SAT / PSAT
SAT / PSAT Prep
History & Social Science
AP World History AP US History AP European History AP Human Geography AP US Government & Politics AP Psychology AP Macroeconomics AP Microeconomics
English
AP English Language & Composition AP English Literature & Composition
Math & Computer Science
AP Calculus AB/BC AP Precalculus AP Statistics AP Computer Science A AP Computer Science Principles
Sciences
AP Biology AP Chemistry AP Environmental Science AP Physics 1 AP Physics 2
World Languages & Arts
AP Spanish Language AP Art History AP Music Theory Start studying →
Unit 4 · Financial Sector Unit Hub Flashcards Cheat Sheet Essentials Visual Review MC Practice FRQ Practice

AP Macroeconomics Unit 4 Visual Review

An 8-slide visual review of the Financial Sector — money creation, the money multiplier, the money market, and monetary policy, built right into the page.

← Back to Unit 4 hub
UNIT 4 · SLIDE 1 What Money Is (and Isn't) Three functions 1. Medium of exchange accepted for transactions 2. Unit of account common measure of value 3. Store of value holds purchasing power Inflation attacks function #3 Commodity vs. fiat Commodity money has value itself (gold, salt) Fiat money value by government decree & public trust (the dollar) Modern money is fiat M1 and M2 M1 — most liquid currency + checkable & savings deposits M2 — M1 + near-monies small time deposits (CDs), money market funds Liquidity = ease of spending Money ≠ income ≠ wealth — money is the liquid asset you can spend right now. Stocks and bonds are NOT money — they must be sold first. Liquidity is what defines money. The Review Hub · AP Macroeconomics Unit 4
Money serves as a medium of exchange, unit of account, and store of value. M1 is the most liquid measure; M2 adds near-monies. Financial assets like stocks aren't money until sold.
UNIT 4 · SLIDE 2 Fractional Reserve Banking — the T-Account FIRST BANK · rr = 10% · YOU DEPOSIT $1,000 ASSETS LIABILITIES Required reserves $100 Your deposit $1,000 Excess reserves $900 → can be LOANED The bank must HOLD 10% of deposits; the other 90% funds new loans. The key vocabulary Required reserves = deposits × reserve ratio (rr) Excess reserves = total reserves − required A single bank can only lend its EXCESS reserves Deposits are LIABILITIES to the bank (it owes you back) How loans create money The $900 loan gets spent, deposited at Bank 2, which holds $90 and lends $810… and so on. Each round adds NEW checkable deposits — the money supply grows far beyond the first $1,000. Your original $1,000 was already money — only NEW loans add money. Banks create money by lending excess reserves — every new loan is new money in someone's account. The Review Hub · AP Macroeconomics Unit 4
A bank must hold required reserves (deposits × rr) and can lend the rest. Those loans become deposits at other banks, which lend again — money multiplies through the system.
UNIT 4 · SLIDE 3 The Money Multiplier Money multiplier = 1 ÷ rr Worked example rr = 10% → multiplier = 1 ÷ 0.10 = 10 $900 excess reserves × 10 = $9,000 max new money from loans = $9,000 Multiply the EXCESS reserves — not the whole deposit — to get new money created. Why reality falls short • Banks may HOLD excess reserves instead of lending • People hold some cash outside banks (leakage) • Borrowers must actually WANT loans Watch the wording (an exam favorite): • Fed BUYS $1,000 bond → all $1,000 is excess → money supply can grow by $1,000 × 10 = $10,000 • Cash deposit → required reserves cut the max Max change in money supply = excess reserves × (1 ÷ rr) — read carefully what the initial change is. The Review Hub · AP Macroeconomics Unit 4
Multiplier = 1/rr. Multiply the excess reserves (not the whole deposit) for new money created. Fed bond purchases inject reserves that are ALL excess — a common exam distinction.
UNIT 4 · SLIDE 4 The Money Market i₁ MS MD Nominal interest rate Quantity of money Money demand slopes down The nominal rate is the OPPORTUNITY COST of holding cash. High rates → park money in bonds; low rates → holding cash costs little. MD shifts with the price level and real income (more transactions) Money supply is vertical The Fed sets the quantity of money — it doesn't respond to the interest rate. MS shifts RIGHT → nominal rate falls MS shifts LEFT → nominal rate rises Money market → NOMINAL rate · loanable funds → REAL rate Vertical MS + downward MD → the nominal interest rate. The Fed moves the vertical line. The Review Hub · AP Macroeconomics Unit 4
MD slopes down because the nominal rate is the cost of holding cash; MS is vertical because the Fed sets it. Their intersection determines the nominal interest rate.
UNIT 4 · SLIDE 5 Monetary Policy — the Fed's Toolkit Expansionary ("easy money") Buy bonds (OMO) · ↓ discount rate · ↓ reserve ratio → MS right → i↓ → I & C rise → AD right → Y↑ Use against a recessionary gap Contractionary ("tight money") Sell bonds (OMO) · ↑ discount rate · ↑ reserve ratio → MS left → i↑ → I & C fall → AD left → PL↓ Use against an inflationary gap Ample reserves (the modern Fed) Banks now hold plentiful reserves, so the Fed steers with ADMINISTERED rates — interest on reserves (IOR). ↓IOR = expansionary · ↑IOR = contractionary — same AD logic The federal funds rate The overnight rate banks charge each other — the Fed's policy TARGET that other rates follow. Both limited- and ample-reserves versions appear on the exam FRQ chain (write every link): tool → MS → nominal i → I & C → AD → real GDP & price level Skipping a link costs the point — always narrate the full causal chain Buy bonds = Bigger money supply — the classic OMO mnemonic, plus IOR for the modern Fed. The Review Hub · AP Macroeconomics Unit 4
Classic tools: open market operations, discount rate, reserve ratio. Modern tool: interest on reserves in the ample-reserves framework. Either way, the FRQ wants the full chain from tool to AD.
UNIT 4 · SLIDE 6 The Loanable Funds Market r₁ D S REAL interest rate Quantity of loanable funds Supply = SAVERS Households & foreigners depositing savings. Shifts: saving behavior, foreign capital inflows. Demand = BORROWERS Firms funding investment + governments running deficits. Shifts: business confidence, deficits. Preview: crowding out (Unit 5) Government borrowing shifts D right → r rises → private investment gets squeezed out. Money market → nominal rate (Fed) · Loanable funds → real rate (savers & borrowers). The Review Hub · AP Macroeconomics Unit 4
Savers supply funds; borrowers (firms + government) demand them. The intersection sets the real interest rate — and government deficits shifting demand right is the setup for crowding out.
UNIT 4 · SLIDE 7 Nominal vs. Real Interest Rates real rate ≈ nominal rate − inflation Worked example Loan at 8% nominal, inflation 3% real return = 8 − 3 = 5% inflation jumps to 7% → real = 1% Lenders quote nominal rates that build in the inflation they EXPECT. When inflation surprises Actual inflation HIGHER than expected: → actual real rate is LOWER than agreed → BORROWERS win, lenders lose Actual inflation LOWER than expected: → actual real rate is HIGHER than agreed → LENDERS win, borrowers lose Same logic as Unit 2's inflation winners & losers — now with rates. Investment decisions and loanable funds run on the real rate; the Fed and money market set the nominal. The Review Hub · AP Macroeconomics Unit 4
Real ≈ nominal − inflation (the Fisher equation). Unexpectedly high inflation shrinks the real rate borrowers actually pay — transferring wealth from lenders to borrowers.
UNIT 4 · SLIDE 8 Unit 4 Quick Reference — Know These Cold Banking math Required reserves = deposits × rr Money multiplier = 1 ÷ rr Max new money = excess reserves × multiplier Single bank lends only its excess reserves Two interest-rate markets Money market: vertical MS → NOMINAL rate Loanable funds: savers/borrowers → REAL rate Fisher: real ≈ nominal − inflation Pick the right graph for the question being asked Fed policy chains Easy: buy bonds / ↓IOR → MS→ → i↓ → I↑ → AD→ Tight: sell bonds / ↑IOR → MS← → i↑ → I↓ → AD← Buy bonds = Bigger MS; Sell = Smaller MS Write EVERY link of the chain on FRQs Money essentials Functions: exchange · account · store of value M1 = most liquid · M2 = M1 + near-monies MD shifts: price level & real income Bonds/stocks are assets, not money Unit 4 is 18–23% of the exam — the money market graph and the policy chain are yearly FRQ regulars. The Review Hub · AP Macroeconomics Unit 4
Bank math, the two interest-rate graphs, the Fed's policy chains, and money definitions — Unit 4 condensed. Know which graph answers which question: nominal → money market, real → loanable funds.
1 / 8

How to use the visual review

Spend 30 seconds per step before clicking next. Look at the diagram, then ask yourself: "Could I sketch this from memory and label every part?"

Use the dots below the diagram to jump straight to any step, or the arrow keys to move forward and back.

This is great for review the night before the exam — fast, visual, and covers every core diagram you need to remember from Unit 4.