UNIT 4 Macroeconomics SAMPLE QUESTIONS Key

1 advanced placement Economics Teacher Resource Manual National Council on economic Education,New York, to SAMPLE Long Free-Response the economy is experiencing rising unemployment,slowing increases in real GDP andmodest Federal Reserve decides to follow an expansionary policy.(A)Describe what this policy might Federal Reserve could be buying bonds on theopen market,reducing the discount rate or reducing the reserve oftheseactions is designed to stimulate an economy that is showing signs ofentering a recession.(B)Ifthe policy is effective,explain the short-run effect it would have on each ofthe following:(i)Interest rates(ii)Private investment(iii)GDP(iv)EmploymentThese actions would(i)reduce interest money is available for loans,and the price ofthis money wouldfall.(ii)With lower interest rates,investment and some consumption would increase.(iii)With an increase in investment and consumption,aggregate demand will increase andGDP will increase.

2 (iv)As a result ofthe increase in aggregate demand and in GDP,employment will alsoincrease to produce the larger FREE-RESPONSESAMPLEQUESTIONSA nswerKey UNIT580 advanced placement Economics Teacher Resource Manual National Council on economic Education,New York, FREE-RESPONSESAMPLEQUESTIONSA nswerKey Federal Reserve Board ofGovernors determines that it is currently appropriate to follow acontractionary policy.(A)Use a correctly labeled aggregate demand and aggregate supply graph to illustrate the situa-tion that would make this policy must be properly labeled,showing outputon the horizontal axis,price level on the vertical,an upward-sloping SRAS and some indica-tion intersection ofSRAS and AD is beyond full employment or LRAS,illus-trating an inflationary economy.(B)Would the monetary policy be to increase or decrease the money supply? policywould be to reduce the money reducing the money supply,interest rates would riseand investment spending and other interest rate sensitive components ofaggregate demandwould decrease,reducing the upward pressure on from the Monetarist view,thereduction in the money supply itselfwould reduce the price level (the SRAS being vertical,reduction in AD lowers price level).

3 PRICE LEVELREAL GDPLRASSRASADA dvanced placement Economics Teacher Resource Manual National Council on economic Education,New York, (C)Describe the policy the Federal Reserve is likely to take,and explain how its action achieves thegoal offollowing a contractionary how the policy would affect each ofthefollowing:(i)Interest rates(ii)Investment(iii)Output(iv)Price level(v)EmploymentThe Federal Reserve would most likely sell bonds on the open market,taking money directlyand immediately out actions the Federal Reserve could take are increasingthe discount rate or raising the reserve requirement.(i)Any ofthese actions will cause interest rates to rise because the supply ofmoney isdecreasing.(ii)As interest rates rise,investment looks less profitable and thus declines.(iii)A decrease in investment leads to a decrease in economy is on the upward-sloping portion ofSRAS,output will decrease with the leftward shift ofAD.

4 (iv)The goal ofthe policy is to lower the price the upward-sloping SRAS,the pricelevel will fall with less spending.(v)Ifon the upward-sloping SRAS,employment will decline with the decline in FREE-RESPONSESAMPLEQUESTIONSA nswerKey UNIT582 advanced placement Economics Teacher Resource Manual National Council on economic Education,New York, FREE-RESPONSESAMPLEQUESTIONSA nswerKey the economy is at E in the graph below and the Federal Reserve decides to implementexpansionary monetary policy to reduce the unemployment rate.(A)Explain the short-run effect ofthe expansionary policy on each ofthe following:(i)Nominal interest rates(ii)Real interest rates(iii)Output(iv)Price level(v)EmploymentThe aggregate demand curve will shift to the AD1in the interestrates and real interest rates will decrease in the short decrease in interest rates willlead to an increase in investment,which in turn increases aggregate ,the pricelevel and employment will all increase.

5 (B)Explain the long-run effect ofthe expansionary policy on each ofthe following:(i)Output(ii)Price(iii)Employm ent(iv)Nominal interest rates(v)Real interest ratesIn the long run,in response to the higher price level,workers will demand higher higher nominal wages will increase the cost ofproduction at every level ofoutput,thus shifting the short-run aggregate supply curve to the left shown in the graph above asSRAS1 .The higher costs ofproduction resulting in higher prices will reduce the outputdemanded and,hence,reduce the level time,based on the Fisher Effect,the nominal interest rate will increase and equal the real rate ofinterest plus the inflation real interest rate will initially decrease and then return to its long-run equilibrium LEVELREAL GDPLRASSRASADEAD1 SRAS1