2015 AP Macroeconomics FRQ #1

2015 AP Macroeconomics FRQ #1

Crying because he waited and crammed for the AP 

and now recognises that it is just to much information.

Watch me answer it on youtube https://youtu.be/lBuO7Jpm_pI

(A) Economy is operating below full employment,,, Draw a CLG of LRAS, SRAS, AD.

You must understand that below full employment means a recession graph.

(B) Assume the FED targets a new Federal Funds Rate to reach full employment. Should the Federal Reserve  target a higher or lower Federal Funds Rate?

1st you need to know what the FED funds rate is, so,, of the cheat sheet.

A lower Fed. Funds rate will entice banks to borrow and loan money at a cheaper rate. This will stimulate more loaning in the economy thus more money creation and therefore will ultimately push AD higher toward full employment.

Answer - One point is earned for stating that the Federal Reserve should target a lower federal funds rate.

(C) Draw a graph of the Money market (nominal interest rates) and the effect that part B had on it,

A lower federal funds rate will increase the level of borrowing between banks and more money creation will occur increasing the MS (money supply) which will lower the nominal interest rates.

Answer - 

(D) The policy makers pursue a fiscal policy rather than a monetary policy in part (B). Assume that the marginal propensity to consume is 0.8 and the value of the recessionary gap is $300billion.

(i) If the government changes its spending without changing taxes to eliminate the recessionary gap, calculate the minimum change in spending that is required.

So if the MPC is 0.8 the multiplier is 5

You have to know these formulas.

If the MPC is 0.8 then the MPS is 0.2 as they both together must = 1

So, 1/0.2 = 5,, the multiplier is 5

This means that the amount that government spends to correct the recession will be multiplied by 5.

If there is a 300b recessionary gap,, the government must spend 60 billion dollars 

because 60b X 5 =  300b.

Answer - One point is earned for calculating the minimum required change in government spending:$60 billion ($300/5=$60) 

(ii) If the government changes taxes with our changing spending to eliminate the recessionary gap, will the minimum required  change in taxes be higher, lower or the same as the change in government spending in part (D)(i)?

If unclear about the difference between the spending and the taxing multipliers then check out this blog post that specifically addresses the issue.

Spending vs tax multiplier

If the government doesn't want to increase spending (expansionary policy) it can reduce taxes (expansionary policy) but it will have to decrease taxes by more than 60b.

Why? To reduce taxes by 60b does mean that 60b of disposable income is now available to be spent by consumers but but but some of that 60b will be saved and thus leaked out of the economy, thus reducing the multiplying of the amount. 

Answer - One point is earned for stating that the minimum required change in taxes will be greater than the minimum required change in government spending.  One point is earned for explaining that the tax multiplier (mpc/mps = 0.8/0.2 = 4) is smaller than the government spending multiplier (1/mps = 1/0.2 = 5) because part of the initial increase in disposable income caused by the decrease in income tax will be saved rather than spent. 

(E) Assume the government lowers income taxes to eliminate the recessionary gap. Will each of the following increase, decrease or stay the same?

(i) AD explain.

AD will increase. Obviously if the government reduces taxes citizen's disposable income will increase and therefor consumption and investment will increase driving AD up.

Answer - One point is earned for stating that aggregate demand will increase and for explaining that lower income tax rates will increase disposable income and/or consumption and investment. 

(ii) Long Run Aggregate Supply, Explain

(Answer 1) Long run aggregate supply will not be affected (stay the same) as in the future government will have to borrow to make up the lack of tax revenue that cutting taxes cost. This scenario never assumes that government would cut taxes spending as governments never do.

Think of the LRAS (Long run aggregate supply) curve as the PPC curve,, what shifts the PPC outward is Technology, population, more resources found or trade. People having money not taken from them (taxes) doesn't change the fact that government would have spent that money also.

Arguments aside,, (we must) if the citizens spend the money or the government does,, won't affect the LRAS curve.

Answer 1 - One point is earned for stating that long-run aggregate supply will stay the same because lowering income taxes will increase consumption and/or investment, or there is no change in inputs.

(Understand that I like answer 1 the best,,, but find the one you understand the best)

(Answer 2) Long run aggregate supply will (increase) as with reduction in taxes, disposable incomes will increase causing more consumption and investment into capital intensive projects, (think technology) and therefore people working smarter and producing more per capita,,, shifting out of the PPC.

Answer 2 - One point is earned for stating that long-run aggregate supply will (increase) in the long run because lowering taxes will increase savings and investment in physical capital, or because of increased incentives to work.

(Answer 3) Long run aggregate supply will (Decrease) as in the future government will have to borrow to make up the lack of tax revenue that cutting taxes cost. This scenario never assumes that government would cut taxes spending as governments never do. If the government borrows to make up the difference in tax cuts then interest rates rise discouraging investment and consumption (crowding out). 

Answer 3 - One point is earned for stating that long-run aggregate supply will (decrease) in the long run because lowering taxes leads to a crowding out of private investment. 

Studied like a boss and got a 5

2015 AP Macroeconomics FRQ #2

2015 AP Macroeconomics FRQ #2

Watch me answer it here

https://youtu.be/mpQ_4l2nctQ

Comparative Advantage

(A) Which country has an absolute advantage in producing solar panels?

I like to draw a graph for comparative advantage problems to see graphically the relationship between the production of the two countries.

 The most important point of these questions is to be able to tell if the problem is an output or an input problem. If you see the phrase, "using the same amount of resources" it's an output problem.

The phrase means that using the same input variables (resources) one country will be more efficient and will produce more than the other. (efficiency is key).

So, it is clear that with the same inputs (resources) that Country Y can produce more as 12 > 8 solar panels.

A knowledge of what absolute advantage is is helpful, from the cheat sheet.

Answer - One point is earned for stating that Country Y has an absolute advantage in producing solar panels.

(B) Calculate the opportunity cost of a furnace in country Y.

I always make a comparative advantage matrix to calculate these calculations.

So, Country X can make 6 furnaces or 8 solar panels

and, Country Y can make 6 furnaces or 12 solar panels

Since it is an output problem we use the over method.  

Output = Over

12 over the 6 and 6 over the 12

This will give us the opportunity cost or what is given up in terms of the good produced.

Understand that what is calculated (in that little box) is what is given up:

To produce 1 furnace we give up 2 solar panels

or said another way, in the other box

To produce 1 solar panel we give up half (.5) of a furnace

Answer - One point is earned for calculating the opportunity cost of a furnace for Country Y: 

2 solar panels per furnace. 

(C) Which country has the comparative advantage in producing furnaces? Explain.

To figure out the comparative advantage,, we must compare,, so, finish the matrix.

Helpful, if we know what comparative advantage is,, from the cheat sheet.

In comparing who has a comparative advantage it is (always) 

the one with the lowest opportunity cost

so, compare the opportunity cost of furnaces with furnaces

and the opportunity cost of solar panels with solar panels.

Compare columns.

Country X gives up (costs) 1.3 solar panels for every furnace produced

compared to 

Country Y gives up (costs) 2 solar panels for every furnace produced

Country X has the lower opportunity cost 

Country X should produce furnaces

Answer - Country X has the comparative advantage in producing furnaces

Country X has a lower opportunity cost of producing furnaces than Country Y. 

(D) If the terms of trade were that 2 furnaces are traded for 1 solar panel, should Country X produce solar panels domestically or import solar panels from Country Y?

As it stands right now, it costs Country X .75 of a furnace to produce 1 solar panel. To give up 2 furnaces for 1 solar panel would be a worse deal. So no deal.

Country X should produce  its own solar panels domestically.

Answer - One point is earned for stating that Country X should produce solar panels domestically.

2015 AP Macroeconomics FRQ #3

FOREX

Watch me answer it here

https://youtu.be/13xyH2d9WBE

2015 AP Macroeconomics FRQ #3

(a)

     (i) If Japan's deficit increases then the Japanese Government spends more than it takes in in tax revenue.

It must borrow to make up the deficit. It borrows by selling bonds. It sells bonds to the public/banks and therefore the money supply decreases. People pay for the bonds with cash, so cash leaves the banks and people's pockets and flows to the government. Money supply decreases.

Less money in the banks means the supply of loanable funds have decreased. 

If the government has the cash,, the banks cannot loan it out. Supply of loanable funds decreases.

From the Fiscal Policy Cheat Sheet

Less money in the banks means that the demand for loanable funds will increase.

Both, supply decreasing and demand increasing raises the RIR (real interest rate).

If demand increases then the banks raise interest rates to deal with the increased demand.

Answer -  (a) i

(a)

   (ii) If there is an increase in Japan's deficit, again,, they must borrow funds from the public. This lowers the supply of loanable funds and because the government has borrowed funds from the public demand increases. Real Interest Rates increase, with higher rates of interest less people can afford to invest.

From the Fiscal Policy Cheat Sheet

Answer (a) ii

If the Real Interest Rate increases due to the borrowing by the government then what happens to the supply of Euros and the price of Yen to Euro.

Ok, so if the RIR (real interest rate) increases in Japan, people from the Euro Zone will want to deposit money into the Japanese banks to take advantage of the high interest rates.

So the supply of Euros (money)  traveling to Japan will increase as people are searching for a higher return on their investment.

From the FOREX Cheat Sheet

If the RIR in Japan increases there will be a rush by Euro zone citizens to deposit money and buy financial assets in Japanese banks to gain the higher interest rates. That means that the supply of Euros in the FOREX market will increase. A larger supply will decrease the value of the Euro relative to the Yen.  The value of the Euro compared to the Yen will start to decrease in value as there is a larger and larger supply in the FOREX market.

Supply increases, value decreases

The opposite happens with the Yen,

As more and more Euros flow into the FOREX market to purchase the Yen  needed to buy these financial products the Yen will become relatively more valuable.  As the Yen becomes more valuable it will take less and less Yen to buy a Euro.

Again, as the supply of Euros increases, the value of the Euro decreases,,, as more people need to buy Japanese financial products they have to exchange their Euros for Yen increasing the demand for Yen, driving up the value of the Yen.

The graph above shows that as the Euro's supply increases it takes less and less Yen to buy a Euro.

If the European Central bank buys the Euro it will reduce the supply of Euros in the FOREX market increasing the value of the Euro relative to the Yen.

2015 AP Microeconomics Exam FRQ #3

2015 AP Microeconomics Exam FRQ #3

Watch me answer it here

https://youtu.be/2cVGLqggiwM

(a) Calculate the total producers surplus at the market equilibrium price and quantity. 

Area of triangle   = (h * b/2)  or (1/2 height * base)

so, 20 (height) X 20 (base)/ 2 = 20*20 =400/2 = 200

Answer - 20*20 = 400/2 = 200 (total producers surplus)

AP - Answer - One point is earned for calculating the total producer surplus as (1/2 × 20 × 20) = $200.

(b) If the government imposes a price floor at $16, is there a shortage, surplus or neither?

Remember (floors are high and ceilings are low). A price floor set below the equilibrium price will have no effect as the market will clear.

Answer - at a $16 price floor neither a surplus or a shortage will occur because the $16 is below the equilibrium price,, it is not an effective or binding price floor.

AP - Answer - One point is earned for stating that imposing a price floor at $16 is ineffective and will not create a surplus or a shortage in the market because it is set below the equilibrium price, or because it is not binding 

(c) If instead the government imposes a price ceiling at $12, is there a shortage, a surplus or neither? 

A price ceiling is a government-imposed price control or limit on how high a price is charged for a product. 

So, the highest price that can be charged for the widgets is $12. At the low price of $12 suppliers will only provide 12 units of this good,, but at the low price of $12 people will demand 24 units. So there will be a shortage.

AP - Answer - One point is earned for stating that imposing a price ceiling at $12 will create a shortage because quantity demanded is greater than quantity supplied, or because the price ceiling is binding. 

(d) If instead the government restricts the market output to 10 units, calculate the deadweight loss.

Understand that a 10 unit restriction on output is represented by a perfectly inelastic supply curve at the 10 unit quantity. All the people/quantity to the right of the 10 unit limit will not be served/produced,, thus it is allocatively inefficient and therefore the efficiency is represented by deadweight loss. 

Area of Triangle = b*h/2

height = 40-10 = 30

base = 20-10 = 10

30*10 = 300/2 = 150

AP - Answer - One point is earned for calculating the deadweight loss as $150 and for showing:

(1/2 × 30 × 10) or

(1/2 × 10 × 10) + (1/2 × 20 × 10) or

$50 + $100 

(e) Assume the price decreases from $20 to $12.

(i) Calculate the PED

(ii) Is demand perfectly elastic, relatively elastic, unit elastic, perfectly inelastic or relatively inelastic?

2015 AP Microeconomics Exam FRQ #2

2015 AP Microeconomics Exam FRQ #2

Watch me answer it here

https://youtu.be/z4nNjKCJOkg

(a) Does each shop have a dominant strategy to set a high price, low price, or  does it have no dominate strategy?

Check the Oligopoly Cheat Sheet

So, While looking at my cheat sheet,, I'm not really sure I like the definition I have included. My understanding is that a dominate strategy is that no matter the actions of the other participant the same action occurs. In essence,, we do the same thing no matter what the other player does. I'm not sure the understanding of this is clear in the definition above... (summer work)

No matter what Quick does,, Bread should go Low,,, therefore Bread has a dominate strategy to go low. Bread always goes low.

Answer - Bread has a dominate strategy to go low,, Quick should do the opposite of whatever Bread does., so it has no dominate strategy.

Answer - AP- One point is earned for stating that Breadbasket has a dominant strategy of setting a low price but Quicklunch does not have a dominant strategy. 

(b) If the two shops don't cooperate on setting prices, what will be the profit for each shop.

Bread will choose Low, because $120 is the highest daily profit it can attain while not cooperating with Quick.

Quick will choose High, because $80 is the highest daily profit it can attain while not cooperating with Quick.

Answer - If there is no cooperation (setting prices) then their payoff will be from the left lower quadrant box,, $120 & $80.

Answer - AP - One point is earned for correctly identifying the profit for Breadbasket is $120 and the profit for Quicklunch is $80. 

(c) The town (politician) government is concerned that food prices are to high (and there is an upcoming election). It (he/she) decides to give a daily subsidy (taxpayer monies) of $20 to any shop that chooses to set a low price for its food items. Redraw the payoff matrix under the new government scheme.

Make a new chart adding $20 to the firms that offer the low price.

Then make a new word chart to answer the following questions:

Once your charts are created,, then go and answer the questions.

(i) Would Quick choose to set a high price or a low price? Explain using values.

(ii) Would Bread's profits, decrease, increase or stay the same? Explain.

2015 AP Microeconomics FRQ #1

2015 AP Microeconomics FRQ #1

Watch me answer it here

https://youtu.be/fEypFthw01Y

(a) Is the market price greater than, less than, or equal to the firms price? Explain.
       So, if it is a perfectly competitive industry,, (Price taker) the firm can't raise its price as all other firms would then be selling the exact same product at a cheaper price and sales would plummet. The perfectly competitive firm also has no incentive to lower its price as it can sell all it wants at that price. The perfectly competitive firm therefore will have a price that is equal to the market price.

Answer - The firms price will be equal to the market price.

(b) Draw a CLG for both the market and a typical firm and show the following:

(i) Market price and quantity, labeled Pm and Qm.

(ii) The firms quantity, labeled Qf.

(iii) The firms average revenue curve, labeled AR.

(iv) The firms average total cost curve, labeled ATC.

(v) The area representing total cost, shaded completely.

(c) If one firm in the market were to raise its price, what will happen to its total revenue? Explain.

If one firm decides to raise its price sales of its product will plummet as all of its competitors will have the same product at a lower price, therefore its total revenues will theoretically fall to zero. 

Answer - total revenue will fall
Answer - One point is earned for stating that the firm’s total revenue will fall to zero, because quantity decreases to zero, or because the firm is a price taker, or because the firm is facing a perfectly elastic demand, or the firm loses all of its customers, or the firm has no market power. 

(d) Now suppose the market is in long-run equilibrium. The government gives a lump-sum subsidy to each firm producing in the industry. Indicate wether each of the following will increase, decrease, or remain the same.

(i) The firms quantity in the short run. Explain.

As a lump-sum subsidy does not effect the MC curve of the firm so we can conclude that quantity of the firm will not decrease or increase.

Imagine that you own a coffee cart out in front of the school. Every day students file buy and buy approximately 100 cups of coffee from your cart. You pay Alice to handle the orders and take the money while you make the coffee. The school principal likes your ingenuity and determination so much that he gets the school board to give a $1,000 donation to your small business. (Of course he takes a photo shoot of him handing you the check with his arms around you. The school paper has this photo with the caption, "Supporting Student Innovators"). Now, you have an extra $1,000 dollars of cash in your pocket. Question? Does that money in your pocket increase the amount of coffee the students will drink? NO,, Will you pay Alice more money because the principal handed you $1,000? NO,,, So, if there is no increase in demand for your coffee and the wages you pay Alice don't increase (variable costs, marginal costs) then why would you increase your production of coffee.

Answer - A lump-sum subsidy will not effect your marginal costs and therefore will not effect your quantity produced.

(ii) The market price and quantity in the long-run. Explain.

Ok, so the school principal is handing out $1,000 to student innovators. You have received your $1,000 for your initiative, while the $1,000 has not increased your production it has increased your profit. You are $1,000 dollars richer. Now the principal feels so strongly about supporting young innovators that he offers a $1,000 to anyone who opens a coffee cart. Hang Yuk decides he would like to get in on this action (profits attract competitors) so he builds his own coffee cart and starts competing with you in supplying coffee to students in the morning. Now,, there are two coffee carts supplying coffee to students in the morning and an increase in the supply of a good tends to drive prices lower while lower prices are an incentive for consumers to consume more coffee.

Answer - The market price will fall with more suppliers and with more suppliers comes a higher quantity produced.

Answer - 

• One point is earned for stating that the firm’s quantity will remain the same in the short run and for
  explaining that MR or MC will not change in the short run. (Or, because the lump sum subsidy has
  no effect on marginal revenue and/or marginal cost, or that only fixed costs will be affected.)
  
• One point is earned for stating that the market price will decrease and the quantity will increase.
  
• One point is earned for the explanation that positive profits lead to entry of new firms that will
  increase the industry supply.