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)

2021 (Set 1) AP Macro FRQ#2

 2021 (Set 1) AP Macro FRQ#2

Watch me answer it here

https://youtu.be/UUaSOOIfgHw

2. Assume the country is operating below full employment.

Below full employment = Recession

a) Identify a fiscal policy that could restore the economy back to full employment.

Fiscal Policy is either (Government spending or Taxes)

Recession = (More Government Spending or Reduce Taxes)

b) Draw a CLG of the loanable funds market and show the effects of the fiscal policy chosen on the equilibrium real interest rate.

Government spending  = an increase in the RIR (Real Interest Rate)

If the government wants to spend more money they must either tax citizens more or borrow the funds. Borrowing of the funds means selling bonds to citizens.

The citizens must take the money out of the banks to pay for the bonds.

(Demand shift) = People walking into banks needing to take out money to buy bonds 

increases (rightward shift) of the demand for loanable funds

(Supply Shift) = As people take the money out of the bank it 

reduces (shifts leftward) the supply of loanable funds in the banks.

Both shifts are technically correct (Use the one that seems correct to you)

Easiest for me to recognize that anytime the govenment is spending they are borrowing from the Banks reducing the supply of lonable funds which increases the RIR.

c) Based solely (only) on the real interest rate change what will happen to the following?

i) Net Exports. Explain.

If the RIR increases then the demand for the currency will increase causing the currency to appreciate which will decrease the amount of exports for the country.

As the RIR increases citizens of other countries will want to put their money in our banks to get the higher interest rate (they want higher profits)

To put their money in our banks they must exchange it in the FOREX, causing the demand for our currency to increase which drives up the value of our currency.

Since our currency is increasing in value our goods are becoming more expensive.

More expensive goods means less people will want to buy our goods therefore

our exports will decline.

ii) Stock of physical capital (capital goods) . Explain.

As the RIR increases (Loans are now more expensive)

Domestic Investment (taking out of loans) will decrease which implies that less capital goods will be produced in our country. Less physical stock (capital formation/goods) means that the country's long-run growth will be damaged.

RIR increase = Less physical stock (capital goods/formation)