Common Errors on the 2006 AP Economics Exam

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Common Errors on the 2006 AP Economics Exam. Arthur Raymond Muhlenberg College Chief Reader, Economics. Common Errors on the 2006 Exam Micro 1, Part (c).

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Common Errors on the2006 AP Economics Exam

Arthur Raymond

Muhlenberg College

Common Errors on the 2006 ExamMicro 1, Part (c)
• Assume the price is set at P2. Assuming the existence of an opportunity cost, indicate whether the museum’s accounting profits would be positive, negative, or zero. Explain why.
• For the graph provided, P2 produces zero economic profits. Because economic profits equal accounting profits minus the opportunity costs of the owners’ resources, the accounting profits must be positive.
• Common Error: Unfamiliarity with the difference between accounting profits and economic profits. A common wrong answer was that accounting profits are zero.
Common Errors on the 2006 ExamMicro, Part 2 (c)
• If the price the firm receives for its product is \$20, indicate the firm’s profit-maximizing quantity of output and explain how you determined your answer.

The first two rows above the above table were provided on the exam and

it was stated that the firm is perfectly competitive. To maximize profits,

firms should produce if MR>MC, until MR=MC, but never produce a unit

for which MR<MC. P=MR is \$20 and the MC is calculated in the second table.

Thus the first four units should be produced.

Common Error: Most students got Q=4, but the reason offered was

because MR is closest to MC at Q=4. That is NOT the reason.

Common Errors on the 2006 ExamMicro, Part 2 (e)
• (e) Assume this firm operates in a constant cost industry and has reached long-run equilibrium. If the government imposes a per-unit tax of \$2, indicate what will happen to the firm’s profit-maximizing output in the long run.
• The simplest answer is that because MC and ATC both increase by \$2, the price must also increase by \$2 in the long run because profits are always zero in the long run. With MC and P both increasing by \$2, the equilibrium level of output will not change.
• Common Error: The assumption that only MC (and ATC) increases, so the equilibrium level of output falls.
Common Errors on the 2006 ExamMicro, Part 3 (c)
• Assume the conversion of open-space land and farmland imposes costs on the general population, which can no longer enjoy the scenic vistas.
• (ii) Explain whether the private market quantity of land converted into residential development is socially optimal.
• The private market quantity occurs where MB=MC. Because MSC>MC, MSC>MB, which is not socially optimal.
• Common Error: Confusion about MSC, MC, and MB at the private market quantity and at the socially optimal quantity.
Common Errors on the 2006 ExamMacro 1, Part (c)
• (c) Given your answer in part (b), explain what will happen to unemployment in the United States in the short run.
• In part (b), the level of production fell, so in the AD/AS model, employment falls in the short run leading to an increase in unemployment
• Common Error: Inability to link increasing unemployment with falling output.
Common Errors on the 2006 ExamMacro 1, Part (d)
• (d) Assume the United States trades with Japan. Draw a correctly labeled graph of the foreign exchange market for the United States dollar. Based on your indicated change in real output in part (b), show and explain how the supply of the United States dollar will be affected in the foreign exchange market.
• The properly labeled graph should contain yen per dollar on the vertical axis, the quantity of \$ on the horizontal axis with the demand and supply curves properly labeled. The effect of reduced output in part (b) means less income in the US, so imports will fall, leading to a reduced supply of dollars on the foreign exchange market.

Common Errors: Mislabeled graph, inability to link reduced

output with reduced imports and supply of dollars.

Common Errors on the 2006 ExamMacro 2, Part (a)
• a) Using a correctly labeled graph of the money market, show how an increase in the income level will affect the nominal interest rate in the short run.
• The correctly labeled graph will have the interest rate on the vertical axis, the quantity of money on the horizontal axis, with the supply and demand schedules properly labeled. An increase in income will increase the demand for money for transactions purposes, shifting Md to the right and increasing the nominal interest rate.
Common Errors on the 2006 ExamMacro 2, Part (a)-Continued
• Common Errors: Mislabeled Graph, shift of Ms to right.
Common Errors on the 2006 ExamMacro 2, Part (b)
• b) Using a correctly labeled graph of the loanable funds market, show how a decision by households to increase saving for retirement will affect the real market interest rate in the short run.
• An increase in savings will increase the supply of loanable funds, which will lower the real interest rate.

Common Errors: General unfamiliarity with the loanable funds framework.

Many used the money supply and money demand framework.

Common Errors on the 2006 ExamMacro 2, Part (c)
• (c) Suppose that the nominal interest rate has been 6 percent with no expected inflation. If inflation is now expected to be 2 percent, determine each of the following.

(i) The new nominal interest rate.

(ii) The new real interest rate.

• With an increase in expected inflation of 2 percent, the nominal interest rate will increase by 2 percent to 8%. The new real interest rate will be 6%, the same as before the change in expected inflation.
• Common Errors: General unfamiliarity with the effect of expected inflation on nominal and real interest rates.
Common Errors on the 2006 ExamMacro 3, Part (c)
• Macro 3
• (c) Assume the government reduces the level of unemployment compensation.

(i) Explain how this affects the natural rate of unemployment.

(ii) Using a correctly labeled graph, show how this affects the long-run Phillips Curve.

• The correctly labeled graph has inflation on the vertical axis, unemployment on the horizontal, and a vertical long-run Phillips Curve. A reduction in unemployment compensation reduces the benefit of unemployment, leading more active job searches and a reduction in the natural rate of unemployment and so a shift to the left of the long-run Phillips Curve.
Common Errors on the 2006 ExamMacro 3, Part (c) - Cont’d

Common Error: Use of a downward sloping Phillips curve.