MACROECONOMICS SECTION 1 Time—70 mines 60 Questions Directions: Esch ofthe questions or incomplete statements below is followed by five suggested answers or comple tions. Select the one that Destin each case and then 1. Which ofthe following would ease the produc- ‘ion possibilities curve shown above to shift outward? (A) Reopening scl plants that had been closed (B) Rehining laid-off seelworkers (©) Using machinery fo mise production instead of see! podaction (D) Using machinery for steel production i of misile production © Developing a more efficent steelmaking process tad 2. tina specified year nominal gross domestic product grew by I! percent an red! gross ‘domestic product grew by 4 percent, inflaton for this year would be (a) 7% ® 1% (© 8% D116 © 13% 3. Which ofthe following is an example of strac- tural unemploymen!? (A) A computer prgranimer who leaves her job to move to Florida (B) A worker who loses his job daring a recession {C) An autoworker who is sepaced by a robot, () A consiroction worker sv is ways ‘unemployed during the winter months (©) A worker who is enaged in unproductive ‘work som il in the comesponding oval on the answer sheet 4, What would be the effet ofa are increase in Tabor productivity on the real gross domestic product andthe price level? Real Gross Done Price Lew (A) Increase Increase (Increase Decrease (©) Noeftect Increase (D) Decrease Increase (B) Decrease Decrease ‘5. An increase in which of the following will increase the value of the spending mulpier? (A) The supply of money (8) Equiteium output (©) Personal income tax rates (D) The marginal propensity to consume (E) The required reserve ratio. 6. According tothe Keynesian model, which ofthe following would increase aggregate demand? (A) An increase in autonomous investment (8) An increase inthe discount rte (©) A decrease in unemployment compensation payments (D) A decrease in government expenditures accompanied by an equal reduction in taxes (©) A decrease in government expenditures on public workscansoare, 88 ° 100011800 GROSS DOMESTIC PRODUCT 7. The graph above indicates equilibrium at E for a closed economy without goverment spending. Ifthe addition of government spending results in equilibelam at F, hich of the following is tue? 1A) Goverment spending it $300 and the molipier iS. 'B) Government spending it $100 and the multiplier is 5 {C) Government spending is $100 and consumption Increases by $500 () Government spending and gross domestic product increase by $500 exch (©) Consumption and gross domestic produc increase ‘by $500 each un8. Commercial banks can crete money by (A) wansferring depoitr’ accounts atthe Federal Reserve for conversion to cath (B) baying Treasury bills fom the Feder Reserve (©) sending vault cash to the Federal Reserve () maintaining a 100 percent reserve requte- ©) lending excess reserves to customers 9. Ie the reserve requirement is 20 percent, the ext- tence of $100 wort of excess reserves inthe banking system can lead toa maximum expan- sion ofthe money supply ewua to (a) 820 ®) si00 (© $300 ©) $500 © 3750 10. If the Federal Reserve lowers the reserve requte- ‘ment, which ofthe following would mos likely ooeur? (A) Imports will rise, decreasing the trade deficit. (B) The sae of saving will increase, (©) Unemployment and inflaton wil both (D) Businesses will purchase mote factories and equipment (&) The budget deficit wil increase, 1. Ifthe public's deste to hold money a curency ‘increases, what wil the impact be onthe Banking system? (A) Banks would be more able to reduce unem- ployment (8) Banks would be more able to decrease ‘ate supply. (©) Banks woul be less abe to decrease aggre te spply (D) Banks would be more sble to expand credit, (&) Banks would be leet able to expand credit. ane12 According to Keynesian theory, decreasing taxes and increasing jpvemment spending will mos ikely change consumption tcpenitures and unemployment in which of the Following ways? Consumption Expenditures Unemplovment (a) Decrease Tnerease (8) Decrease No change () Increase Decrease (0) Increase Increase (@) No change Decrease 13, Which ofthe following poicy combinations is most likely to cure & ‘Qpen-Market Operations Taxes IA) Buy securities 1B) Boy securities IC) Buy secunes 1D) Sell secures 1B) Sell secuties Increase Decrease Decrease Decrease Increase be Government Spending Decrease Increase Decrease Decrease Increase14. In an economy at full employment, a presidential candidate proposes cuing the government debt in half in four years by increasing income tax rates and reducing govertment expenditures ‘According to Keynesian theory, implementation ‘ofthese polices is most Heely to increase (A) unemployment (B) consumer prices (© aggregate demand () aggregate supply (E) the mate of esonomie growth 15. To protect high-cost domestic producer, a ‘country imposes a tariff onan imported com- ‘modiy, ¥. Which ofthe flowing is most likely to occur inthe short ran? L.A decrease in dome production of Y 1. An increase in domestic production of Y TL An increase in foregn output of ¥ () Toaly ®) Monly (© monly (D) [and IM only (©) Wand MI only 16. Suppose two counties are each capable of indi- ‘idually producing two given commodities. Insted, each specializes by prodecing the com- rodiy for which it has «comparative advantage and then tades withthe oer county. Which of the following is most likely wo result? (A) The two countries will become more inde- pendent of eachother (®) Unemployment will increase ia one country And decrease inthe cer, (©) There will be more eficient production in ‘ne country but less efficent production in the other. ©) Both countries will beome beter off {®) Both countries willbe producing ther com modi ineficiently 17, Which ofthe following means of reducing mil- tary spending would have the greatest postive pact on gross domestic product forthe United States? (A) Combining two domestic military bases into one overseas base (@) Cuting reirement benefits military per onnel (©) Closing overseas military bases and relocating those operations to the United States (©) Closing overseas military bases and laying off iltry personnel (© Canceling contacts with domestic producers Tor new airplanes Angenste Supply Aggrgste Demand 18. According tothe graph above, which of the following wil necessarily result in a decrease in output? 1. A rightward shift ofthe aggregate demand TA eftward shit ofthe aggregate demand TL. A rightward shift ofthe aggregate supply IV. A leftward shift of the aggregate supply (A) Loaly @) Woaly (©) Land I only () Mad only (®) Mand IV caly an19. Which of the following wl result in the greatest increase in aggregate demand? (A) A $100 increase in taxes (B) A $100 decrease in taxes (©) A $100 increase in government expenditures (D) A $100 increase in government expenditires, ‘coupled with 2 $100 increase in axes (©) A $100 increase in government expenditures, ‘coupled wit a $100 decrease in taxes 20, Ifthe economy isin a severe recession, which of the following i he fiseal policy mos effective ‘in simolaing production? (A) Government pending increases (B) Government sending decreases. (©) Personal income taxes are increased, () The Federal Reserve sells bonds onthe open marke. (B) The Federal Reserve buys bonds on the ‘pen market se ‘Questions 21.22 refer tothe diagram below, which ‘epics an economy's consumption function TS 53,000 REACIRCOME 21. If the marginal propensity to consume increases, ‘he equim levels of income and consumption will change in which of the following ways? Equilibrium Level Equlibsium Level of Income, ‘of Consumption 1A) No change No change (B) No change Increase (©) Irereae No change () Trerease Increase (©) Decrease Decrease 22. If private investment of $100 is add to the economy, the equilibrium levels of income and Consumption will change in which ofthe following ways? Equilibrium Level Equilibrium Level sf Tnsome, of Consumption (A) Increase Decrease (B) Increase Increase (©) tacrease [No change (D) No change Increase () No change No change23, The real vale of the Unted Stats dollar is determined by (A) federal regulations regarding prchasing power (B) the value of the gold backing the dol (©) the goods and services it wll boy (D) the money muliple= (the marginal propensty 19 consume 24, The demand for money increases when national income increses because (A) spending on goods and services increases ) isterest rates increas (©) the budget deficit inseases (©) the money supply imereasee (© the public becomes more optimirti about the fare 25, An aggregate supply curve may be horizontal lover some range because within that range (A) a higher price level ets to higher interest ‘tes, which reduce the mooey supply and consumer spending () changes in the aggregate pice level do not indice substation (© output cannot be increased unless pices and (©) rigid prices prevent employment from fuc- ating (©) resources are underemployed and an increase “in demand willbe stifled without any pressure oa the pie level 26, I the Federal Reserve withes to use monetary policy to reinforce Congiess ical policy changes, it should (A) increase the money supply when government ‘spending is increased (B) increase the money apply when government spending is decreased (©) decrease the money supply when government spending is increased (©) increase imerest ates when goverment spending is increaed (©) decrease interest aes when government spending is decreased 21. Which ofthe following relationships is illustrated by a short-un Philips curve? (A) A decrease inthe rte of inflation is ‘sccompanied by an inerease inthe rte of economic growth () A decrease inthe rte of inflaton is ‘sccompanied by an increase inthe rate of lnemploymen (©) Am increase in the rate of infation is sccompanied by 2 decrease in the eae of conomie growth (D) An increase inthe rate of ifation is ‘ccompanied by an increas in the rate of Snemployment (B) A decrease in the rate of economic growth is sccompanied by a decease inthe rate of unemployment 28, Which ofthe following could cause simultaneous increases in inflation and unemployment? (A) A decrease in government spending (B) A decrease inthe money spy (©) A decrease inthe velocity of money (D) An increase in inflationary expectations (© An increase inthe overall evel of productivity 29, Ifthe things are held constant, an increase in United States imports will (A) tend to cause the dollar to appreciate because the world suply of dollars wil ise (@) tend to cause the dolar o appreciate because the word demand for dlls will se (©) have no effect on the exchange rate forthe dollar because exports will aso increase (D) tend to cause the dolar o depreciate because the world supply of dolls will se (©) tend 10 eause the dollar to depreciate becuse the world demand fr dllars wil rise nom30. An increas in whick of the following is most likely to cause an improvement inthe standard of lising overtime? (A) Size ofthe population (B) Size ofthe labor force (C) Number af banks (D) Level of texauon (B) Productivity of bor 31, The long-run aggregite supply cuveistikely 19 shift tothe ight when there i 4A) am increase in the cost of productive (8) an increase in productivity (©) an increase inthe federal budget deficit (D) a decrease inthe money supply (©) a dzcreate inthe labor force 32, The consumer price index measures which ofthe following? (A) The change overtime ofthe weighed prices ‘of a particular group of goods and services (8) The change overtime of the weighted wholesale price index (C) The change overtime ofthe diference between te gross domestic product deflator and the wholesale price index () tation comected for changes inthe real ‘toes domestic product (®) Intaioncomeced for changes inthe wholesale price index 33, Which ofthe following iste if he economy is producing at he fallemployment level of output? (A) The unemployment rat is zr (B) No person is receiving unemployment Compensation from the goverment (©) There is Fetionsl unemployment (D) The government's budget is balanced, (E) The balance of tae i in equilibrium, ve. Which of the following iss asi tenet of classical ezonomie analyse? (A) Saving is usualy greater than investment (B) The economy is seltcocecting to fall employment, (©) The economy may be in equiibium at less ‘than fll employment (©) Inflation is nota seri economic problem. (©) The prices of products tend tobe inflerble, ‘Which of the following will most likely result ‘rom a decrease in government spending? (A) An increase in outpt (B) An increase in the price level (©) An increase in employment (D) A decrease in aggregate supply (B) A decrease in aggregate demand Curent equilibrium ouspet equals $2,500,000, Potential ourpa equals 82,600.00, and the marginal propensity t consume equals 0.75 Under these conditions, a Keynesian economist | most likely to recommend 1A) decreasing taxes by $25,000 (B) decreasing axes by $100,000 (©) increasing government spending by $25,000 () inereasing government spending by $33,333 (E) increasing government spending by $100,000 ‘An infaionary gap could be reduced by (A) an increase in government spending () an increase in the supply of money (©) an ncrese inthe income 18k rate (D) a decrease inthe discount rate (8) a decrease inthe reserve requirement238, The eiculr flow of economic activity between ‘consumes and produces nclodes which ofthe following? I. Households buy fatr services from firms 1. Households sll factor services to fms, TUL Households bay oupus from fms. IV, Households sell pute to firms (A) Monty @) WV enly (©) Land T only (D) Hand Tt only (©) Mand V only 239, Suppose the require resewe ratio is 20 percent and a single bank with no excess reserves receives a $100 deposit fom a new customer, “The Bank now has excess eserves equsl (0 (a) 20 B) $80 (©) $100 @) $400 ® $500 «0. a un Which ofthe following is most Hkely to increase it the public decides to increase is holdings of currency? (A) The interest te (B) The price level (©) Disposable persona income () Employment (€) The reserve requirement During « mild recesion, if policymakers want to reduce unemployment by ineveasing investment, ‘which ofthe following pliies would be most appropriate? (A) Eaual increases in goverament expenditure ‘hd taxes (B) Am increase in government expenditure oaly (©) An increase in tanfer payments (D) An intent in the reserve requirement () Purchase of government securities by the Federal Reerve42, Which of the following monetary and fiscal policy combinations would most 1ikely result n'a decease in aggregate demand? acount Rute Open.Matket Operations Goverment Spending (a) Lower Buy bonds Increase (B) Lower Buy bonds Decree (©) Rese Sell bonds Increase (D) Rese Buy bonds Increase © Raise Sell bonds Decrease 43, Which ofthe following is tre of supply shocks? (A) They tend to change both tlaive prices and the general pice level inthe (B) They affect only the general price level (€) They can be anticipated and ase with appropiate fiscal policy. {(D) They canbe atiipted and offset with appropiate monetary policy (8) They make the aggregate supply curve vertical 444 Suppose chat, from 1985 ro 1986, unemployment fll from 7.2 to 7.0 percent and inflation fll from 3. to I percent. An explanation ofthese changes ‘might be thatthe (a) agaregate demand curve sifted to the left () agarepate demand curve sified tothe sight (©) agarepate supply curve sified tothe lett (D) agarepae supply curve shite to the right () Storeeun Philips curve shifted to the right som45, Ifhigher United States interest rates cause foreign demand forthe dolar inrease, which ofthe following wil occur tothe Intemational valve of the dollar and to United Stes exports? Inernational Vale ofthe Doar Exports (A) Increase Tnerease (B) Increase Decrease (© Increase No change (D) Decrease Increase (©) Decrease Decrease 46. The table below indicates the number of labor ours required in Counties X and ¥ to produce fone unit of food or one uni of clohing. Sour Food Clothing X ——20howrs 50 hours Y¥ 10 hous 20 nurs Given this information, which ofthe following (A) X has «comparative advantage in the production of both food and clothing, (B) Y has a comparative advantage inthe production ofboth fod and clothing (©) X has comparative sdvanage in food ‘production, whereas Y has a comparative vantage in clothing production, (D) Y has a comparative edvanage in food production, whereas X has comparative ‘advantage in clothing production, (©) Neither country has a comparative sdvantage inthe prodstion of either goo. 47. Which ofthe following props of people would benefit fom unanticipated inflation? 1 Savers 1. Borrowers TI, Lenders (A) Toaly (8) Tenly © Monly () I snd I only (©) Vand I only 48. An increas in the labor force participation ate wll (A) increase investment and decrease savings (B) increase savings and decrease investment (©) have no effect on unemployment (D) make it easier reduce unemployment (©) make it more difficult o reduce ‘unemployment 49, Which ofthe following isa key feature of ‘Keynesian economics? (A) The level of saving depends mostly on (B) The level of government expenditure depends ‘mostly on interest ates (©) Supply creates its own demand () Macroeconomic equilibium can occur a ess than fll employment (©) Wages are more flexible than prices. 50, If are increase in tosl spending has no effect ‘on real gross domestic product, it must be tre that (A) the price level i ising (B) the economy is experiencing high unemploy- (©) the spending mulipie is equal to 1 () the economy isin short-run equilibrium () aggregate supply has increased ‘5. According to Keynesian theory, the most impor ‘ant determinant of saving and consumption isthe (A) interest rte ®) price evel (©) level of income (D) level of employment (©) Mexibilty of wages and prices52, Under which ofthe following circumstances ‘would increasing the money supply be mest effective in increasing real gross domestic product? Business Interest Rates Employment Optimism (4) High Pall High () High Less than full High (© Low Fall High (©) Low Fal Low €) Low Less than full Low 53, Faced with lage federal budget deft, the sovernment decides to decrease expendiires and tax revenues bythe same amount. Ths action I affect ouput and interest rates in which of the following ways! Out Inert Rates| (a) Increase Increase (8) Increase Decrease (©) Nochange Decrease () Decrease Increase (E) Decrease Decree 54, If crowding ot only parialy offsets the effects ‘of tox cut, mich ofthe following changes in meres ates and gross domestic produc are ‘most likely to occu? Gross Domestic Inerest Rates _Product (A) Tncease increase (8) Increase [Remain unchanged (C) Increase Decrease (D) Remain unchanged Increase () Decrease Decrease SS. All ofthe following are components of the ‘money supply inthe United States EXCEPT. (A) paper money (8) gold bation (C) checkable deposits (D) coins (©) demand deposits mn 7 depicts an economy's aggregate regte supply curves. I aggregate ‘demand remains constant, the equlbrism pice levels in the shor un and in the long run willbe hich ofthe fllowing? Short Ren Long Run (4) 08 0A, @) 0B 0A (© 0B oc (D) 0c re © 0c oc According to both monetarists and Keynesian, ‘which of the following happens when the Federal Reserve reduces the discount ate? (A) The demand for money decease and market (B) Te demand fr mony nese and mart (©) The supply of money fcenes and market (©) The sup of mony ress and matt (Both ibe demand fot money and the apy money ene and ae et ts58. An increase in which ofthe following is most likely to increase the longrun growth ate of an ‘economy's real per capita ncome? (A) Population growin (B) The proportion of gross domestic product consumed (C) The educational atainnent ofthe population (D) The soppy of money in circulation () Personal income taxes 59, Am increase in the money supply will have the {retest effect on real gross domestic product if (A) the marginal propensity to consume is low () unemployment is very low (© investment spending i nt sensitive to ‘changes in interest rues (D) the quantity of money demanded is not very (E) the requited reterve ra i hi (0. I the Pederal Reserve underakes a poticy 0 reduce interest rates, international capital lows wil be affected in which of the folowing ways? (A) Long-run capital outflows from the United States wil decrease (B) Long-ron capital inflows tothe United Sates ‘will inrease, (© Shor-nun capital outflows from the United ‘States will decreas, (©) Shor-run capital inflows tothe United States will decrease. © Shor-run capital inflows to the United States will nt change. aneMACROECONOMICS, SECTION 1 ‘Time —$0 minutes Directions: You have fy minutes to answer al thre of he following questions. Is suggested that you take afew rminites to plan and outline each answer time onthe fi i remaining time eavally beeen the next two questions. Ia answering the questions yu should emphasize the ine of ‘easoning tha generated you results; it spot enough 1 list the results of your analysis Include diagrams, iF useful, in explaining your answers. All grams should be cletly labeled 1. Over the pas two years, the unemployment ate in County X haste fom 5 percent o 9 percent, AS he lederof| (Country X. you have been presented with two policy options to addres the unemployment problem. Policy 1: Use tariffs and quotas to restrict imports anc thus protec jobs in Country X. Policy 2: Use monetary and fiscal policies to solve the unemployment problem without resorting to trade (2) Explain two disadvanages of selecting Policy () Describe in detail one specific monetary policy action and one specific fiscal policy action you woul take to reduce unemploymen: Explain how each of these actions would sect each ofthe following inthe sho on, (@) Assregae demand (i) Outpt and he pice level (ii) Rea interest ates (© Moke interest te effets you identified in Pat) continue in the lng run, explain the impact ofthese effec ‘on esonomic growth,21. Assume that the economy isin arecesson. (a). Explain each ofthe following {i} Monetary and fiscal policies advocated by monearist 0 eliminate he recession (i) Monetary andfieal policies advocated by Keynesians 1 elimiaate the recession (©) Expltn how monearists and Keynesian differ in thee conclusions abou the effets of crowding out ssscised withthe sabization pices oatlned in Pat (a). 5: Explain how some inisidusl are helped and otbers harmed by unanticipated inflation as they patipatein each of the folowing mares (a) Credit markers () Labor markers (s)_ Product markersChapter IIT Answers to the 1995 AP Macroeconomics Examination IE SECTION I: MULTIPLE-CHOICE who stempted each question and answered it cor Tmeibcowaetecmmeenwtemnpe, (i Amamwer sheet gided with he coect choice question and th percentage of AP candidates ““Pomse* aPPeat onthe next page Section I Answer Key and Percent Answering Correctly Correct j noose >omctm mace aomoomEs sean 8 aveFree Response Question 1 (Over the pst two years, the memployment rate in Country X has sen fom 5 percent to 9 pescent. As the leader of Country X. you have Been pesented with two policy options to addres the unemployment problem Policy Policy 2: ‘Use tris od quotas o restrict imports an tus rset jbs in County X. Use moneury and fiscal policies t solve the unemployment problem without rev to wade (2) Explain wo disadvantages of selecting Policy 1 (b) Describe in detail one specie monetary policy action and one specific fiscal policy ation you ‘would ate to reduce unemployment Explain how each of these actions woul affect each of the {ollowig inthe short rn, (@ Azgrezate demand (i) Oupatand the race lve (i) Real interest aes () Ite ineres rt effects you identified in Part (6) continue i the lng un, explain the impact of these efets on economic growth ‘Question 1 Scoring Guide Basically the point distibuin is 2 points for Pat (a) 5 for Part (b); and 2 for Part(). Part (a): 2 points ‘Two disadvantages to tariffs and quotas may include: ‘© domestic prices wil se resulting in @ lower standard of ving: ‘+ trade warfetaliation resulting in increased ‘domestic prices and unemployment: «if foreign income decreases de wo lost domestic market of Country X, resulting in a decreased demand for exports of Country X, then unem- ployment in Country X will increase: + increase in unemployment in import dependent industries: ‘+ loss of economic efficiency (comparative advan- tage explanation; ‘© reduced competition in Country X implying increased market power in domestic industries; Poin | point per disadvantage and explanation, Part (b):S points Expansionary monetary and cal policies ae required, Expansionary monetary policy must include ne ofthe following: OMO purchases, reduction in reserve requirement, oF reduction in discount rate. Monetary policy leads 1 an increase in the money supply decrease in real interest rte: an increase in invest ‘ment which isa component of Aggregate Demand; AD Increases, resulting in incresed output and prices, Fiscal policies are increasing government spending or decreasing taxes (corporate or personal income). An increase in G will directly increase AD resulting in an increase in output and prices. A decreas in axes will increase C (or 1 if corporate taxes discussed) and direcly increase AD. Output, employment and prices will ise Real interest ates wil ise because the increase in government spending inteassthe demand for funds in the bond market (or loanable funds market). An alternative explanation is that nominal iaterest rates will rise because the expansionary fiscal policy {increases income whic, in tm, increases the demand or money. The effect on real intrest ates ambi fous because the magnitude of the price increase rela- tive othe nominal interest rates" increase is unknown, Points 1 — Correct suabilizaton policies (as point for each policy) 2 — Monetary policy explanation of linkages of eal interest rate-investment-AD, output end price. 1 { TM bi tion 1 { TsTAD TAD +79. 1P 1 — Fiscal policy linkages of G/TX resulting in AD, ‘output and price explanation 1 — An explanation ofthe scl policy effet on ealPart ):2 points ‘There are contadicory effects of interest rates a8 a result ofthe two stabilization policies — this should bbe noted by the student; however, consistency with answer to Part (b) is paramount, Decreasing interest, ‘ates will encourage investment which will stimulate capital stock growth or economic growth which in tm will shit the Tong-ron aggregate supply curve or the prodvction possibilities curveffrontier. [Positive net Investment increases 0° investment in excess of replacement investment increases | Inreasing interest rates ill have just the reverse effect — including a leftward shiftn the long an aggregate supply curve or roduetion possibiies eve. Points: 1 — For the linkage of interest => investment economic growih,Iterest rate direction must be consistent with answer in Part (b). 1 — Shift in tong run aggregate supply curve or the production possibiliies curve. Alternative Acceptable Answers: ‘+ The monetarsts wouldsay that fiscal policy would ‘not be as effective as Keynesians would and tha it was probably fiscal pelicy which got us into the ‘current situation. The monetarists would use the ‘monetary policy tools mainainaconstant money ‘supply growth to ensue a stable financial environ- ‘ment t0 permit the economy to sel-adjst toward {all employment GDP. ‘Suppl-siders would suggestthat a decreas in taxes ‘would provide incentives fr increasing prodtiv- ity and thus the AS curse would shift rightward, An accompanying AD shit is require for fll ered ‘To receive credit for an alternative answer, the sto: ent had to specify that he answer was using a par ‘cular theory Ober econonie schools of thought Were accepted and evaluated; however, no other school of ‘thought generated a sufiient umber of answers to provide a rubric. These answers were evaluated bythe table leader ‘Besides counting points the answer may be looked at as a whole and ulimatly judged by its overall (quality. This is particularly ue ithe total point count includes a half, The final total should mean something in terms ofthe overall quality of the answer: 8 or 9 should reflect an excellent answer (29 is not necessat- ily a perfect answer); 6and 7, good answer, 4 and 5, fan adequate answer, 3, a seriously deficient answer, but sill an answer; 2, answers that ae lots of words signifying nothing except one sustained argument 1, 8 correct, relevantto-the-question statement; 0, no rel- evant economic answer to the question. Using the holistic approach, te 1 or 2isa“"botom up" approach, Overall Comment on ‘Student Responses to Question 1 ‘Students continued to experience ditficulty in adress- ing the impact of fiscal policy on interest rates and cevonomic growth questions. ‘The primary mechanism by which fiscal policy fects interest rates is through the losnable funds ‘market. I the goverment desires to inerease govern- ‘ment spending or decrease tates, the resulting budget ‘deficit must be funded through the sale of government securities. When the Treasury enters the loanable funds marke, the demand for losnabe funds increases and the interest rate rises, The reverse occurs with contractionary fiscal policy. Many students address the interest rate effect of fiseal policy through the ‘money demand function. The standard ine of reason ing is that increases in goverment spending increase aggregate demand which in turn increase equilibeium income. The increase in income will increase the demand for money thereby increasing interest rates. ‘The above reasoning is corect; however, itis asec: ‘ondary effect, which applies to expansionary mon- tary poliy aswell as to expansionary fiscal policy ‘On the issue of economie growth, students confuse increases in GDP brought about by increases in aggre= gate demand with economic growth. Economic growth involves the change in productive capacity. We can represent economic growth by a change in potential GDP, changes inthe long-run ageregate supply curve, ‘or shifts inthe production possiblities curve. Merely sting that an increase in investment leads to eco- nomic growth is not sufficient, The increase in invest- ‘ment must be beyond replacement investment ler ‘atively tbe student could state the efect ak an increase in et investment aoe‘Sample Student Responses Student Response 1 (Seore@f 9)Comment: The essay rectives fll eed in Par (a) with the arguments of a decreased standard of living and the effects of retaliatory tars and quotas. The discussion of fiscal policy meets and exceeds the standards by Supplying the informatio concerning the government spending mulpiet The interest ae effect of fiscal policy is via the money demand function, which in reality is a secondary effec, which also exists in expansionary ‘monetary policy, The prefered interes rat effects thao increased demand for loanable Funds which occurs with the government Financing the increased expenditures through the sale of Treasury securities, The expansionary monetary policy discussion is complete, although the student mistakenly refers to increases inthe money supply ‘ia open market operations as Fiscal policy. In Prt), the student relates the low interest rates to stimulating investment which increas technology to shift the production possibilies curve outward, thus demonstrating an “understanding of economic growth. This answer has two characteristics which ae important to underscore: firs the student uses graphical analysis to enhance the answers and to ensure thatthe reader understands the verbal presentation; second, while the stedent did missate fiscal policy instead of monetary policy, the student stil received full credit. (A 9's not necessarily a perfect answer}Free-Response Question 2 Assume thatthe economy iin recession, (@) Explain each of the a ing. (@) Monetary an fel polices advocated by monetarss to eliminate the recession ai “Monetary and fica policies advocated by Keynesian eliminate the recession (©) Explain how monet and Keynesians dite in thee conclusions about the effects of crowding out associated ‘withthe stabilization polices outlined i Pa (a). ‘Question 2 Scoring Guide ‘Bascalythe point distribution is 3 points for Part (a); 2 for Par). Part (a): 3 points Monetariss would advocae « money rule with no Aisretionary monetary oF fiscal policy. They believe that fiscal policy is neural due to crowding out. The ‘monetary rule is growth ofthe money supply atthe growth rate of real GDP, at 3-55 a year or at an nounced constant rate, Keynesianselieve that anexpansionary fiscal policy shouldbe used to eliminate secession, Keynesian in ‘general, thnk that monetar policy is “unteliable” or less effective than fiscal polices. Low interest rates will not necessarily induce increased busines invest ment o consumer spending. Points: 1 Student demonstrates an understanding of the ‘monetary rule. Student must do more than tte thatthe monearstshave a monetary rule, but ‘doesnot have to explain it in det Sh Monetarss believe fiscal policy is ineffective 1 — Keynesians advocate an expansionary fiscal policy to eliminate aecession, 'k— Fiscal policy is more effective than monetary policy, or monetary policy is ineffective, of monetary policy is complementary 10 fiscal policy Part (b):2 points Monetaits belive tat thee is complete crowding ‘ut, thus making fiscal poli ineflecive, Keynesians believe that there is litle o 39 crowding out. Crowd- ing out oceurs when the goerament borows money toincrease government spending and ths ces the amount of loanable funds avalale othe private sector, Alteratvely, the govement enters the loanable funds market and is willing to pay whatever interest rate is necessary teal fort” the fund quired. The Increase in interest rates reduces investment in the private sector, ‘Some students may discuss the differences between Keynesians and monetariss in terms of the interest sensitivity ofinvestment — this is acceptable if correct. Points 1 — Statement that monetarits believe that dere is crowding out and Keynesians believe there is Title oo crowding out | — Explanation of why monetarss and Keynesians take these positions. This explanation needs to demonstrate an understanding of crowding out ‘Besides counting points, the answer may be looked at as 4 whole and ultimately judged by its overall quality. This is particularly te if the total sore Includes a half point. The final total should mean something in terms of the overall quality ofthe answer, 5 should reflect an excellent answer but not necessar- ily perfect, 4, an excellent answer with & flaw: 3. ‘ood answer, 2, an adequate answer, I, a seriously efcient answer, but sll an answer 0, al els, Overall Comment on ‘Student Responses to Question 2 ‘The first short answer question asked the student to focus on the difference between the monetrist and ‘Keynesian policy prescriptions for an economy in a ‘recession. This question emphasized the need for know ing two important schools of economic thought and, in panicular, the stabilization policies advocated by the Afferent schools of thought. Many students responded by providing discussion of expansionary stabilization polices, completely ignoring the viewpoints of Keynes and the monetarits. There was also evidence that students are unabe to explain the crowding-out effect, although they may know the monetaris and Keynesian views of exowding out acm‘Sample Student Responses ‘Student Response I (Score of ) San in anne RPP 1 pact — Pie? de_achs, Sear, LéL os Lal! eel. bor Kiypariane, 20 ectease tn or etting sag ot ull tnctlese. in: Capucmes lwmendt Citttcl ie leneet rates somFree-Response Question 3 Explain how some individuals are helped and others harmed by unanticipated inflation a the patcpate in each of the following markets. (2) Crit markers (©) Labor markets (6) Product markess ‘Question 3 Scoring Guide ‘Basically the pont distritution ie 2 points for Pat (a, 2 for Prt (b), and 1 for Par (). Part points total ‘With unanticipated inflation, borrowers are helped in that they repay in dollars which have less purchasing power than the dollars they borrowed, Likewise credi- fors are hurt because they receive payment in dollars which have les purchastg power. The student must assert whois helped and who is hurt, Points: 1 —For assertion 1 —Forexplanation, Part (b):2 points total Employers benefit if output prices rise faster than labor costs. The unanticipated inflation hurts employ- ees if their real wages have decreased. (Possible to receive a point) Points: 1 —Employer's impact with explanation 1 Employee's impact with explanation. ‘Sample Student Responses Student Response I (Score of S) Part (€):1 point total If producers can ris prices faster than cost, they are helped. If producers have long-term contacts on prices, then they are hurt because costs could rise faster than prices. Consumers are hurt because real income is falling. '— Conect argument with explanation, Besides counting points, the answer may be looked at as a whole and ultimately judged by ite overall ‘quality. This is paicularly tre ifthe ttl point count includes a half point. The final total should mean something in terms ofthe overall quality of the answer. 5 should reflect an excellent answer bit not necessar lly perfec; 4, an excellent answer witha flaw; 3,8 ood answer, 2, an adequate answer; I, a seriously deficient answer, but stil an answer, 0 al ese (Overall Comment on ‘Student Responses to Question 3 ‘The second short question onthe AP Macroeconomics Exam focused onthe effects of unanticipated inflation ‘on credit labor, and product markets. The students did ‘not appeartoknow who the players were in each ofthe ‘markets, and the language of “markets” appeared to confuse the students, The students did seem to have a firm understanding of the impact of unanticipated inflaton on the credit marke. smComment: This isan excellent essay writen without using economic jargon. The student cover the eed and labor markets very well. The stdent cars the point fr Part (cforconluding that consumers (buyers) ar hut becatne their el income is falling. The second statement in Prt) i not relevant to the question but no points we ‘educted. Only one cont anument is required fr Par ()- Not: this answer indicates that «5s ot» perfect