Principles of Macroeconomics Set 2

AP Macroeconomics ® Free-Response Questions Set 2 MACROECONOMICS SECTION II Total Time—1 hour Reading Period—10 minutes Writing Period—50 minutes 3 Questions Directions: You are advised to spend the first 10 minutes reading all of the questions and planning your answers. You will then have 50 minutes to answer all three of the following questions. You may begin writing your responses before the reading period is over. It is suggested that you spend approximately half your time on the first question and divide the remaining time equally between the next two questions. Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. If the question prompts you to “Calculate,” you must show how you arrived at your final answer. Use a pen with black or dark blue ink. You may plan your answers in this orange booklet, but no credit will be given for anything written in this booklet. You will only earn credit for what you write in the separate Free Response booklet. 2 1. Assume the United States economy is in short-run macroeconomic equilibrium at an output level greater than potential output. (a) Draw a correctly labeled graph of the aggregate demand, short-run aggregate supply, and long-run aggregate supply curves, and show each of the following. (i) The current equilibrium real output and price level, labeled as Y1 and PL1, respectively (ii) The full-employment output, labeled as YF (b) Assume government spending increases by $100 billion. On your graph in part (a), show the short-run effect of the change in government spending on the equilibrium real output and price level. Label the new equilibrium output as Y2 and the new equilibrium price level as PL 2. (c) Assume the marginal propensity to consume is 0.8. As a result of the increase in government spending, what is the numerical value of the maximum change in each of the following in the short run? (i) Real output (ii) Household savings (d) Draw a correctly labeled graph of the money market and show the effect of the change in real output identified in part (c)(i) on the equilibrium nominal interest rate. (e) Based on the change in the nominal interest rate shown in part (d), what will happen to the prices of previously issued bonds in the short run? (f) The United States and the European Union are trading partners with flexible exchange rates. The currency in the United States is the dollar, and the currency in the European Union is the euro. Assume the inflation rate in the United States increases relative to the inflation rate in the European Union. As a result of the change in the United States inflation rate, what will happen to each of the following in the foreign exchange market? (i) The demand for dollars. Explain. (ii) The international value of the dollar (g) Suppose the Federal Reserve attempts to keep the value of the dollar constant in the foreign exchange market. Based on the change in the value of the dollar in part (f)(ii), should the Federal Reserve buy or sell each of the following? (i) The euro (ii) The dollar __________________________________________________________ Begin your response to this question at the top of a new page in the separate Free Response booklet and fill in the appropriate circle at the top of each page to indicate the question number. 3 2. The table below shows macroeconomic data for Country A. Year Nominal GDP GDP Deflator Population 2020 40,000 100 100 2021 88,000 200 110 (a) Calculate each of the following for Country A in year 2021. Show your work. (i) Real GDP (ii) Real GDP per capita (b) Based solely on the data provided, has the standard of living for the average person in Country A increased, decreased, or stayed the same between 2020 and 2021 ? Explain. (c) How would an increase in government spending on education affect economic growth in Country A? Explain. (d) Assume that Country A produces consumer goods and capital goods. Draw a correctly labeled production possibilities curve for Country A, and show the effect of the increase in government spending on education on your graph. __________________________________________________________ Begin your response to this question at the top of a new page in the separate Free Response booklet and fill in the appropriate circle at the top of each page to indicate the question number. 4 3. The economy of Country Zeta is in long-run equilibrium; however, the government is concerned about the size of the national debt. (a) Identify one specific fiscal policy action the government could take to reduce the national debt. (b) Draw a correctly labeled graph of the loanable funds market, and show the effect of the fiscal policy action identified in part (a) on the real interest rate. (c) Based on the change in the real interest rate identified in part (b), what will happen to each of the following? (i) Aggregate demand in the short run. Explain. (ii) Potential real output. Explain. __________________________________________________________ Begin your response to this question at the top of a new page in the separate Free Response booklet and fill in the appropriate circle at the top of each page to indicate the question number. 5