2014 Microeconomics FRQ #3

2014 Microeconomics FRQ #3

You can. 

Yes. Yes, you can. 

I think so.

Now, you must think so.

Watch me answer this on youtube https://youtu.be/_ZZAvxgohsE

3. Assume that gasoline is sold in a competitive market in which demand is relatively inelastic and supply is relatively elastic.

(a) Draw a CLG of the gasoline market. On your graph show the equilibrium price and quantity of gasoline, labeled Pe & Qe.

(b) Suppose the gov't imposes a $2 per unit tax on the producers of gasoline. On your graph from part (a), show each of the following after the tax is imposed.

(i) The price the buyer paid, labeled PB.

So, the government imposes a $2 dollar tax, on producers. Producers supply the good so the price of the good has to include the tax,, therefore the (S + tax) shifts up by the $2 dollar amount.

(ii) The after-tax price received by sellers, labeled PS.

Remember, that the seller has to send $2 of what he receives to the government, and the distance between S & S + tax is the $2 dollar amount.

(iii) The quantity labeled, QT.

(C) Using the labelling on your graph, explain how to calculate the total tax revenue collected by the government.

The total tax revenue can be found by taking the amount of the tax ($2) and multiplying it by the new (after tax) quantity sold.

So, $2 x QT

or, (PB - PS) x QT  

or , TAX x QT

(D) Will the tax burden fall entirely on buyers etc etc etc etc...

The tax buyers will fall more on buyers and less on sellers because the demand curve is more inelastic than the supply curve.

If the demand curve is inelastic (think drugs) then consumers will have less substitutability and will not change their buying patterns (relatively) with the increase in price.

Therefore, even when the price goes up,, demand for the good does not decline as much as the price rise.

Look at the graph, the wedge between PE and  PB (buyers wedge) is greater than the wedge between PE and PS (sellers wedge).

The wedge is the amount of tax incidence on each party,, buyer or seller.

2014 AP Microeconomics FRQ #2

2014 AP Microeconomics FRQ #2

Oh! I just love me 

some unskilled labor.

Watch me answer it here

https://youtu.be/61JblK9bWSg

(a) Using correctly labeled side-by-side graphs for the labor market and Ray's Stable, show each of the following.

(i) The equilibrium wage and quantity for unskilled labor.

(ii) The wage paid by Ray's Stable and the quantity of unskilled labor hired.

(b) Is the MFC of unskilled labor for Ray's Stable greater than, less than, or equal to WE?

If you were able to draw the graph above then it seems fairly straight forward that the equilibrium rate of pay for unskilled employees is equal. The explain,, part of this question is the fact that Ray's Stable is in the perfectly competitive factor market (factor as in employee) and perfectly competitive as in Ray's is a wage taker and can't pay more or less than the market wage rate as the market sets the price of wages.

Answer - wage rates are equal in the market and at Ray's, and the wage rate is set by the market as Ray is a wage taker.

(c) Now assume the government imposes a minimum wage for unskilled labor.

(i) Show the minimum wage & quantity for unskilled labor.

You must understand that a minimum wage is a price floor (floors are high) and that to be binding (effective) it must be drawn above equilibrium... (as minimum wage below the market equilibrium will not effect the employees wages)

What we know about price floors is that they cause a surplus,, at the higher price less employees are demanded but more will be supplied.

(ii) On the labor market graph in part (a) show the quantity of unskilled labor supplied in the labor market as a result of the new minimum wage, labeled Qs.

(iii) As a result of the new minimum wage, will the marginal revenue product (MRP) of the last worker hired by Ray's Stable increase, decrease, or stay the same?

So 1st off,, I don't like this question. It's a literal question,, as in look at the graph. Are we travelling up the MRP curve as we fire people... Yes... If we fire the fifth worker,, the 4th worker hired would have a higher MRP.

Does that workers MRP (the 4th) change??? Does it really increase??? or is it just higher?

What we do know is that the 4th worker has a higher MRP...

What we also know,, is that 75% of students missed this question.

I think if they had used the word (higher) instead of increase there would have been less confusion.

As in the 4th workers MRP is clearly higher but it didn't increase..

Answer - the MRP of the next worker hired increases

Perhaps,, that should be a fallback response,, if in doubt look at the graph.

2014 AP Microeconomics FRQ #1

2014 AP Microeconomics FRQ #1

How you will feel if you 

study hard for the test.

Watch me answer it here

https://youtu.be/1cZSNaUUua8

(a) Using the numbers given in the graph, identify each of the following for the profit-maximizing monopolist.

(i) The quantity produced.

If its a profit-maximizing monopolist,, then profit - max is where MR = MC.

Answer - MC=MR @ a quantity of 4

(ii) The price.

Where MR=MC and then follow a straight line straight up until you run into the demand (price) curve and then left until the vertical axis,,, now read the price.

Answer - the price is $40

(iii) The allocative efficient quantity. 

You must know what allocative efficiency is... Monopoly Cheat Sheet.

Allocative Efficiency is where the MC curve intersects with the demand(price) curve. They want to know at what quantity that is. Allocative Efficiency (P = MC)

Answer - The MC curve intersects the D curve at a quantity of 8,, 

(b) At the profit-maximizing quantity from part (a) (i), is the monopolist experiencing economies of scale? Explain.

Economies of Scale -  are the cost advantages that enterprises obtain due to size, output, or scale of operation, with cost per unit of output generally decreasing with increasing scale as fixed costs are spread out over more units of output

Translation - with economies of scale we are producing more output and our marginal costs must be decreasing. 



Remember this graph below.

Look closely and you will see that the LRAC, (Long-Run Average Cost) curve. Notice that it is downward sloping in the Economy of Scale section,, flat in the Constant-Cost section & upward-sloping in the diseconomies of scale section.

Now look again,, at your graph.

The LRATC curve is flat,, our Marginal costs per unit of output are constant. Not decreasing.

Answer - This firm is not experiencing economies of scale as the LRATC is not downward sloping.

(c) Now assume that the monopolist produces at 10 units. Using the numbers given in the graph, calculate each of the following (show your work).

(i) The monopolists profit.

When the monopolist produces 10 units, the price he receives for each unit is $10. Remember, the monopolist can choose the quantity produced or the price but not both. So his total revenue is $100 dollars. But we see that the monopolists ATC (MC) is $20 dollars a unit. If the monopolist is being forced to supply 10 units at $10 each,, yet each unit is costing him $20 dollars,, then he is loosing $10 dollars on each unit he produces,, or a total loss of $100 dollars.

Answer - the monopolists economic profit is a negative $100.

($10 - $20) x 10 = -$100         (P - ATC) x Q

(ii) The consumers surplus.

Remember, at a quantity of 10 units the consumer surplus is the large triangle (Area = 1/2 b x h)

Answer = CS = 1/2 ($60 - $10) x 10 = $250

(iii) The deadweight loss.  

Tricky,, tricky,,

So, Deadweight loss can be thought of as the opposite of efficiency (allocative efficiency) specifically.  If allocative efficiency is where P=MC the we can see that our MC > P is an inefficiency. If we have a situation where MC's are greater than price we are overproducing the good. Resources going into the extra production of this good & should be allocated to something more valued by society. Check out my post on efficiency.

Instead of what most students are use to P > MC,, with the DWL being on the left side of P=MC because monopolists are profit maximizers. The DWL would be shaded in on the right side of where P=MC.

Answer - DWL - 1/2 ($20-$10) x (10-8) = $10

(d) What quantity is Demand unit elastic? 

Monopoly Cheat Sheet -

Notice, that at the top of the TR curve , where revenue is maxed,,, is also where the MR=0, unit elasticity is where MR = 0.

Now ,, you just have to find the quantity where MR = 0.

Answer - at a quantity of 6, MR = 0 and at that quantity is unit elasticity.

(e) Suppose the monopolist perfectly price discriminates and chooses the quantity that maximizes profit. Determine the dollar value of each of the following.

(i) The monopolist's profits.

A Perfect Price Discriminating Profit Maximizing monopolist charges every one of its customers the most that they are willing to pay for the good. Goods are supplied and charged for at the quantity where the MC = P or allocatively efficient quantity. 

Answer - 1/2[($60 - $20) x 8] = $160,,,   remember that with a horizontal MC curve that the profit for the monopolist is a triangle, (Area = 1/2 b x h )

(ii) The consumer's surplus.

Notice the difference between a single price monopolist and a price discriminating monopolist,,, there is no consumer surplus with a price discriminating monopolist.

Answer  - there is no consumer surplus = 0.

How you will feel if you 

don't study for the test.

2014 AP Macroeconomics Exam FRQ #3

2014 AP Macroeconomics Exam FRQ #3

Even this guy could get a five.

Watch me answer it here, 

https://youtu.be/R-kSt2Ugy1o

3. The US and South Korea are trading partners, and the US has a zero current account balance. Assume now that the inflation rate in the US decreases relative to the inflation rate in South Korea.

(a) Based on the decrease in the inflation rate in the US, will US exports to South Korea increase or decrease?

 Check the FOREX cheat sheet -

If the inflation rate (PL) in the US decreases,, the price level PL is falling,,, US goods are becoming cheaper and thus more affordable compared to South Korean goods. South Koreans import more US goods,,, the US exports more of its cheap goods to South Korea.

Answer - US exports increase

(b) Based on the change in the US exports in part (a) answer each of the following.

(i) Will the US current account balance remain at zero, be in surplus, or be in deficit.

FOREX - Cheat Sheet

Answer - if the current account is at zero,, and the US exports increase,, then exports will be greater than imports, so the US's current account balance will be in surplus.

(ii) What will happen to the real gross domestic product in the US in the short-run?

Answer - If exports increase, then AD will increase,, therefore the R-GDP will increase.

(c)  The South Korean currency is the won. Draw a CLG of the foreign exchange market for the US dollar. Show the effect of the lower inflation rate in the US on the won price per US dollar.

 If the US price level is falling, then US goods are getting cheaper relative to the South Korean goods, therefore the Koreans import more US goods. The S. Koreans trade won for US goods, therefore there is a surplus of won in the FOREX market,, the won's value decreases.

On the other side - the US exports goods, to be able to buy these US goods the S. Koreans must exchange their won for US dollars,, causing a higher level of demand for US dollars,, therefore the US dollar appreciates relative to the won.

The important part to recognize ion this question is that the college board is asking for the price of won per dollar... So the horizontal axis will be in dollars.

You could either show the above,, a demand increase or a supply decrease,, either will get you the points,, as long as they show the number of won per dollar to be increasing. 

Answer - draw a CLG of the FOREX,, show (arrows) of a shifting right of the demand curve (increase) or a leftward shift of the supply curve (decrease),, and an increase of the won/dollar ratio.

I told you I would get a 5.

2014 AP Macro Exam FRQ question 2

2014 AP Macro Exam FRQ question 2

Watch me anser it here

https://youtu.be/KdjuxZ7Dy9s

2. The Federal Reserve can influence the supply of money.

(a) Assume the Federal Reserve targets a lower federal funds rate.
(i) What open market operation can the Federal Reserve use to achieve a lower target?

The Federal reserve has three tools at their control,,, OMO Open market operations (buying and/or selling bonds), reserve requirement (increase /decrease), discount rate (increase/decrease).
 1st you must know what the federal funds rate is -  cheat sheet.

The Federal Funds Rate is the interest rate that commercial banks charge one another in loaning out their excess reserves.

The example above shows an increasing Federal funds rate,, we want a decreasing Federal Funds rate.

Answer - if the Fed was to buy bonds,, the MS, increases and the Nom. IR, Nominal interest rate decreases,, thus lowering the rate of interest the commercial banks will charge each other in loaning out their excess reserves.

(ii) Given your answer to part (i) what will happen to the price of bonds.

If the Fed buys bonds,,, the price of bonds will increase.  The easiest way to understand this is to think about supply and demand,, demand for bonds goes up... price of bonds increase.

Better yet understand that interest rates and Bond Prices are inversely related.

FED Cheat Sheet here.

Answer - if the fed is buying bonds then the price of bonds is increasing.

(b) Using a correctly labeled graph of the money market, show the effect of the open market operation fro part (a) (i) on the nominal interest rates.

Cheat sheet - 

You must know how to draw and label a money market graph from memory.

Answer - if the fed is buying bonds,, then it is paying for those bonds in cash,,, citizens are giving up their bonds and receiving cash. The money supply is therefore increasing. As the money supply increases nominal rates are falling.  Look Below.

(c) Assume the Federal reserve buys government bonds from commercial banks. Based only on this transaction, will the level of required reserves in the commercial banks increase, decrease, or remain the same?

You should understand that the required reserves are required for customers demand deposits (checkable accounts),, cash from selling assets does not effect the banks reserve requirements. 

Answer - Fed's purchase of bonds will not initially affect commercial banks required reserves.

(d) another monetary policy action involves changing the discount rate. Define the discount rate.

Answer - the discount rate is the interest rate that the Fed charges banks for borrowing from it's discount window.

How I would have looked at the college board 

after Reading some of these questions.

2014 AP Macro FRQ #1

2014 AP Macro FRQ#1

I can't wait!!

Watch me do it on youtube

https://youtu.be/F-YvJktcaA8

1. Assume that the US is currently operating below the full-emplyment level (think of this as code language for (Recession) ,, of R-GDP with a balanced budget. 

(a) Draw a correctly labeled graph (CLG) of aggregate demand (AD), short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS),,.. and show each of the following in the US.

 (i) Current output and price level, labeled as Y1 & PL1.

(ii) Full- employment output, labeled as Yf.

So operating below full employment is code for Recession,,, and then you have to add all the pieces to create a CLG correctly labeled graph,, with AD, SRAS, & LRAS,, and then label as they demand.

     I always start all of my AD/AS curves from Equilibrium and then show a shift to recession. You might have been taught different,, and that is OK,, just make sure that you have all the pieces and you show what is happening.

How do we show? We use arrows or we write it out. The people grading your test shouldn't have to hunt for the answers. Make it easy on them...

Do we have all the pieces? CLG,,, axis labeled, LRAS, SRAS, AD (shifting), Y1, PL1, arrows,,,,,Check, check, check, check, check.

OK, move to

(b) The US increase spending on goods and services by 100 billion, which is financed by borrowing, how will the increase in government spending affect each of the following.

(i) Cyclical Employment.

So, first you must know what cyclical employment is. From my cheat sheet...

So, if cyclical employment varies with business conditions and the economy is in a recession,, then we have to assume that the Gov't spending 100 billion will cause consumption (C) to increase and Investment (I) to increase , and therefor AD will increase causing businesses to increase employment.

Answer (i) Increased employment causes by Gov't spending causes Cyclical Employment to decrease. 

(ii) The Natural Rate of Employment

So, first you must know what the Natural Rate of Employment is,,, from my cheat sheet.

Gov't spending will affect cyclical employment but will not change, Frictional as government spending doesn't effect people searching for work,, and there is no technological change so no structural change either.

Answer (ii) the natural rate of employment will not change.

(c) If the Marginal propensity to consume is equal to .75, calculate the maximum, possible change in real gross domestic product that could result from the $100 billion increase in government spending.

Translation - if the MPC is .75 using the multiplier what happens to the $100b to R-GDP.

If the MPC is .75 then the MPS must be .25 ,,  together they must equal 1.

A dollar earned can only have to things done with it,, spend it (consumed) or save it. If .75 was consumed then .25 must be saved..  From the Cheat sheet..

The formula for the multiplier is 1/1-MPC = 1/1-.75 or 1/.25 = 4 (look at the cheat sheet above)

with a multiplier of 4 and $100b being spent by the gov't the maximum possible change on the Real-GDP is $400 billion,,, 4(multiplier) X $100b (gov't spending) = $400 billion.

Answer (C) $400 billion

Ok, question? Why did they underline maximum. Because they know that you have been studying your head off trying to prepare for the exams and you have crammed all this knowledge into that wee brain and they just want you to do the math and not try and figure in crowding-out affects,, etc,, etc... They (college board) do try and help sometimes...

(D) Using a CLG of the loanable funds market show the effects of the $100 billion increase in government spending on the real interest rate RIR.

First,, you must know how to draw a loanable funds graph,,, if you can't see it in your mind how to draw a CLG (correctly labeled graph) of the loanable  market then you have some studying to do. Then you should look at the cheat sheet.

As we can see,, government borrowing will raise the RIR.

You should be able to talk (causal chain of thinking) your way through what happens.

It is tricky,, so do it a number of times,, until it is stuck in your head... and draw the graph 50 times.

As the demand for loanable fund increases and the real interest rate rises,, more people are enticed to place their funds in the banks to get the higher interest rate (foreigners included) and therefore the quantity of loanable funds increases.

Answer - CLG of the LF market,, RIR on vertical axis,, quantity of funds on horizontal axis,, simple supply and demand shifts,, but showing both will guarantee points as both happen together,, arrows showing an increase on both graphs of the RIR,, always good to write out what happens also.

(e) Based on the Real Interest Rate changes in part (d), what is the effect on the long-run economic growth rate.

Fiscal Policy cheat sheet

The Long-Run Growth rate is negatively effected because the RIR is pushed higher,, a high RIR means that their will be less investment (capital formation) in the long-run,,, remember that Keynesian government spending during a recession was a short term fix,,,,, because in the Long-Run we are all dead.

Answer - Long-Run growth will be sacrificed with short-run government spending, due to higher real interest rates that will decrease domestic investment and therefore capital formation.

(f) Now assume that instead of financing the $100b increase in government spending by borrowing, the US government increases taxes by $100 billion. With this equal increase in government spending and taxes, will the real gross domestic product increase, decrease, or remain the same? Explain.

I haven't put this in a cheat sheet  but I have blogged about it (http://econowaugh.blogspot.hk/2016/03/spending-multiplier-vs-taxing-multiplier.html) that with an increase in government spending and an equal increase in taxes. The government spending (expansionary) will flow directly into the economy,, all 100 billion and then will be multiplied, The tax multiplier works in reverse with an increase in taxes, (Contractionary) with this question,, and we know that the tax multiplier is less than the spending multiplier so the net effect will still be an increase in the RGDP.

Answer - the real GDP will increase as the expansionary policy of government spending increases by a multiple larger than the contractionary policy of an equal increase in taxes.

This is fun