2010 Macro FRQ #1

2010 Macro FRQ #1

Watch me answer it on youtube 

https://www.youtube.com/watch?v=aX2zAKId5RQ&feature=youtu.be

(A) Draw a CLG of AD/AS and show each of the following.

(i) The Long Run Supply Curve.

(ii) The current equilibrium output/price levels, labeled a sYE & PLE.

(B) Assume the government increases spending on national defence without raising taxes.

(i) On your graph in part (a), show the effect on AD.

Government spending on national defence is government spending that increases the G in the GDP formula. So, C + I + G + XN = GDP,,, If, G increases (defence spending) then AD increases, increasing GDP.

(ii) How will this action affect the unemployment rate in the short-run? Explain.

If the government is spending then the G is increasing, people are supplying goods to the government, so GDP is increasing and output is increasing which means businesses are hiring to keep up with the increased demand from government spending and increased output. 

(C) Assume that the economy adjusts to a new long-run equilibrium after the increase in government spending.

(i) How will the new short-run aggregate supply curve compare to the initial SRAS curve in part (a)? Explain.

The college board is simply asking you what happens in the long-run, after inflation happens in the economy. Notice that when an economy is in equilibrium and then the government spends, that we are in an inflationary gap. If the government does nothing in the long run the SRAS curve will shift leftward as prices and wages adjust. In essence during an inflationary gap, there isn't enough labor to handle the increased demand for goods and services, so wages rise to entice more people into the workforce and prices also rise.

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

If the government is borrowing from the public then the demand for loanable funds is increasing driving up the interest rate.

(E) Given the change in the Real Interest Rate in part (d), what is the impact of the following.

(i) Investment.

Crowding out will occur as the real interest rate rises it deters people from taking out loans to invest. As the government drives up the interest rates by borrowing there is less and less private investment.

(ii) Economic growth rate. Explain.

If there is less private investment there will be less long-term growth as there will be less capital formation, less capital goods produced so in the long-run society will suffer.

AP 2007 B Macroeconomics Exam FRQ#1

AP 2007 B Macroeconomics Exam FRQ#1

Watch me answer it here

https://youtu.be/zZw7ER5gzYg

(A) Assume that Australia begins to recover from its recession. Using a CLG (correctly labelled graph) of aggregate demand and aggregate supply for New Zealand, show the impact of Australia's rising income on each of the following in the short-run.

(i) Aggregate demand in New Zealand, Explain.

(ii) Output in New Zealand

Ok, so if Australia's citizens are recovering from a recession they are buying more New Zealand goods. New Zealand's exports are increasing. Aggregate demand must be increasing and therefore output must also be increasing.

(B) Using a correctly labeled graph of the money market for New Zealand, show the effects of the output change in part (a)(ii) on the following.

(i) Demand for Money. Explain.

(ii) The nominal interest rate. (NIR)

Understand - As incomes increase (Y1 to Y2) the demand for money increases. Why? If output is increasing it means that the PL is increasing, if the price level is increasing then the demand for money is increasing. If the demand for money is increasing the demand for loanable funds is increasing, therefore the NIR (nominal interest rate) is increasing.

From the Fiscal Policy Cheat Sheet, Here.

You want more? OK. As the economy improves (output/GDP increases) then people are being hired back to work. Prices are rising as more and more people have the incomes to buy the goods they want pushing the prices ever higher. The citizens need more cash on hand for daily purchases as the prices rise (demand for loanable funds increases). This means that they are either taking the money out of the bank as prices rise (supply of loanable funds decreases. Either way the Real Interest Rate is going to increase. If the real rate is increasing the nominal rate is also increasing.

The Real Rate is the opportunity cost of borrowing money (price of money borrowed) or the purchasing value of the money when borrowed.

The nominal rate is the opportunity cost of holding money or the change in the value due to inflation.

Check out the Real vs Nominal blogpost here.

(C) Assume that the price level in New Zealand rises. Given your answer to part (b)(ii), explain what will happen to Real interest rates.

College Board Suck It.

** For the Record, this question is looking for the Geniuses**

IF, the nominal rate is rising the real rate is rising. Inflation causes the Real rate to fall but if the nominal rate is rising faster than inflation then the real rate is still increasing, but if inflation is rising faster that the nominal the real rate is falling.

Remember the Unemployment/Inflation/Phillips curve cheat sheet Here.

(Real Interest Rate = Nominal Interest Rate -(minus) Inflation Rate)

Consider that if there is no inflation the RIR = NIR

(6%NIR - 0%Inf) with the rise in Inflation being 0%  = (RIR6%)

but, what if:

(6%NIR - 2%Inf) with the rise in Inflation being 2%  = (RIR4%)  the RIR is 4%

but, what if:

(6%NIR - 4%Inf) with the rise in Inflation being 4% = (RIR2%) the RIR has fallen to 2%

but what if:

(6%NIR - 1%Inf) with the rise in Inflation being 1% = (RIR5%) the RIR has increased to 5%

(D) Although recovering, Australia remains in recession and its government takes no action. Indicate wether each of the following curves will shift, left, right or no change in the long run in Australia.

(i) Aggregate Supply

(ii) Aggregate Demand

Recession, government takes no action, what shifts in the long-run.

SRAS shifts rightward. AD no change.