Long-Run Aggregate Supply & PPC Cheat Sheet

Long-Run Aggregate Supply 

& 

PPC Cheat Sheet

2017 AP Macroeconomics FRQ #3

2017 AP Macroeconomics FRQ #3

(A) Draw a CLG of the PPC, with consumer goods on the horizontal axis and capital goods on the vertical axis. Indicate a point on your graph, labeled X, that represents full employment and a possible combination of goods produced.

PPC Cheat Sheet here.

Answer

(B) Assume that there is an increase in the country's national savings. Draw a CLG of the loanable funds market, showing the change in the real interest rate from the increase in savings.

Fiscal Policy Cheat Sheet here.

Understand that if savings is increasing then the supply of loanable funds is increasing.

If the supply of loanable funds is increasing then the RIR, real interest rate is falling.

Answer

(C) On the same graph in part (A), show another point, labeled Z, that represents full employed and a new combination of consumer goods and capital goods consistent with the increase in the nations increased savings.

Higher rate of savings implies a higher rate of capital investment which will lead to more future growth.

Answer

(D)Referring to your answer in part (C), will the long run aggregate supply curve shift right, left or remain the same.

The LRAS will increase in the long-run as savings increase, consumption and investment will increase. Investment will increase in capital goods and therefore future growth can be expected with a shifting rightward of the LRAS curve.

Answer

AP views on Interest Rates & Investment, Growth in the SR & LR - FRQs

AP views on Interest Rate Changes & Investment, 

Growth in the SR & LR - FRQs

So, I've noticed that there are quite a few questions asking about growth, investment in the short-run and the long-run and I wanted to clarify a few points in my own head.

You must understand what causes interest rates to increase and decrease. This means that fiscal policy actions (expansionary & contractionary) and monetary policy actions. These also might be given in combo questions as in the Government spending increases and at the same time the FED sells bonds. What would the effect be to the interest rate and how would this affect the growth rate.

Fiscal Policy Cheat Sheet here.

Monetary Policy Cheat Sheet here.

Combo (Monetary & Fiscal) post here.

Summation of FRQ's

Investment 

2016 - Monetary expansion (buying bonds) = NIR decreases = Investment increase in the short-run

2013 - Personal Savings Increase = RIR decrease = Investment increases

2010 - Fiscal Expansion (Gov't spending) = RIR increases = Investment decreases

2008 - Fiscal Expansion (Gov't spending) = RIR increases = Investment decreases

2005 - Fiscal Expansion (Gov't spending) = RIR increases = Investment decreases

2005B - Fiscal Expansion (Gov't spending) = RIR increases = Investment decreases

Growth

2015 - Fiscal expansion (taxes decrease) = LRAS - Growth decreases in the long-run (crowding out)

2014 - Fiscal expansion (gov't spending inc.) = Growth rate decrease (slows capital formation)

2013 - Savings Increases = RIR decrease = Investment increases - Short-Run Growth increases

2010 - Fiscal Expansion (gov't spending inc.) = Growth rate decrease (slows capital formation)

2008 - Fiscal Expansion (gov't spending inc.) = Growth rate decrease (slows capital formation)

2005 - Fiscal Expansion (gov't spending inc.) = Growth rate decrease (slows capital formation)

2003B - Fiscal Expansion (gov't spending inc.) = Growth decrease/long run (slows capital formation)

Understanding

*Fiscal Exp. = Investment, SR & LR growth rate decreased, Why? - (slows capital formation)

*Fiscal Cont. = Investment, SR & LR growth rate increased, Why? - (more capital formation)

*Monetary Exp. = Investment, SR & LR growth rate increased, Why? - (more capital formation)

*Monetary Cont. = Investment, SR & LR growth rate decreased, Why? - (slows capital formation)

Understand that if society chooses to produce more capital goods instead of consumer goods as seen on the PPC, (capital goods = investment), this represents more growth.

Long-run growth is driven by productivity and this is promoted with more capital goods.

Here is a post on **Growth, PPC & Productivity and includes valuable multiple choice questions.

Notice that the Nominal & Real rates of interest always point in the same direction. 

(If you can figure out one then you know what the other is doing)

So, Investment, Growth,  Long-Run & Short-Run

Understand that Investment decreases when Interest Rates (Ir) increase and Investment increases when Ir. fall. This makes sense as businesses tend to want lower rates on their loans. Lower interest rates mean higher potential profits.

The volume of investment made today will, in turn, determine how much capital we have tomorrow-and thus influence the size of our potential GDP. 

A larger national debt may lead a nation to bequeath less physical capital to future generations. If they inherit less plant and equipment, these generations will be burdened by a smaller productive capacity-a lower potential GOP. In other words, large deficits may retard economic growth. By the same logic, budget surpluses can stimulate capital formation and economic growth.

Let us look at some problems involving growth, investment and a short or long-run view. 

I will only answer the questions that pertain to this issue.

2016 AP Macro FRQ #1

Specifically, questions (C), (D) and (E) are where we are looking.

(C) If the Federal Reserve wants to lower unemployment, what expansionary open-market policy should it use?

If the FED wants to lower (make less) unemployment then the FED needs to increase the money supply (buy bonds) which will lower the nominal interest rate causing investment to increase.

(D) How will the OMO effect the following:

       (i) Federal Funds rate

       (ii) Real Interest Rate in the Short-Run

 (E) Given your answer in part (D)(ii), what is the affect on the GDP in the Short-Run? Explain.

So, clearly with an expansionary monetary policy (buying bonds) interest rates will fall stimulating investment in plant and equipment in the short-run.

2015 AP Macro FRQ #1

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

(i) Aggregate Demand. Explain. (Not really interested in this part)

(ii) Long-Run Aggregate Supply. Explain (THIS!)

Obviously the point is to be able to explain either point you choose. I choose that LRAS (Growth) will decrease in the long run as lowering taxes will lead to a crowding out of investment. Lowering taxes without lowering overall government expenditures implies the money will just have to be borrowed.

Confusing , Yes?

2014 AP Macro FRQ #1

(D) Using a CLG of the loanable funds market, show the effect of a $100b increase in government spending on the real interest rate.

(E) Based on the real interest rate change in (D), what is the effect on the long-run economic growth rate? Explain.

2013 AP Macro FRQ #1

(B) Assume that personal savings in the US increases Using a CLG of the loanable funds market, show the impact of the increase in personal savings on the real interest rate.

(C) Based on the real interest rate change in (B)
(i) will interest rate expenditures increase, decrease or remain the same.
(ii) What will happen to the rate of economic growth? Explain.

2010 AP Macro FRQ #1

(D) In order to finance the increase in government spending on national defense from part (B), the government borrows funds from the public. Using a CLG of the loanable funds market, show the effect of the government's borrowing on the real interest rate.

 (E) Given the change in the real interest rate in part (D), what is the impact on each of the following?
(i) Investment
(ii) Economic Growth Rate. Explain

2008 AP Macro FRQ #1

(D) Using a CLG of the loanable funds market, show the impact of the increased government spending on the real interest rate in the economy.

(E) How will the real interest rate change in part (D), affect the growth rate of the US economy? Explain.

2005 AP Macro FRQ #2

(A) Assume that now the country's government increases deficit spending (borrowing). Explain how the deficit spending will affect the real interest rate.

(B) Indicate how the real interest rate change you identified in (A) will affect investment in plant and equipment.

 (C) Explain how the real interest rate change will affect long-run economic growth.

2005B AP Macro FRQ #3

(A) Using a CLG of the loanable funds market, show the effect of an increase in A's budget deficit (government spending) on the real interest rate.

 (B) Given your answer in (A), what is the effect on the business investment in A?

2003B AP Macro FRQ #1

(C) Using a CLG of the loanable funds market, show the effects of the increase in deficit spending on the real interest rate.

(F) Given the result in th loanable funds market discussed in (C), explain how the government deficit spending would influence long-run growth.

Summation:

Investment 

2016 - Monetary expansion (buying bonds) = NIR decreases = Investment increase in the short-run

2013 - Personal Savings Increase = RIR decrease = Investment increases

2010 - Fiscal Expansion (Gov't spending) = RIR increases = Investment decreases

2008 - Fiscal Expansion (Gov't spending) = RIR increases = Investment decreases

2005 - Fiscal Expansion (Gov't spending) = RIR increases = Investment decreases

2005B - Fiscal Expansion (Gov't spending) = RIR increases = Investment decreases

Growth

2015 - Fiscal expansion (taxes decrease) = LRAS - Growth decreases in the long-run (crowding out)

2014 - Fiscal expansion (gov't spending inc.) = Growth rate decrease (slows capital formation)

2013 - Savings Increases = RIR decrease = Investment increases - Short-Run Growth increases

2010 - Fiscal Expansion (gov't spending inc.) = Growth rate decrease (slows capital formation)

2008 - Fiscal Expansion (gov't spending inc.) = Growth rate decrease (slows capital formation)

2005 - Fiscal Expansion (gov't spending inc.) = Growth rate decrease (slows capital formation)

2003B - Fiscal Expansion (gov't spending inc.) = Growth decrease/long run (slows capital formation)

2002 AP Macro Exam FRQ #2

2002 AP Macro Exam (Question 2)

I love this question as it is one of the best FRQ's to further your 

understanding of the LRAS Curve.

KNOW THIS!!

1^st. Understand that (potential real gross domestic production) is the boundary of the production possibility curve. (on the curve)

2^nd. Understand that what increases/decreases the PPC does the same to the LRAS curve. (Population, Trade, Resources, Human Capital ,Technology (productivity, capital formation))

Past Blog Post on this subject/topic

(a) A decrease in the labor force participation rate. (Population)

If the population decreases there are less people to work (overall) and therefore LRAS will decrease. This is not to be confused with unemployment, which is a short-run view of idle resources and is inefficiency, not a reduction in potential)

Answer - 

(b) An increase in the government deficit following a reduction in personal income taxes. (Technology)

A reduction in personal income taxes is contractionary fiscal policy.

The increase in government deficits implies an increase in government spending which is expansionary.

Which one is more powerful and why?

A decrease in taxes will increase disposable income and increase consumption and investment and thus aggregate demand but some of that tax decrease will be saved and not spent and therefore will have a less of an effect than government spending.

Government spending will be consumed in its entirety and has a larger multiplier.

More importantly, government spending implies that some of that increase in investment will be toward capital formation, (ports, technology, equipment and factories) and therefore will increase the long-run aggregate supply/potential real gross domestic production.

Government spending will increase potential real gross domestic production thus increasing long-run aggregate supply.

Answer - 

(c) A decrease in the quantity of inputs needed to produce a unit of output. (productivity/technology)

A decrease in the quantity of inputs needed to produce a unit of output implies there has been an increase in technology/productivity. An increase in technology allows the production possibility curve boundary to shift outward and LRAS curve shifts rightward.

Answer - 

(d) An increase in the quality and quantity of education. (human capital)

Increases in the quality/quantity of education is an increase in human capital is a shifter of the PPC curve (outward) and therefore would cause the LRAS curve to shift rightward.

Answer - 

(e) An increase in the rate of savings.

An increase in the rate of savings means that the supply of loanable funds has increased which lowers the Real Interest Rate and spurs investment. Some of that investment will be capital formation and will shift the LRAS curve to the right.

Answer -