2014 AP Macroeconomics Exam FRQ #3
Even this guy could get a five.
3. The US and South Korea are trading partners, and the US has a zero current account balance. Assume now that the inflation rate in the US decreases relative to the inflation rate in South Korea.
(a) Based on the decrease in the inflation rate in the US, will US exports to South Korea increase or decrease?
Check the FOREX cheat sheet -
If the inflation rate (PL) in the US decreases,, the price level PL is falling,,, US goods are becoming cheaper and thus more affordable compared to South Korean goods. South Koreans import more US goods,,, the US exports more of its cheap goods to South Korea.
Answer - US exports increase
(b) Based on the change in the US exports in part (a) answer each of the following.
(i) Will the US current account balance remain at zero, be in surplus, or be in deficit.
FOREX - Cheat Sheet
Answer - if the current account is at zero,, and the US exports increase,, then exports will be greater than imports, so the US's current account balance will be in surplus.
(ii) What will happen to the real gross domestic product in the US in the short-run?
Answer - If exports increase, then AD will increase,, therefore the R-GDP will increase.
(c) The South Korean currency is the won. Draw a CLG of the foreign exchange market for the US dollar. Show the effect of the lower inflation rate in the US on the won price per US dollar.
If the US price level is falling, then US goods are getting cheaper relative to the South Korean goods, therefore the Koreans import more US goods. The S. Koreans trade won for US goods, therefore there is a surplus of won in the FOREX market,, the won's value decreases.
On the other side - the US exports goods, to be able to buy these US goods the S. Koreans must exchange their won for US dollars,, causing a higher level of demand for US dollars,, therefore the US dollar appreciates relative to the won.
The important part to recognize ion this question is that the college board is asking for the price of won per dollar... So the horizontal axis will be in dollars.
You could either show the above,, a demand increase or a supply decrease,, either will get you the points,, as long as they show the number of won per dollar to be increasing.
Answer - draw a CLG of the FOREX,, show (arrows) of a shifting right of the demand curve (increase) or a leftward shift of the supply curve (decrease),, and an increase of the won/dollar ratio.
I told you I would get a 5.