2007 Macroeconomic Exam FRQ #1

2007 Macroeconomic Exam FRQ #1

WHAT GOES UP.

Ok, so investors are running to their computers trying to sell their stocks. On the other side investors are rushing to the bank to try and take the money out of their banks to buy the stocks. This implies that the supply of loanable funds is decreasing and/or the demand for loanable funds is increasing,, Yes, they both are happening at the same time because they are the same thing. Check out the graph below. Either one I believe would have been acceptable on the exam.

Supply of loanable funds is decreasing as people take the money out.

Demand for loanable funds is increasing as more and more people rush to take the money out.

Notice, that both cause the RIR to increase. If the RIR is increasing then the NIR (Nominal Interest Rate) is also increasing. Check out this post, Here.

If an economies stock market is decreasing very fast then investors will be trying to get their money out of stocks and into cash. Why? Cash values don't fall as quickly, whereas stock values can plummet over night. So cash is safer.

This implies that the Demand for Money will be increasing.

(B) Due to the decline in wealth caused by the change in the stock prices, the general price level in the US falls relative to the general price level in Japan, a trading partner. Use a CLG (correctly labeled graph) of the FOREX (foreign exchange market) for the US dollar to show the impact of the change in relative price levels on each of the following.

(i) Demand for the dollar.

(ii) Price of the dollar (Yen/dollar)

When you see the phrase "fall in the price level", you should think of inflation. Inflation and the price level are most often the same thing. So, if the price level (inflation level) is falling it means that US goods are getting relatively cheaper than Japanese goods.

This means that Japanese citizens will be buying more US made goods. Japanese will be importing US goods. To buy the US goods Japanese housewives will be dumping money into the FOREX market to purchase US dollars. (Demand for the US $ is increasing therefore the Value of the US$ is increasing, or said another way, the price of the dollar is increasing relative to the Yen) Why? because they will be demanding US dollars $ to buy the US goods as US suppliers don't accept Yen ¥.

* To buy US goods Yen must be exchanged for US dollars. Yen is sold in the FOREX and US dollars are bought.

Check out the FOREX cheat Sheet, Here. 

(C) How will the change in the price of the dollar you indicated in part (b)(ii) affect net exports of the US? Explain.

As the value of the US dollar increases our US goods will become more expensive relative to Japanese goods and those same Japanese housewives will buy less US goods and more Japanese goods. The US exports will decrease.

(D) Using an AD/AS curve show how changes in net exports in part (C) will affect each of the following in the short-run.

(i) Aggregate Demand

(ii) Output & Price Level

If Net Exports are declining then AD is falling as Net Exports (Xn) is a determinant of AD/GDP.

Check out AD/AS Cheat Sheet, Here.

(E) Given your answer in part (D), what will happen to unemployment in the short-run. Explain.

As output decreases then less workers are needed so some are let-go and unemployment will increase. 

Read careful here as the College Board likes to use employment/unemployment and if read incorrectly easy to give the wrong answer.