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 - 

2002 AP Macro Exam FRQ #1

2002 AP Micro Exam (Question 1)

(a) Identify one fiscal policy action that Congress might initiate to decrease the unemployment rate.

Expansionary fiscal policy would decrease unemployment either Government Spending increase or Tax decrease.

Answer - 

(b) Assume the policy you identified in part (a) reduced unemployment, but the economy is still operating below full employment. Using a CLG of aggregate demand/aggregate supply, show and explain, how the action you identified would affect each of the following

(i) Price

(ii) Output

Expansionary fiscal policy would increase output and the price level as Government spending will increase AD and thus output and will also increase the PL.

Cheat Sheet Fiscal

Answer - 

(c) Explain how the policy identified in part (a) would affect short-term interest rates.

Government Spending will increase the demand for loanable funds and therefore the Real interest rate will increase. Nominal interest rates are increased as the demand for money increases. Demand for money increases when incomes (Y) increase.

Answer - 

(d) Given the economy is still below full employment, identify the open market operation that the Federal reserve could implement to increase the money supply.

Monetary expansion = Open market operation = Buy Bonds

Answer - 

(e) Using a CLG, show and Explain, how an increase in the money supply will affect each of the following in the short run

(i) Short term interest rates

(ii) Output

(iii) Price levels

From the Monetary Cheat Sheet - (Fiscal Monetary Blog Post)

Money supply increases will decrease the nominal interest rates that will spur investment and consumption which will shift aggregate demand rightward increasing output and pushing up the price level. (Output & Price levels increase while Interest rates decrease)

Answer - 

2002 B AP Macro Exam FRQ # 3

2002 AP Macro Exam (Form B) Question 3

Feel the FOREX, Luke.

(a) Using a CLG of the FOREX, explain the impact of the capital inflow on the international value of the currency of Country X.

The Country of X is table and therefore a safer place to invest,, so citizens of other countries invest in Country X. The demand for Country X's currency increases driving up the value of country X's currency.

(b) For Country X, explain the effect of the change in the international value of its currency on each of the following.

(i) Exports

(ii) Imports

If the value of the currency of country x is appreciating then they (country x's citizens) can buy more foreign goods with their Country X dollars. AS the currency appreciates they become relatively richer and thus import more goods from foreign countries. (Imports Increase)

If country X's currency appreciates then foreigners would have to give up more of their currency to buy country X's goods. In essence, Country X's goods have become relatively more expensive than other countries,, and therefore exports decrease.

Study or don't, there is no try.

2002 B AP Macro Exam FRQ #2

2002B AP Macro Exam (Form B) Question 2

This one hurts.

Watch me answer it here

https://youtu.be/gpLOGzMPHeA

(a) What is the effect of the change in tax policy on each of the following?

(i) Consumption

(ii) National Savings

Consumption would naturally decrease as the price of things are increased. If consumption decreases and citizens can either spend or save then if spending decreases savings must increase. National savings increases.

I like the College Boards answer better than my own. 

1. Answer - Income becomes savings and consumption, so to tax income is effectively to tax both savings and consumption. If the government replaces the income tax with a national sales tax, only consumption will be taxed, and saving will become more attractive. Thus, consumption will decrease and national saving will increase. 
   

(b) Using a CLG of the loanable funds market, explain how the change in tax policy will affect each of the following.

(i) Real interest rate

(ii) Investment

If national savings has increased then the supply of loanable funds must increase lowering the Real Interest Rate (RIR) decreases. If the RIR decreases then we should expect Investment (I) to increase.

Answer - As indicated in the graph above, an increase in saving will shift the supply of loanable funds to the right, thereby decreasing the real interest rate. Investment responds positively to a decrease in the real interest rate. 

(c) Explain how this change in policy will affect long-run economic growth.

If RIR decrease then we should expect an increase in Investment which implies that there will be more capital formation (more equipment, technology) - Long run economic growth will increase as capital formation.

Answer - In the long run economic growth will increase, because the decrease in the interest rate will increase investment, which increases the capital stock and boosts productivity. 

2002B AP Macro Exam (Form B) Question 1

2002 AP Macro Exam (Form B)

Good question for the College Board.

Watch me answer it here,

https://youtu.be/uLNxuZDJO5I

Answer - Investment is a component of aggregate demand, so when investment decreases, AD decreases (shifts left) as indicated on the graph above. This decreases output from Y to Y', and the price level falls from PL to PL'. 

(b) Using the results in part (a), explain how employment is affected.

When private investment decreases then Aggregate Demand (AD) shifts leftward which means that output decreases and therefore employment decreases. 

Answer - Employment rises and falls with the (real) output level. In this case employment will decrease because output decreases. 

(c) Identify one specific fiscal policy that might be implemented to offset the decrease in investment, and explain how the policy would affect each of the following in the short run.

(i) Aggregate Demand

(ii) Output & Price Level

(iii) Real Interest Rates

One fiscal policy that could be implemented would be an increase in government spending (Gs), in the short run an increase in government spending would increase aggregate demand (AD), output and the price level & real interest rates would also increase.

(Notice that they have in the short-run) because in the long-run Government spending will decrease aggregate demand due to rising real interest rates. As Keynes said, we are all dead in the long-run and therefore we sacrifice long run investment (capital formation) to gain short term boosts in aggregate demand.) This is asked about a lot,, know it...

From the Fiscal Policy cheat sheet.

Answer - To off set the effects of the decrease in investment, the government could increase its expenditures (G) or decrease taxes. With an increase in Gs, AD will increase since G is a component of AD. The increase in AD will increase output and the price level. Increases in government borrowing in the loanable funds market will increase the interest rate, as will increases in the demand for money resulting from increases in income. 

(d) Identify an open market operation that the central bank might implement to offset the effects of the decrease in investment, and explain how the policy would affect each of the following in the short run.

(i) Real Interest Rates

(ii) Aggregate Demand

(iii) Output and the Price Level

One Monetary policy would be to buy bonds, thus injecting cash into the economy.

From the Monetary Cheat Sheet.

Answer - The central bank could buy government bonds to increase the money supply. The increase in the money supply will cause real interest rates to fall. AD will increase because investment and interest-sensitive consumption will both increase, and both investment and consumption are components of AD. The increase in AD will cause the price level and output to increase. 

(e) If the central bank continues the open market operation described in (d) , explain the long-run effects on each of the following.

(i) Inflation

(ii) The value of the currency in the foreign exchange market (FOREX).

If the Price level (PL) is increasing then inflation is increasing as they are the same thing. 

Careful,, College Board is being tricky.

If the FED (Central Bank) is increasing the money supply then the value of the currency is decreasing as our goods are going up in price (PL increasing) and therefore our goods look relatively more expensive compared to foreign goods prices therefore there is less demand for our goods and less demand for our currency in the FOREX. Less demand = value decreases. 

Also lower interest rates caused by an increase in the money supply will reduce capital flows as investors are looking for higher rates of interest rates than their own. At the margin with lower interest rates there will be less demand for our currency to invest in our interest bearing assets. Less demand less value.

Answer - If the central bank continues to increase the money supply, the price level will continue to increase as explained in part (d), resulting in an increase in inflation. The higher price level and lower interest rate that result from an increase in the money supply will make domestic prices and interest rates relatively unattractive. The domestic currency will be exchanged for foreign currency by those wishing to purchase goods and invest capital elsewhere, and less domestic currency will be demanded by foreigners, causing a devaluation of the domestic currency in foreign exchange markets. 

College Board give me my 5

Fiscal & Monetary

Independence and Interdependence of Fiscal & Monetary Policy

It appears to me that the AP is interested as an explanation for the direction of the RIR using the Price Level as an explanation.

Let me take a shot at explaining. (This is not for the AP explanation)

 (If the Money Supply is increasing then the amount of money in circulation is increasing which with our understanding of supply and demand means that the value of the money decreases. (more money less value) The RIR is about purchasing power so if the quantity (supply) of money increases then the purchasing power of each dollar falls. As the more money supplied gets into people's hands they spend it,, more people spending money pushes the price level up, price levels increase. 

Next connection & clarification. 

If the money supply is increasing then the value of the currency is falling as more people have more of it and therefore demand for it falls reducing the value.  RIR is a direct reflection of the cost to purchase money (borrow, get a loan). So if the supply is increasing the banks want to make loans so they lower the cost to purchase money, RIR decreases. 

Next connection & clarification.

If the banks have more loanable funds then their opportunity cost of holding more cash increases and they therefore lower their interest rates (price to borrow) to entice more people to borrow. Remember that the demand curve is downward sloping on the purchasing of money (borrowing),, and to get more people to borrow the banks must lower their rates.

To explain for the AP, monetary policy expansion and the RIR, I think it is best to say that since the Price Level (PL) is increasing therefore the RIR must be falling.

Still easier than this stuff.

Perfect Competition Show Me Quiz

Perfect Competition Show Me Quiz

HERE WAS THE QUIZ FOR TODAY ON PERFECT COMPETITION