2002 AP Micro Exam (Question 1)
(a) Identify one fiscal policy action that Congress might initiate to decrease the unemployment rate.
Expansionary fiscal policy would decrease unemployment either Government Spending increase or Tax decrease.
(b) Assume the policy you identified in part (a) reduced unemployment, but the economy is still operating below full employment. Using a CLG of aggregate demand/aggregate supply, show and explain, how the action you identified would affect each of the following
Expansionary fiscal policy would increase output and the price level as Government spending will increase AD and thus output and will also increase the PL.
(c) Explain how the policy identified in part (a) would affect short-term interest rates.
Government Spending will increase the demand for loanable funds and therefore the Real interest rate will increase. Nominal interest rates are increased as the demand for money increases. Demand for money increases when incomes (Y) increase.
(d) Given the economy is still below full employment, identify the open market operation that the Federal reserve could implement to increase the money supply.
Monetary expansion = Open market operation = Buy Bonds
(e) Using a CLG, show and Explain, how an increase in the money supply will affect each of the following in the short run
(i) Short term interest rates
(iii) Price levels
Money supply increases will decrease the nominal interest rates that will spur investment and consumption which will shift aggregate demand rightward increasing output and pushing up the price level. (Output & Price levels increase while Interest rates decrease)