

Supply 供给 relates price to the quantity sellers will offer; the law of supply 供给定律 makes it slope upward. Its determinants – input prices, technology, taxes and subsidies 补贴, number of sellers, expectations – shift the curve, while the good's own price moves along it.

The supply curve slopes up; costs, technology, tax, and subsidy shift it

Equilibrium 均衡 is where supply meets demand, clearing the market. Above the equilibrium price a surplus 过剩 pushes price down; below it a shortage 短缺 pushes price up. When a determinant shifts one curve, price and quantity move predictably; when both shift, one of them is indeterminate.

Worked example. A new technology lowers producers' costs, shifting supply right. Along the unchanged demand curve, the equilibrium price falls and the equilibrium quantity rises. If instead a rise in incomes shifts demand right at the same time, quantity clearly rises but the effect on price depends on which shift is larger – the "both shift" indeterminate case.

Equilibrium price and quantity where demand meets supply

Exam skill: macro builds on these micro tools – you must draw and shift supply-and-demand and PPC graphs correctly, because the same shift logic drives the aggregate (whole-economy) models later in the course.

Market equilibrium sits where supply meets demand; away from it lie surplus and shortage

• Opportunity cost is what you give up — read it off a PPC as the slope; a bowed-out PPC shows increasing opportunity cost.
• Comparative advantage (lower opportunity cost), not absolute advantage, decides who should specialise and trade.
• Points inside the PPC are inefficient, outside unattainable; more resources/technology shift it out (growth).
• Distinguish a movement along a demand/supply curve (own price) from a shift (a determinant).
• These micro tools drive the aggregate models later — draw and shift the correct curve in the correct direction.

The circular-flow model 循环流动模型 shows money moving between households and firms: households supply factors and earn income; firms sell goods and earn revenue. Every dollar of spending is someone's income, which is why output and income are two sides of the same total.

The circular flow of income, with its leakages and injections

Gross domestic product (GDP) 国内生产总值 is the market value of all final goods and services produced within a country in a year. Three ways to measure it give the same number:

• Expenditure approach: $GDP = C + I + G + X_n$ – consumption 消费, investment 投资 (business spending on capital, plus new housing and inventory), government purchases 政府购买, and net exports 净出口 (exports minus imports).
• Income approach: add up all wages, rent, interest, and profit.

Exclude intermediate goods (avoid double counting), used goods, purely financial transactions, and transfer payments.

GDP measures market output, not well-being. It omits non-market production (unpaid housework, volunteering), the underground economy 地下经济, leisure, and the distribution of income, and it ignores environmental damage and resource depletion. So a higher GDP does not automatically mean a better standard of living. GDP per capita (GDP $\div$ population) is a better welfare proxy than total GDP.

GDP per capita shows average output but misses distribution, unpaid work, and more

The labor force 劳动力 is the employed plus the unemployed (those without work who are actively looking). People not looking are not in the labor force.

Three types of unemployment: frictional, structural, and cyclical

Worked example. A country has $150$ million employed and $10$ million unemployed (actively looking), with $40$ million working-age adults not looking. The labor force is $150+10=160$ million, so the unemployment rate is $\dfrac{10}{160}=6.25\%$ and the participation rate is $\dfrac{160}{200}=80\%$.

Three types of unemployment:

• Frictional 摩擦性失业: between jobs or searching for a first job (normal, short).
• Structural 结构性失业: skills or location don't match available jobs (technology, trade).
• Cyclical 周期性失业: caused by a recession (a downturn in the business cycle).

Frictional + structural make up the natural rate of unemployment 自然失业率. At the natural rate cyclical unemployment is zero and the economy is at full employment 充分就业. The rate understates joblessness because it omits discouraged workers 灰心工人 and the underemployed.

Inflation 通货膨胀 is a sustained rise in the average price level. It is measured with a price index 价格指数, most often the consumer price index (CPI) 消费者价格指数, built from a fixed market basket of goods a typical household buys:

Demand-pull and cost-push inflation on the AD-AS diagram

The inflation rate is the percent change in the index between two years. Deflation 通货紧缩 is a falling price level; disinflation is a slowing of inflation.

Worked example. If the CPI is $200$ this year and was $190$ last year, the inflation rate is $\dfrac{200-190}{190}\times100\%=5.3\%$. A basket that cost $\$190$ then costs $\$200$ – the same goods, more dollars.

Inflation redistributes and distorts:

• It hurts lenders and savers and helps borrowers when it is unexpected, because loans are repaid in cheaper dollars. It erodes the value of money and fixed incomes.
• Menu costs and uncertainty discourage investment.
• Anticipated inflation is less harmful because contracts and interest rates adjust for it. This is why we separate nominal and real values.

• Nominal GDP 名义GDP is valued at current prices, so it rises with both output and prices.
• Real GDP 实际GDP is valued at constant (base-year) prices, stripping out inflation, so it reflects true output. Real GDP is the honest measure of growth.

Worked example. Nominal GDP is $\$22$ trillion and the GDP deflator is $110$. Real GDP is $\dfrac{22}{110}\times100=\$20$ trillion. The extra $\$2$ trillion of nominal GDP is pure price rise, not real output – which is why growth is always measured with real GDP.

Exam skill: be fluent converting nominal to real using a price index, and computing an inflation rate or a growth rate as a percent change.

The business cycle 经济周期 is the economy's short-run ups and downs in real GDP around its long-run growth trend: expansion 扩张 (rising output, falling unemployment) up to a peak 顶峰, then contraction/recession 衰退 (falling output, rising cyclical unemployment) down to a trough 谷底, then recovery. A recession is commonly two consecutive quarters of falling real GDP. Unemployment and inflation move roughly opposite over the cycle – the tension the rest of the course tries to manage.

Real GDP swinging around its long-run trend

• Compute GDP by the expenditure method $C+I+G+X_n$ and count only final goods (avoid double counting).
• Unemployment rate = unemployed ÷ labor force; discouraged workers leave the labor force (so the rate can understate joblessness).
• Know the three unemployment types (frictional, structural, cyclical) and that the natural rate excludes cyclical.
• Inflation is the % change in the CPI; convert nominal to real with a price index and always use real GDP for growth.
• Place events on the business cycle (expansion → peak → contraction → trough).

Aggregate demand (AD) 总需求 shows the total quantity of real output ($C+I+G+X_n$) buyers want at each price level 价格水平. It slopes downward for three reasons special to the whole economy:

Aggregate demand is total spending: consumption, investment, government, and net exports

• the wealth effect 财富效应 (a higher price level shrinks the real value of money, so people buy less),
• the interest-rate effect 利率效应 (a higher price level raises money demand and interest rates, cutting investment),
• the net-export effect (a higher domestic price level makes exports dearer and imports cheaper).

A change in the price level is a movement along AD. AD shifts when any component of $C+I+G+X_n$ changes for another reason – consumer confidence, business expectations, government spending, taxes, or foreign incomes.

A change in spending sets off further rounds of spending, so the final change in GDP is larger than the initial change – the multiplier effect 乘数效应. It depends on the marginal propensity to consume 边际消费倾向 (MPC), the fraction of extra income that is spent (the rest is the marginal propensity to save 边际储蓄倾向, MPS, with $MPC+MPS=1$):

One injection multiplies into a larger overall rise in income

A tax cut works through the multiplier too, but more weakly, because part of the tax cut is saved:

The tax multiplier is smaller in size and negative (a tax cut raises GDP; a tax rise lowers it). Total change in GDP $=$ (multiplier) $\times$ (initial change).

Worked example. If $MPC=0.8$, the spending multiplier is $\dfrac{1}{1-0.8}=5$, so a $\$10$ billion rise in government spending lifts real GDP by $5\times\$10=\$50$ billion. The tax multiplier is $-\dfrac{0.8}{0.2}=-4$, so a $\$10$ billion tax cut raises GDP by only $\$40$ billion – weaker, because part of the tax cut is saved.

Exam skill: compute both multipliers from the MPC and find the resulting change in real GDP – an almost-guaranteed calculation.

Short-run aggregate supply (SRAS) 短期总供给 slopes upward: in the short run some input prices (especially nominal wages 名义工资) are sticky 粘性, so a higher output price level widens profit margins and firms produce more. SRAS shifts with input prices, productivity, taxes/subsidies on producers, and supply shocks (e.g. an oil-price change). A rise in input costs shifts SRAS left.

Long-run aggregate supply (LRAS) 长期总供给 is vertical at the economy's full-employment (potential) output 潜在产出 $Y_f$. In the long run all prices and wages adjust, so output depends only on real factors – resources, technology, institutions – not the price level. LRAS shifts only with economic growth (more or better resources). The vertical LRAS is why, in the long run, demand policy changes prices, not output.

Supply-side policy shifts long-run aggregate supply right: more output, lower prices

The economy settles where AD meets SRAS, fixing the equilibrium price level and real GDP. Comparing that output to $Y_f$ (the LRAS line) gives the economy's state:

Macroeconomic equilibrium where aggregate demand meets aggregate supply

• output $: a recessionary gap 衰退缺口 (cyclical unemployment),
• output $>Y_f$: an inflationary gap 通胀缺口 (overheating),
• output $=Y_f$: long-run equilibrium.

• A demand shock shifts AD: a positive one (more spending) raises both price level and output (and lowers unemployment); a negative one lowers both.
• A supply shock shifts SRAS: a negative one (higher input costs) raises the price level and lowers output at once – stagflation 滞胀 – the hardest case for policymakers, because fixing one worsens the other.

Left alone, the economy self-corrects through flexible wages:

• In a recessionary gap, high unemployment eventually pushes nominal wages down, shifting SRAS right until output returns to $Y_f$ at a lower price level.
• In an inflationary gap, labor shortages push wages up, shifting SRAS left back to $Y_f$ at a higher price level.

The debate over how fast this happens is the case for (or against) active policy: self-adjustment is slow and painful, which is the argument for intervening.

Fiscal policy 财政政策 is the government's use of spending and taxes to shift AD:

Expansionary fiscal policy shifts AD right, raising output and prices

• Expansionary 扩张性 (more spending or lower taxes) shifts AD right to close a recessionary gap.
• Contractionary 紧缩性 (less spending or higher taxes) shifts AD left to close an inflationary gap.

Size the policy with the multipliers: to close a gap of a given size, the required change in spending is (gap) $\div$ (spending multiplier). Limits include time lags, crowding out (below), and political difficulty.

Worked example. An economy has a $\$100$ billion recessionary gap and $MPC=0.75$ (spending multiplier $=\dfrac{1}{0.25}=4$). To close it, the government must raise spending by $\dfrac{\$100\text{ billion}}{4}=\$25$ billion. Using a tax cut instead (tax multiplier $-3$) would require a larger $\dfrac{100}{3}\approx\$33$ billion cut.

Exam skill: you must draw the correctly labeled AD-AS graph, identify the gap, prescribe the right fiscal action and its direction, and often calculate the exact spending or tax change needed.

Automatic stabilizers 自动稳定器 are features that dampen the cycle without new legislation. In a downturn, progressive taxes collect less and transfer payments (unemployment benefits, welfare) rise automatically – cushioning incomes and spending; in a boom they do the reverse. They soften the cycle and act instantly, avoiding the lags of discretionary 相机抉择 policy.

• Aggregate demand slopes down for the wealth, interest-rate, and net-export effects; it shifts when $C$, $I$, $G$, or $X_n$ changes.
• Compute the spending multiplier $\tfrac{1}{1-MPC}$ and the smaller, negative tax multiplier $-\tfrac{MPC}{1-MPC}$.
• Draw a correctly labeled AD–AS graph, identify a recessionary or inflationary gap, and prescribe the right fiscal action.
• Short-run AS slopes up (sticky wages); long-run AS is vertical at full-employment output.
• Size a policy with the multipliers: required spending = gap ÷ spending multiplier.

A financial asset 金融资产 is a claim that stores value: money, stocks 股票 (ownership shares), bonds 债券 (loans that pay interest), and bank deposits. Assets trade off liquidity 流动性 (how easily converted to cash), risk, and return. A key inverse relationship: 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 price falls.

• The nominal interest rate 名义利率 is the stated rate, not adjusted for inflation.
• The real interest rate 实际利率 is what you actually earn in purchasing power:

Lenders and borrowers care about the real rate. If inflation turns out higher than expected, real rates fall – helping borrowers and hurting lenders.

Worked example. A loan carries a nominal rate of $6\%$ while inflation runs at $2\%$. The real rate is $6\%-2\%=4\%$, so the lender's purchasing power grows by $4\%$. If inflation instead jumped to $7\%$, the real rate would be $-1\%$ – the lender would actually lose purchasing power.

Money 货币 is anything widely accepted in exchange. Its three functions: a medium of exchange 交换媒介 (avoids barter), a unit of account 记账单位 (a common measure of value), and a store of value 价值储藏 (holds value over time). Modern money is fiat money 法定货币 – valuable because the government declares it legal tender and people trust it, not because it is backed by gold.

The four functions of money

Money is measured in tiers by liquidity: M1 (currency plus checkable deposits – the most liquid) and the broader M2 (M1 plus savings deposits and other near-money).

Banks operate on a fractional reserve 部分准备金 system: they keep a fraction of deposits as reserves 准备金 and lend the rest. The fraction they must keep is the required reserve ratio 法定准备金率 (rr). Lending creates new deposits, which are re-deposited and re-lent, expanding the money supply by the money multiplier:

A new $1000 deposit with$rr=0.1$can expand the money supply by up to$1000\times\frac{1}{0.1}=10,000$. Use a bank's T-account (assets = reserves + loans; liabilities = deposits) to track required reserves and excess reserves 超额准备金 (the amount available to lend).

Worked example. A bank receives a $\$1000$ deposit with $rr=0.20$. It must hold $0.20\times1000=\$200$ as required reserves, leaving $\$800$ of excess reserves to lend. With a money multiplier of $\dfrac{1}{0.20}=5$, that $\$800$ of new lending can expand the money supply by up to $800\times5=\$4000$ across the banking system.

Exam skill: given a required reserve ratio and a deposit, compute excess reserves, the money multiplier, and the maximum change in the money supply.

The money market 货币市场 determines the nominal interest rate:

The interest rate is set by the demand for and supply of money

• Money demand 货币需求 slopes downward against the interest rate – the rate is the opportunity cost of holding money instead of interest-bearing assets. It shifts right with a higher price level or more real GDP.
• Money supply 货币供给 is vertical – set by the central bank, independent of the interest rate.

Their intersection sets the equilibrium interest rate. If the central bank increases the money supply, the supply line shifts right and the interest rate falls.

Monetary policy 货币政策 is the central bank's (the Federal Reserve's) use of the money supply to steer the economy, working through the interest rate:

How a higher interest rate works through the economy to slow inflation

• Expansionary (easy) 扩张性: increase the money supply $\to$ interest rate falls $\to$ investment and consumption rise $\to$ AD shifts right (fights recession).
• Contractionary (tight) 紧缩性: decrease the money supply $\to$ interest rate rises $\to$ AD shifts left (fights inflation).

Tools: open-market operations 公开市场操作 (buying bonds injects money, selling bonds withdraws it – the main tool), changing the reserve requirement, and changing the discount rate 贴现率 (the rate banks pay to borrow from the central bank). Follow the full chain on the exam: money supply $\to$ interest rate $\to$ investment $\to$ AD $\to$ output, price level, unemployment.

The loanable funds market 可贷资金市场 determines the real interest rate and connects saving to investment:

• Supply of loanable funds comes from saving and slopes upward.
• Demand for loanable funds comes from borrowers (firms investing, government borrowing) and slopes downward.

More saving shifts supply right and lowers the real rate; more government borrowing shifts demand right and raises the real rate – the mechanism behind crowding out. Distinguish the two graphs: the money market sets the nominal rate (vertical money supply), while loanable funds sets the real rate (upward-sloping saving supply).

Exam skill: know which graph to draw – money market for monetary policy, loanable funds for saving, deficits, and crowding out – and trace how a shift in one feeds into AD-AS.

• Know money's three functions and the M1/M2 measures.
• The money market sets the nominal interest rate (vertical money supply); more money supply lowers the rate.
• Compute the money multiplier $\tfrac{1}{rr}$ and the maximum change in the money supply from a new deposit.
• Trace monetary policy: money supply → interest rate → investment → AD → output.
• Distinguish the money market (nominal rate) from the loanable-funds market (real rate); use the real rate $=$ nominal $-$ inflation.

Both policies work by shifting AD in the short run. Fiscal policy 财政政策 changes government spending or taxes; monetary policy 货币政策 changes the money supply and thus the interest rate. They can work together (both expansionary to fight a deep recession) or be mixed (e.g. loose fiscal + tight monetary). In the short run, expansionary policy raises output and the price level and lowers unemployment; contractionary policy does the reverse.

The Phillips curve 菲利普斯曲线 shows the short-run trade-off between inflation and unemployment:

The short-run and long-run Phillips curves

• The short-run Phillips curve (SRPC) 短期菲利普斯曲线 slopes downward – lower unemployment comes with higher inflation. It is the mirror image of AD-AS: a rightward AD shift moves the economy up-left along the SRPC (less unemployment, more inflation).
• The long-run Phillips curve (LRPC) 长期菲利普斯曲线 is vertical at the natural rate of unemployment 自然失业率 – the counterpart of vertical LRAS. In the long run there is no trade-off: policy changes inflation, not unemployment.
• A supply shock shifts the SRPC (a negative shock moves it right – worse inflation and unemployment, i.e. stagflation). A change in expected inflation also shifts the SRPC.

Exam skill: link the AD-AS and Phillips graphs – a recessionary gap in AD-AS corresponds to a point on the SRPC to the right of the natural rate; know what shifts SRPC versus moves along it.

In the long run, inflation is a monetary phenomenon. The quantity theory of money 货币数量论 states $M\times V = P\times Y$ (money supply $\times$ velocity $=$ price level $\times$ real output). With velocity $V$ and real output $Y$ roughly stable in the long run, growth in the money supply translates almost one-for-one into inflation. Printing money faster than the economy grows raises the price level, not real output – the root of high inflation and, in the extreme, hyperinflation 恶性通货膨胀.

Worked example. Suppose the money supply grows $8\%$ per year while real output $Y$ grows $3\%$ and velocity $V$ is stable. Rearranging $M\times V=P\times Y$ into growth rates, inflation $\approx 8\%-3\%=5\%$. The $5\%$ of money growth not matched by extra output simply becomes higher prices.

A budget deficit 预算赤字 occurs when government spending exceeds tax revenue in a year (a surplus 盈余 is the reverse). The accumulated total of past deficits is the national debt 国债. Deficits are financed by borrowing – selling government bonds – which adds to the debt and to future interest payments. Persistent deficits raise concerns about crowding out and the burden of servicing the debt.

Crowding out 挤出效应 is the main long-run cost of deficit-financed fiscal policy. When the government borrows heavily, it increases the demand for loanable funds, raising the real interest rate. Higher rates reduce private investment (and interest-sensitive consumption). So expansionary fiscal policy partly cancels itself: the AD boost is offset by weaker investment. Worse, less investment today means a smaller capital stock and slower long-run growth.

Government borrowing raises interest rates and crowds out private investment

Exam skill: show crowding out on the loanable funds graph – government borrowing shifts demand right, the real interest rate rises, and private investment falls.

Worked example. A government borrows $\$500$ billion to finance a deficit. On the loanable funds market this shifts the demand for funds right, pushing the real interest rate up (say from $3\%$ to $4\%$). At the higher rate firms scale back investment – perhaps by $\$150$ billion – so the net boost to AD is smaller than the $\$500$ billion, and the lost investment slows long-run growth.

Economic growth 经济增长 is a sustained rise in real GDP per capita – the true source of higher living standards. It comes from more or better resources and is shown as a rightward shift of LRAS (and an outward shift of the PPC). Its main drivers:

Economic growth shifts the production possibilities curve outward

• physical capital 实物资本 (more tools and machines per worker),
• human capital 人力资本 (education, skills, health),
• technology 技术 and innovation,
• productivity 生产率 (output per worker) growth, the deepest driver.

Governments can raise long-run growth by policies that build capital and productivity: investment in infrastructure and education, research and development incentives, protecting property rights 产权 and the rule of law, encouraging saving and investment (which finances capital), and keeping inflation low and stable. The recurring long-run theme: policies that crowd out or discourage investment slow growth, while those that encourage capital formation speed it up.

• The short-run Phillips curve shows the inflation–unemployment trade-off; the long-run curve is vertical at the natural rate.
• In the long run inflation is a monetary phenomenon (money growth beyond output growth → inflation).
• Show crowding out on the loanable-funds graph: government borrowing raises the real rate and cuts private investment.
• Growth comes from more/better resources — physical capital, human capital, technology — shifting LRAS right.
• A supply shock moves inflation and unemployment the same way (stagflation), unlike a demand shock.

The balance of payments 国际收支 records all transactions between a country and the rest of the world, in two main accounts:

The four parts of the current account

• The current account 经常账户 tracks trade in goods and services (exports minus imports), plus income and transfers. A trade deficit makes it negative.
• The capital (financial) account 资本账户 tracks flows of financial assets – foreigners buying domestic assets, and residents buying foreign assets.

The two are mirror images: a current-account deficit is matched by a capital-account surplus (a country that imports more than it exports pays with assets, so foreign investment flows in). They sum to zero.

An exchange rate 汇率 is the price of one currency in terms of another. A currency appreciates 升值 when it gains value (buys more foreign currency) and depreciates 贬值 when it loses value. Always track which currency: if the US dollar appreciates against the euro, the euro depreciates against the dollar – the same event from two sides.

Worked example. Suppose $\$1=\text{€}0.90$, so $\text{€}1=\dfrac{1}{0.90}\approx\$1.11$. If the dollar then appreciates to $\$1=\text{€}1.00$, each dollar now buys more euros, while the euro has depreciated – it now buys only $\$1.00$ instead of $\$1.11$. The single event is an appreciation of the dollar and a depreciation of the euro.

A floating exchange rate set by the demand for and supply of a currency

Most currencies today are floating 浮动, set by supply and demand in the foreign-exchange market.

Each currency has its own supply-and-demand graph (price $=$ the exchange rate, quantity $=$ amount of that currency).

• Demand for a currency comes from foreigners wanting its goods, services, or assets.
• Supply of a currency comes from its own residents wanting foreign goods, services, or assets.

The equilibrium exchange rate is where they cross. A rightward shift in demand for a currency causes it to appreciate; a rightward shift in supply causes it to depreciate.

Exam skill: always draw the graph for the currency named in the question, label the axis with that currency's price, and shift the correct curve – mixing up the two currencies' graphs is the most common error.

Exchange rates respond to:

• Relative interest rates: a higher domestic real interest rate attracts foreign financial investment, raising demand for the currency and causing appreciation.
• Relative price levels/inflation: higher domestic inflation makes goods less competitive, lowering demand for the currency (depreciation).
• Relative incomes: higher domestic income raises imports, increasing the supply of domestic currency (depreciation).
• Tastes and expectations about future value.

Monetary policy has a strong link: expansionary monetary policy lowers interest rates, reduces demand for the currency, and causes depreciation (which then boosts net exports).

Exchange rates feed back into AD through net exports:

Appreciation makes exports dearer and imports cheaper; depreciation does the reverse

• A depreciation makes exports cheaper for foreigners and imports dearer, so net exports rise and AD shifts right.
• An appreciation makes exports dearer and imports cheaper, so net exports fall and AD shifts left.

Worked example. A US car priced at $\$30{,}000$ costs a European buyer $\text{€}27{,}000$ when $\$1=\text{€}0.90$. If the dollar depreciates to $\$1=\text{€}0.80$, the same car now costs only $\text{€}24{,}000$ – cheaper for foreigners, so US exports rise while imports (now dearer in dollars) fall, lifting net exports and shifting AD right.

This is how the foreign-exchange market and the AD-AS model connect – a currency change is a channel through which policy reaches output.

Money chases the highest real return, so capital flows 资本流动 respond to real interest rates:

• A higher domestic real interest rate attracts inflows of foreign financial capital – foreigners buy domestic bonds, raising currency demand and causing appreciation.
• A lower real rate causes outflows and depreciation.

This ties the whole course together: government borrowing raises the real interest rate (loanable funds), which attracts foreign capital, appreciates the currency, and reduces net exports – so a budget deficit can widen a trade deficit (the "twin deficits"). Tracing these linked effects across the loanable-funds, forex, and AD-AS graphs is the capstone skill of AP Macroeconomics.

• The current account and financial account are mirror images and sum to zero.
• Always draw the forex graph for the currency named, and label its price with that currency; one currency appreciating is the other depreciating.
• A depreciation raises net exports (exports cheaper); an appreciation lowers them.
• Higher domestic real interest rates attract capital inflows → currency appreciates → net exports fall.
• Link it all: a budget deficit raises the real rate, appreciates the currency, and can widen the trade deficit (twin deficits).