Friday, November 18, 2016

2009 B Macroeconomics FRQ #3

2009 B Macroeconomics FRQ #3

Yes, that is the Canadian Prime Minister, Trudeau.

(A) Using a CLG of the foreign exchange market (FOREX) for the Canadian Dollar, show the effect of the higher real interest rate in India on each of the following.

FOREX Cheat Sheet is here.

(i) Supply of the Canadian dollar. Explain.

If the interest rate in India rises above the Canadian interest rate then Canadians will move their money (capital flows) to India to get the higher interest rates. But you have to be careful, the question is actually asking about the Supply of Canadian dollars in the FOREX, NOT the supply of Canadian dollars in Canada.

Think of it like this,,,, The FOREX is a place in the sky. "I know but be patient".
On one side is Canada with its 5% interest rate on the other is India with its 8% interest rate.

Now Canadians would like to invest their money in interest assets to get the 8%. What is an interest asset? Bond. So Canadians would like to buy Indian bonds that promise to pay 8% a year.

But, the Indian banks do not accept Canadian dollars. So the Canadian investors must exchange their Canadian dollars for Indian Rupees in the FOREX. "In the sky"

Now, since Canadians are dumping their Canadian dollars in the FOREX, the supply of Canadian dollars is increasing. Why?

Capital Flows "I know, in AP economics Capital means machinery not cash/money" but not all of the world has taken AP economics.

Capital Flows from countries with lower interest rates to countries with higher interest rates. Why? If I take my money from a bank in Canada, where my money is earning 5% a year and move it to a bank in India where my money will earn me 8% a year then I will be financially better off. Always seeking higher earnings.

(ii) The value of the Canadian dollar, assuming a flexible exchange rate.

If the supply of Canadian dollars is increasing in the FOREX, then the value of the Canadian dollar $ will fall. Supply increases then value falls relative to the Indian Rupee ₹.

(B) Using a graph of the loanable funds market in Canada, show how the increase of the real interest rate in India affects the real interest rate in Canada.

Understand, that the loanable funds market graph is a model of the cash in banks. If cash is leaving Canada and travelling to India, then the supply of loanable funds in the banks in Canada is decreasing. Therefore the RIR (real interest rate) in Canada is rising.

Recognise, that when speaking about the supply or demand of Canadian dollars or Indian Rupees the College Board is speaking to the supply/demand in the FOREX.

Loanable Funds is the supply/demand of Canadian dollars/Indian Rupees in that country's banks.

2009 B Macroeconomics FRQ #1

2009 B Macroeconomics FRQ #1

(A) Using a CLG of AD/AS, show the current equilibrium RGDP, labelled Yc, and PL in Southland, labelled PLc.
Understand that the phrase unemployment is greater than the natural rate of unemployment is code for recession.

I always start my AD/AS curves from Equilibrium and then draw in the effect of what's going on in the question.
Show means to draw & label graph correctly, use arrows showing effect & describe with correct terminology what is happening.

The President of Southland is receiving advice from two advisors. Kohl's and Raymond - about how best to reduce unemployment.

(B) Kohelis advises the president to decrease personal taxes.
(i) How would such a decrease in taxes affect aggregate demand? Explain.

A decrease in taxes is an expansionary policy action, like if the government had increased spending. So, a decrease in personal taxes increases the disposable income in people's pockets and therefore they will spend more, increasing (C) consumption and AD will increase. AD increasing will push increase output and more people will go back to work. 

From the Fiscal Policy Cheat cheat sheet here.

(ii) Using a CLG of the SRPC (short-run phillips curve), show the effects of a decrease in taxes. Label the initial equilibrium as (A) and the new equilibrium from the decrease in taxes as point B.

Phillips Curve cheat sheet is here.

Check yourself 
If the PL increases and unemployment has decreased on your Phillips curve, your AD/AS curve  after the personal tax decrease should have the same effects. 

(C) Raymond advises the President to take no action.

(i) What will happen to the SRAS curve in the Long-Run? Explain.

Understand that "take no policy action" is code for "in the long run".

So, if there is a recession and the government does nothing, two things will happen. 

1) Prices will fall - which will stimulate quantity demand
2) Wages will fall - unemployed will accept lower wages - employers will hire more people as wages fall

Wages is an input cost (resource cost) - it also is a determinate of supply. If wages for a firm fall then the supply curve shifts rightward and more output is produced. If the wages in all of society fall, then the SRAS curve shifts rightward and output/RGDP increases. If output increases then unemployment falls.

(ii) Using a CLG of the SRPC (short-run phillips curve), show the effects of a change in the short-run aggregate supply you identified in part (c)(i).

Understand that if AD shifts on the AD/AS curve it is a movement on the Phillips Curve, but if AS shifts it is a shift of the Phillips Curve. 

PL decrease
Unemployment decreased

So, What would the AD/AS curve look like for Recession "In the long-run"
From the Phillips Curve Cheat Sheet here.