2021 (Set 2) AP Macro FRQ#2

 2021 (Set 2) AP Macro FRQ#2

Watch me answer it here

https://youtu.be/33MXyLESSdU

a) Draw a single CLG with both SR & LR Phillips curve. Showing the initial SR equilibrium point as X.

Recession = a movement down the SRPC

AD shifting left is a movement down the SRPC

b) Suppose the government impements fiscal policy in order to achieve full employment output and the MPC is .75.

i) Calculate the minimum government spending needed to get back to full employment. Understand the recessionary output gap is 600 billion. So we need 600 billion of RGDP to get to full employment.

The government does not have to spend the full 600b to get us back to full employment because of the magical (multiplier)

 The MPC = .75

The MPS = .25

MPC (.75) + MPS (.25) always = 1

The multiplier is 1/MPS = 1/.25 = 4 , The multiplier is 4

Government spending x multiplier = change in RGDP

Gov't spending ? x  4 = 600b

or we can rewrite it as 600b/4 = 150b

Government needs to spend 150b x 4 = the 600b to get us back to full employment

ii) Suppose instead the gov't wants to change taxes. Calculate the minimum change in taxes needed to push aggregate demand by the amount of the output gap (600b).

((The Tax Multiplier is always (1 less) than the Government Spending Multiplier))

Put it in your brain and don't forget it.

Since the Government Spending multiplier in (i) was 4 the Tax multiplier is 3

so 600b/3 = 200b

The government must lower taxes by 200b to push Aggregate Demand back to the 600b full employment point as less taxes is expansionary.

The Tax multiplier formula is -MPC/MPS or 600b/3 = -200b

Taxes need to be reduced by 200b that is why the minus is there

c) Assume instead the government takes no policy actions to close the output gap. Explain how the economy will adjust in the long-run.

Recognize that this is now a Classical View question.

If we are in a recession and there is no Fiscal or Monetary policy

in the long run wages, prices, inflationary expectations will decrease

wages and input prices decreasing shifts the SRAS curve to the right

We return back to full employment at a lower PL (price level)