2008 Macro FRQ #1

2008 Macro FRQ #1

(A) Using a CLG of the short-run Phillips Curve, show the effect of the decrease in consumption spending. Label the initial position "A" and the new position "B".

(B) What is the impact of the recession on the Federal Budget? Explain.

Initially  the economy was at full employment with a balanced budget. Now (C) Consumption spending has decreased leading to a recession.

During a recession, governments spend more on welfare and unemployment benefits and tax revenues decrease as people's incomes decrease. This happens automatically due to Stabilisers.

Fiscal Policy Cheat Sheet Here.

The Federal budget will be in a deficit.

(C) Assume that the current RGDP falls short of full employment by $500 billion and the MPC (Marginal Propensity to Consume) is 0.8.

(i) Calculate the minimum increase in government spending that could bring about full employment.

Now, I know that with an MPC of 0.8 the multiplier is 5 and therefore the government will need to increase spending by $100 billion to shift the AD curve rightward to full employment.

But please look at the MPC/MPS Cheat Sheet, Here.  Learn it!!!

Here is a post and some videos on the MPC/Multiplier

(ii) Assume that instead of increasing spending the government decides to decrease personal income taxes. Will the reduction in personal income taxes required to achieve full employment be larger than or smaller than the government spending change you calculated in part (c)(i)? Explain why?

So instead of a Spending Multiplier we will be using the Taxing Multiplier.

A taxing multiplier will always be less than the spending multiplier. WHY? When the government spends all of the $100 billion will be spent. A tax cut will increase (C) consumption spending in the economy as people have more money to spend,, but some of that money will be saved (a leakage) and the multiplier will not be as large.

Check out this post on the difference between a spending and taxing multiplier, Here.

• If the government decreases taxes by 100b the (GDP/AD/Incomes) will increase by the        Tax Multiplier,, so,, -MPC/MPS,, so,, -0.8/0.2 = -4 x -100b = 400b increase in AD

** You must read this carefully to answer - to get the AD curve to shift rightward to full employment (500 billion) the personal income taxes must be reduced by more than 100 billion.***

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

((If Gov't Spending Increases, RIR Increases.))

Understand that the government wanting to spend,, it must borrow this reduces the supply of loanable funds increasing the RIR, real interest rate.

Understand that the government borrowing increases the demand for loanable funds (as the government's demand is added to all other demand) and therefore the RIR rises.

These both happen at the same time as they in essence are the same thing.

If you go into the grocery store and buy a bag of lemons, you are increasing the demand for lemons and reducing the supply.

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

Look again at the Expansionary = Crowding Out graph above.

Notice the bottom sentence in bold - It says,"LR Growth is sacrificed for a Short Run Aggregate Demand increase with an expansionary policy."

This is the essence of crowding out - The Government spends to increase AD but it must borrow to do the spending. This Government spending raises the RIR which keeps some Private Industries from taking out loans and starting businesses. Why does it keep them out? Remember that the RIR is the price to borrow money, if the price is to high (due to gov's borrowing) then the private companies will not borrow and will not produce.

Long-Run Growth is primarily achieved through increasing productivity and this is done through shifting the SRAS curve rightward in the short-run and the LRAS in the Long-run.

This could really use a good post.

2007 B Macroeconomics FRQ#3

2007 B Macroeconomics FRQ#3

(A) Assume that the RIR in the US falls to 3.75%.

(i) How will the flow of financial capital between the US and the EU be affected? Explain.

If the US RIR falls to 3.75% then international investors will move their money from the US to the EU. Why? Because they want profit, they want to make more money on their savings. 

4.5% - 3.75 = .75% of profit annually

So if you invested 1,000,000 and earned an extra .75% for 10 years that is close to 80,000 dollars.

Future Value Calculator Here.

People move their money for all kinds of reasons but profit is a big reason.

(ii) Using a CLG of the FOREX for the (EURO), show how the value of the euro would change relative to the US dollar in a flexible exchange rate system.

Value of the Euro € will appreciate from V1 to V2.

(B) Explain how the change in the value of the euro in part (a)(ii) would affect the EU's net exports.

According to (A) the value of the € is appreciating or getting stronger. This means that it will take more US $ to buy a Euro €. The price of Euros is increasing, which means that the prices of Euro goods is increasing.

If the EU's goods prices are increasing relative to the US goods then US citizens will stop buying as much expensive EU goods and start buying more relatively cheaper US goods.

So, EU exports will decline as their currency € gets stronger and becomes more expensive, but they will with their stronger € import more US goods. 

The EU net exports will decline.

Crash Course does a good job of painting this picture.

1950 propaganda cartoon (via ChinaSmack). The caption in the right panel reads, Now currency has stable rates, gold and greenbacks are disgraced, Renminbi are widely trusted, speculators have been busted.

2007 B Macroeconomics FRQ#2

2007 B Macroeconomics FRQ#2

watch me answer it here

https://youtu.be/oXWJLq81Ba8

(A) Assume that businesses are granted a tax credit on spending for machinery. Using a CLG of the loanable funds market, show the effect of the business sector's response on the real interest rate.

OK, so if business are getting a tax credit (a tax credit means that they will get money from the government for buying machinery) for buying machinery. We can assume that more businesses will take out loans to buy machinery. 

I think of loanable funds as money (funds) sitting in the banks and if businesses are going to the bank and taking out those funds then the supply of loanable funds must be decreasing.

It is also acceptable to think of this as government spending, if the government is giving money to businesses then we can think of it as government spending. 

If you remember anything, when government spends the RIR increases.

Real interest rates is increasing.

(B) Now assume that the tax rate on interest income from household savings is lowered and there is no change in government budget deficits. Using a second loanable funds graph show the effects of the household's response on the real interest rates.

This means that the tax you pay, on interest you earn, from your savings account is lowered. So we can assume that more people will save. This implies that people will save more money in the banks and that the supply of loanable funds will increase.

If the supply of loanable funds increases then the RIR will fall.

Fiscal policy cheat sheet, Here.

(C) Given your answer to part (b) what will happen to the countries PPC in the Long-Run?

If people are saving more money, then the RIR is falling and more people will be taking out loans. Why? A lower interest rate means the cost of borrowing is lower and therefore more people borrow.

If more people borrow, we can assume that businesses are borrowing and that they are investing some of that money into Capital Goods. (Also called Capital Stock)

Capital Goods are goods like, factories, equipment, tools, shipping containers, cranes, etc and these are used to create other goods and in the long-run we expect society's ability to produce more goods to increase.

In essence the PPC will shift outward.

This post links, Growth, PPC, Productivity, Here.

** Productivity is linked with Capital Goods, as most people buying new machinery for their businesses are buying better machinery, this will make their workers more productive.**

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.

2007 Macroeconomics FRQ#3

2007 Macroeconomics FRQ#3

Watch me answer it here

https://youtu.be/91lo4cetSWA

(A) The value of a used textbook sold through an online auction in 2006.

Check out GDP cheat sheet, Here

Used means second hand and implies that the value of this textbook was already counted in a previous year, therefore it is not counted this year.

(B) Rent paid in 2006 by residents in an apartment building built in 2000.

Rent is payment (income earned) for the service of using someones property therefore it is counted in GDP for 2006.

(C) Commissions earned in 2006 by a stockbroker. 

Commissions paid on sale (a service) of stock or bonds,,, above.

(D) The value of an automobile produced in 2006 entirely in South Korea by a firm fully owned by US citizens.

from the cheat sheet - 

((Total Value of all Final goods and services produced in the US in a year))

Excludes - production outside the US even by Americans,

2007 Macroeconomic Exam FRQ #2

2007 Macroeconomic Exam FRQ #2

Watch me answer it

https://youtu.be/BnJSiAHQJoY

(A) Define the Federal Funds Rate.

From, the Fiscal Cheat Sheet, Here

(B) If the Federal Reserve wants to lower the federal funds rate, what open-market operation would be appropriate?

The OMO (open market operation) to lower the Federal Funds Rate is for the FED to buy bonds. The FED buys bonds and the cash is injected into the economy. The money supply has been increased due to the injection of cash. The Nom IR (nominal interest rate) falls/decreases and so does the Federal Funds Rate.

(C) Assume that the OMO operation you indicted in part (b) is equal to 10 million. If the required reserve ratio (RRR) is 0.2 calculate the maximum change in loans throughout the banking system.

Required Reserves are .2 or 20% of all deposits must be kept in reserve, and that implies that 80% can be loaned out. The multiplier works here. Check out the MPC/MPS Cheat Sheet Here.

If the banks can loan out 80% of the 10 million that is 8 million dollars. BUT, it asks for the maximum change in loans,, and that money will be multiplied/created/expanded into 8 x 5 = 40 million.

** Understand that there is a mistake (I believe) in this problem's answer.

If the FED buys bonds on the open-market and wants the maximum change in the MS

it would buy bonds from banks

If bought from banks there is no reason that some of the funds would need to be held

in the Required Reserves as none of the money would go into checkable deposits,

Buying Bonds from a bank would cause all of the 10m to flow directly into Excess Reserves

All 10m could be loaned out

10m x 5 = 50m maximum increase in the MS.

(D) Indicate the effect on the OMO that you indicated for part (b) on the nominal interest rate.

In part (b) the FED's plan was to buy bonds, buy bonds and the nominal interest rate falls.

Check out the monetary cheat sheet Here.

(E) Assume that the FED's actions cause some inflation (you think!!!) What would be the impact of the OMO (buying bonds) on the real rate of interest. ((EXPLAIN..))

So, the real rate of interest as we have learned is the Loanable Funds graph. If the FED is dumping money into the economy by buying bonds, we can assume much of the cash is finding its way into the banks. That implies that the supply of loanable funds is increasing in the banks. Supply of loanable funds increases and this pushes the Real Interest Rate down as banks compete for customers.. Graph??

Supply increases, RIR decreases

EXPLAIN.. It appears that explanation that is acceptable is that the Real Rate has fallen because the Nominal Rate has fallen and inflation has increased.

Reserve Requirement Cheat Sheet

Reserve Requirement Cheat Sheet

This is a cheat sheet to help with those pesky reserve requirement like questions posed by the college board.

 Read it critically as I haven't thoroughly gone over it. In other words trust but verify.