Monday, April 6, 2015

2013 AP Macroeconomics FRQ #3

2013 AP Macroeconomics FRQ #3

3 Inflation and expected inflation are important determinants of economic activity.

(a) Draw a CLG of the short-run Phillips curve.

You should know how to do this without thinking,,,
Phillips Curve, a tradeoff between inflation and employment
Unemployment & Inflation Cheat Sheet -

Short-Run Phillips curve downward sloping with axis labeled appropriately.

(b) Using your graph is part (a), show the effect of an increase in the expected rate of inflation.

Expected Inflation not actual inflation

(c) What is the effect on the increase in the expected inflation rate on the Long-Run Phillips curve.

The long-run phillips curve is effected by situations that will decrease or increase the NRU, Natural Rate of Unemployment,,, so if the government expand unemployment benefits the LRPC will shift right,, and if the government cuts unemployment benefits the LRPC will shift left.

There is no trade-off between unemployment and inflation in the Long-Run.

Answer - an increase in the expected rate of inflation does not effect the LRPC.

(d) Given the expectation of the increase in inflation from part (b)

(i) will the nominal interest rates on new loans increase, decrease or remain unchanged?

If inflation is expected to increase then the Price Level is expected to increase then the demand for money is expected to increase.. If demand for money is expected to increase then interest rates for new loans will increase.

Answer - Nominal interest rates will increase.

(ii) Will the real interest rate on new loans, increase, decrease, or remain unchanged?
Ok, so if the nominal interest rate is rising with the expected level of inflation the bankers crafting new loans will be building into the loans the expected rise in inflation.

In essence,, I'm a banker and I'm selling loans at the nominal rate of interest of 5% and this is also the real rate with no inflation,,, but I expect the rate of inflation to increase by 2%,,, I'm going to sell all new loans at 7% rates of interest. I'm going to build into the loans the expected rate (2%) of inflation. Thus the real rate will not change it will still be 5%.

Nominal Rate = Real Rate (no inflation)
Real Rate = Nominal Rate - Inflation
Nominal Rate = Real Rate + inflation

Answer - The real interest rate will not change

(e) Assume that the nominal interest rate is 8%. Borrowers and lenders expect the rate of inflation to be 3% and the growth rate of the real GDP is 4%. Calculate the real interest rate.

Real Rate = Nominal Rate - Inflation
5% = 8% - 3%

Answer - the real interest rate is 5%

2013 AP Macroeconomics FRQ #2

2013 AP Macroeconomics FRQ #2

(2) Assume that the Country of Fischerland produces only consumer goods and capital goods.

(a) The graph above shows the PPC for Fischerland. The production of which of the following exhibits increasing opportunity cost: consumer goods only, capital goods only, both goods, or neither good?

The PPC is a perfect example of showing the concept of scarcity,, and that because of scarcity we must make choices, (to choose is to act) and in the process of choosing one, we simultaneously not choose something else. The opportunity cost is the cost of what we didn't choose or the opportunity foregone.

The bowed out shape of the PPC shows that there is increasing opportunity cost. Consider the difference between a society making Bridges (capital goods) or butter (consumer goods),, if we take the machinery that is used to make bridges and use them to try and make butter it will not be as efficient and therefore costs will increase,, the more butter we choose to make the less efficient the bridge making resources.

The shape of the curve ,, bowed out,, shows increasing opportunity costs,, whereas a straight line PPC would demonstrate that there is opportunity cost but not increasing opportunity cost.

Answer - both goods exhibit increasing opportunity cost.

(b) Redraw the graph above. Show a point that shows fully employed & efficiently used resources on the redrawn graph and label it A.

Any point on the PPC curve is efficient and attainable.

(c) Assume there is a recession in Fischerland. On your graph show a recession, label it C.

Answer - Look Above

C is attainable but inefficient,,, usually C represents unemployment,,, and in a recession we have much unemployment.

(d) Identify a fiscal policy action the government can take to address the recession.

Fiscal policy - Government spending or Taxes

Answer - the government can increase spending or decrease taxes.

(e) Assume that no discretionary policy actions are taken, will short-run aggregate supply curve, increase, decrease, or remain the same in the long run. Explain.

From equilibrium to recession to equilibrium again with a lower PL... SRAS curve will shift right as wages and prices adjust.

Answer - wages and production costs decrease and the SRAS curve shifts right.

This junks easy!!!

2013 AP Macroeconomics Exam #1

2013 AP Macroeconomics Exam #1

1. Assume the US is operating at full employment.
(a) Using a CLG of the long-run aggregate supply, short-run aggregate supply, and aggregate demand, show each of the following.

(i) Current price level, labeled PL1
(ii) Current output level, labeled Y1

This first part should be automatic,,  no real thinking,,,, they just want to see if you have memorized the graphs. You should be able to draw (at the drop of a hat) AD/AS curves for Equilibrium, recession, LR-recession, Inflation, LR-inflation, Stagflation, Growth and LR-Growth...

Check out the cheat sheets and practice. AD/AS Cheat Sheet

(b) Assume that personal savings in the US increases. Using a CLG of the loanable funds market, show the impact of the increase in personal savings on the real interest rate.

Straight forward question,, people save more and they deposit their cash in the commercial banks,, therefore the supply of loanable funds increase. If the Supply of loanable funds increase then the Supply of loanable funds curve shifts down (to the right) and the real interest rate decreases.

Loanable Funds Cheat Sheet

(c) Based on the real interest rate change in (b),

(i) Will interest sensitive expenditures, increase, decrease, or remain unchanged?

The use of the phrase interest sensitive expenditures is code for loans,,, so if we use different language could this question make more sense??

When the RIR (Real Interest Rate) falls will the number of people taking out loans, increase, decrease, or remain unchanged?

Answer - Interest sensitive expenditures will increase

(ii) What will happen to the rate of growth? Explain.

An increase of savings leads to a lowering of interstate rates that will encourage investment,, more investment leads to higher levels of capital formation (business plants, roads, construction, equipment, etc, etc) which leads to an expanding rate of growth in the economy.

Answer - growth rate will increase with an increase in capital formation.

(d) Assuming the real interest rate of the Euro Zone increases relative to the real interest rate of the US. Draw a CLG of the foreign exchange market for the Euro and show the impact of the change in the real interest rate in the Euro Zone in each of the following.

(i) Demand for the Euro. Explain.

If real interest rates are higher in the Euro Zone,, then US citizens wish to take advantage of the higher rates so they wish buy Euro Zone bonds (as these Euro Zone bonds are paying more than the US bonds) ,, to buy Euro Zone bonds they must exchange their US dollars for Euros. All of the US investors wishing to invest in Euro Zone bonds lead to a higher demand for the Euro.

Answer - Demand for the Euro increases because the higher real interest rate leads to higher returns for investors, thus US investors funds flow to the Euro Zone.

(ii) Value of the Euro to the US dollar.

Look at the graph, the value of the Euro is increasing,,, which also means the value of the dollar is decreasing,,, it will take more US dollars to buy a Euro as the values diverge.

(e) Assume that the US account balance is zero. Based on the change in value of the Euro identified in part (d) (ii), will the US current account be in surplus, deficit, or remain at zero?

As the Euro is increasing in value,, then the US goods and services will be cheaper ,, relatively to Euro goods and services,, and since the current account is about goods and services,, we would assume the US will be exporting more goods and services to the Euro Zone.

Answer - the US current account balance will be in surplus.

Surprisingly Easy!