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Course: AP®︎/College Macroeconomics > Unit 8
Lesson 1: Prepare for the 2020 AP Macro ExamExample free response question from AP macroeconomics
This video walks you through the concepts covered on an AP Macroeconomics Free Response Question.
Want to join the conversation?
- what's the difference between the LRPC and the NAIRU?(2 votes)
- why does AS in short run shift to the right when there's high unemployment in an economy? Would it shift to the left as firms reduce production due to low demand (a lot of unemployed workers and thus have less money to spend)? I don't understand the point that the firms increasing production simply because labor becomes cheaper in the situation where there's no demand. I would really appreciate your help here.(2 votes)
- The key is to distinguish between the short run and the long run. Think of the short run as what happens immediately and what happens later due to the change being the long run. When labor becomes cheap enough, producers will make profit though aggregate demand may lag for a bit longer. Think of the business cycle. The economy would never be able to re-bound without government or central bank intervention unless producers begin to purchase more labor during the recessionary part of the cycle.(1 vote)
- The Foreign Exchange market answer towards the end for Q. e & f are not correct. On the AP Macroeconomics lessons, we learn that due to expansionary fiscal policy, the government borrows loans because of the deficit in the budget. This increases the loans demanded in the loans market and the new equilibrium shows a higher interest rate. That interest rate then lowers the investment demand. This is called the crowding out effect.
When the interest rates rise compared to the rest of the world, capital inflow increases and the capital account shows as a surplus while the current/trade account shows as a deficit. This is due to the law of balance of payments where both sides always equal 0.
During the capital inflow process, the rest of the world wants USD because they can only invest using US dollars inside the U.S. This increases thedemand for USD in the foreign exchange market and appreciates the value of USD in terms of other foreign currency.(2 votes) - Was this an example of the long free response question or one of the shorter ones?(1 vote)
- This is an example of the long question (the first question) in the AP Macroeconomics exam.(2 votes)
- Are the questions on Khan harder than the eventual AP tests?(1 vote)
- what is the market model?(1 vote)
- Assume the U.S. economy was operating at a short-run equilibrium when interest rates for investment loans increased.
(a) Identify the effect of the change in investment spending on each of the following:
Real output
Price level. Explain.
Employment
(b) Identify one fiscal policy government could implement to reverse the change in investment spending.
PLEASE HELP!!(1 vote)
Video transcript
- [Instructor] In this video,
I want to tackle an entire AP macroeconomics free
response exercise with you. Assume that the economy of Country X has an actual unemployment rate of 7%, a natural rate of unemployment of 5%, and an inflation rate of 3%. Using the numerical values given above, draw a correctly labeled
graph of the short-run and long-run Phillips curves. Label the current short-run
equilibrium as point B. Plot the numerical values
above on the graph. So pause this video if
you are inspired to do so, but I will now work through it. So remember, Phillips
curves show the relationship or the theoretical relationship between the unemployment
rate and the inflation rate. So I'm gonna do the inflation rate in the vertical axis which is typical. And then on the horizontal axis, I am going to do my unemployment rate. So this is going to be my unemployment rate which is going to be a percentage. Now we want to graph the short-run and long-run Phillips curves. Let's do the long-run first
because we've seen before the long-run just sets
our unemployment rate at the natural rate of unemployment, and it isn't related
to our inflation rate. It'll just be a vertical line. And so it'll be a vertical
line at our natural rate of unemployment which is 5%. So maybe it looks just like this. So I could call that our
long-run Phillips curve, and it's going to be right there at 5%. And now I have to do the
short-run Phillips curve, and that will show a relationship between inflation rate and unemployment. And just think about what's going on. If you have low rate of unemployment, especially if it's below your
natural rate of unemployment, well then there's a lot
of demand for people. And so people say, hey,
if you want me to work, you gotta pay me a little bit more, and so that could just lead
to a higher inflation rate. And then if a lot of
people are unemployed, they might be willing to work for less or they might have less
money in their pocket with which to drive up the
prices, and so you will have this inverse relationship right over here. So this is the short-run Phillips curve, which is downward sloping. And then they say, label the short-run
equilibrium as point B. So let's say this is
point B right over here. And they say the short-run
equilibrium we have an unemployment rate of 7%
and an inflation rate of 3%. So our unemployment rate
right over here is 7%, and our inflation rate
right over here is 3%. All right, let's do the next section. Assume that the government of Country X takes no policy action
to reduce unemployment. In the long run, which of the
following shift to the right, shift to the left, or remain the same? So here they're saying short-run aggregate supply curve, explain. So here it's kinda tricky
'cause you might be thinking they're asking about what you just drew. But here they're talking
about aggregate supply. So let me draw a graph to
even help to visualize this. So if we're talking about aggregate demand and aggregate supply, our vertical axis is going
to be our price level, I'll just call that PL, and our horizontal axis that
is going to be our real GDP. So this is real GDP
right over here, G-D-P. Now you're just going to
have a long-run supply curve which is vertical. That's just the full employment
output for our country. So that's the long-run aggregate supply. But what about the short-run
aggregate supply curve? Well, that's going to be upward sloping. If price levels are low,
people might not be willing to output a lot, and if
price levels are high, people will output more. So our short-run aggregate supply would look like that. I'll call that sub one,
since we're gonna think about how it shifts, and then aggregate demand
would look something like this. Let me draw it like that. And notice, our equilibrium
point right over here, let me call that aggregate
demand right over here. Let's call that Y sub one, and we are at price level sub one. I drew it to the left of the long-run aggregate supply curve. I drew it to the left of
the full employment output because we are dealing
with a recession here. Our unemployment rate is higher than the natural level of unemployment. So if our actual
unemployment rate is higher than natural rate of
unemployment, what will happen to the short-run aggregate supply? So one way to think about
it, at a given price level, because there's people out
there looking for a job, you might be able to get more output. Or for a given amount of
output, it might cost less because there's just people out there competing for that work. And so you would have your
short-run aggregate supply curve shift to the right, short-run
aggregate supply sub two. And then your equilibrium
price level would go down, price level sub two would go down. So we could say because of high unemployment, that could apply wage pressure. We could say wages come down which would shift the short-run aggregate supply curve to the right. And there's a couple of
ways to think about that. You would have more output at a given price level. You could also think at
a given output level, you would have a lower price level, at a given price level. Part two, long-run Phillips curve, so that's this vertical
line right over here. And the thing to appreciate
is the long-run Phillips curve or the long-run aggregate supply curve, these don't change unless
something structurally changes in the economy, unless the economy changes in some very fundamental way, maybe a change in education
levels, change in population, or change in technology. And so here we would say
it just remains the same. All right, we have more parts here. Now let's go to part (c). Identify a fiscal policy
action that could be used to reduce the unemployment
rate in the short run. So you have to be very careful here. They're saying a fiscal policy action, not a monetary policy. If you said hey, we would
change the federal funds rate or we would increase the money supply or decrease the money supply, those would be monetary actions. We care about a fiscal policy action. And this would be in
relation to lowering taxes or raising taxes or increasing or decreasing government spending. Well, if we want to reduce
the unemployment rate, one way to do the that would be to shift aggregate demand to the right. And one way to do that,
would be to put more money in people's pockets, and one way to do that,
is to have a tax cut. Draw a correctly labeled
graph of aggregate demand and short-run aggregate
supply, and show the impact on the equilibrium
price level and real GDP of the fiscal policy action
identified in part (c). All right, let me draw that. So this is going to be so that we have our price level axis up here, and we just drew something
very similar to this, real GDP. And now let's draw our
short-run aggregate supply which we have seen before. That would be upward sloping, as the price level increases
or the economy might be willing to output more, so that's
short-run aggregate supply. And then let's draw an
aggregate demand curve. So let's call that AD sub one. And then you have the equilibrium output, let's call that Y sub one. And you have your equilibrium
price level, PL sub one. And now if you have a
tax cut, that would shift aggregate demand to the right. At any given price level,
people are gonna want more. They're gonna demand more 'cause now they have more
money in their pockets, and so it's going to shift to the right. So I'll do a aggregate demand sub two. And now we have a different
equilibrium real GDP, so that is going to be Y sub two. And it happens, and then we
have price level sub two. So you see our price level goes up and our aggregate output, our GDP, our real GDP, goes up as well. Based on the change in real
GDP identified in part (d), will the supply of Country X's currency in the foreign exchange market increase, decrease, or remain the same, explain? The way I think about it is if
you have real GDP increasing, you're in a situation where you just have more economic activity, the
national income has gone up. And if national income has
gone up, people are gonna do a lot more of everything
including buying imports. And to buy imports, they would
have to increase the supply of their currency in exchange markets because they want to convert
it into foreign currencies to buy those imports, and
so this will increase. And we could say, because national income has gone up, people will buy more imports, so the supply of Country X's currency for exchange will go up. Currency X's currency for exchange will go up. All right, part (f). Based on your answer
to part (e) and assume a flexible exchange rate system, will Country X's currency
appreciate, depreciate, or remain the same in the
foreign exchange market? Well, if you hold all else equal, but you increase the supply of something, well, then the price of
it is going to go down. If the demand for it stays constant, but you increase the supply, and that's what we just
talked about in part (e), well, then the price is going to go down. And if we're talking about
the price of a currency and we say it's going
down, we would say that that currency is depreciating, so it would depreciate, and we're done.