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MACROECONOMICS. 2010 FRQ. Norman. 2010 FRQ. 1. Assume that the U.S. economy is currently in long-run equilibrium. (a) Draw a correctly labeled graph of aggregate demand and aggregate supply and show each of the following. ( i ) The long-run aggregate supply curve

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MACROECONOMICS

2010 FRQ

Norman


2010 FRQ

1. Assume that the U.S. economy is currently in long-run equilibrium.

(a) Draw a correctly labeled graph of aggregate demand and aggregate supply and

show each of the following.

(i) The long-run aggregate supply curve

(ii) The current equilibrium output & price levels, labeled as YE and PLE, respectively.

SRAS

LRAS

AD1

PL2

E2

PLE

E1

AD2

YE

YI

Real GDP

(b) Assume that the government increases spending on national defense without

raising taxes.

(i) On your graph in part (a), show how the government action affects AD.

(ii) How will this government action affect the unemployment rate in the short run?

Explain.

Answer: 1. (b) (i) As can be seen on the graph, the increase in G would increase

AD to AD2, increasing PL and Y.

1. (b) (II) The increase in AD to AD2 would decrease unemployment in

the short run, as the increase in AD would lead to an increase in output & profits,

resulting in more workers being hired and therefore the decrease in unemployment.


2010 FRQ

1. (c) Assume that the economy adjusts to a new long-run equilibrium after the

increase in government spending.

(i) How will the short-run aggregate supply curve in the new long-run equilibrium

compare with that in the initial long-run equilibrium in part (a) ? Explain.

(ii) On your graph in part (a), label the new long-run equilibrium price level as PL2.

LRAS

SRAS2

SRAS1

PL2

E2

PLE

E1

AD

YE

YI

Real GDP

Answer: 1. (c) (i) The increase in AD will result in more inflation and workers

demanding higher wages. This increase in resource cost at contract time in

the long run would move the SRAS to the left.

(c) (ii) PL2, as shown on the above graph, is a higher PL than PLE.


1. (d) In order to finance the increase in government spending on national defense from

part (b), the government borrows funds from the public. Using a correctly labeled

graph of the loanable funds market, show the effect of the government’s borrowing

on the real interest rate.

(e) Given the change in the real interest rate in part (d), what is the impact on each of

the following?

(i) Investment

(ii) Economic growth rate. Explain.

Mankiw users: Increasing government borrowing reduces the supply of private loanable funds. Interest Rates would also go up, and investment would decrease.

D2

LFM

D1

S

r2

E2

2010 FRQ

Real Interest Rate, (%)

r1

E1

F1

F2

Quantity of Loanable Funds

  • Answer to 1. (d) As can be shown in the graph, the government borrowing would

  • increase demand for money in the LFM and push the RIR up.

  • (e) (i) The higher RIR will result in less investment in tools and machinery.

  • (e) (ii) The decrease in tools and machinery will decrease overall productivity

  • and economic growth [capital stock].


2. A drop in credit card fees causes people to use credit cards more

often for transactions and demand less money.

(a) Using a correctly labeled graph of the money market, show how the nominal

interest rate will be affected.

(b) Given the interest rate change in part (a), what will happen to bond prices in the

short run?

2010 FRQ

Answer to 2. (a) The decrease in Dt for money

would decrease the Dm curve resulting in a

lower NIR and RIR.

2. (b) Bond prices are inverse to the interest

rate so bond prices would increase

Dm1

MS

n1

Answer to 2. (c) The lower IR will increase

AD due to more investment and interest

sensitive consumption [the lower IR would

also depreciate the dollar and increase Xn].

All 3 cause an increase in AD & PL in the SR.

2. (d) Selling bonds would be the OMO as

it would increase NIR and decrease AD & PL.

Nominal Interest Rate

n2

Dm2

Money Market

(c) Given the interest rate change in part (a), what will happen to the price level in the

short run? Explain.

(d) Identify an open-market operation the Fed could use to keep the nominal interest

rate constant at the level that existed before the drop in credit card fees. Explain.


3. A United States firm sells $10 million worth of goods to a firm in Argentina,

where the currency is the peso.

(a) How will the transaction above affect Argentina’s aggregate demand?

Explain.

(b) Assume that the United States current account balance with Argentina is

initially zero. How will the transaction above affect the United States current

account balance? Explain.

2010 FRQ

Answer to 3. (a) The selling of $10 M of U.S. goods to Argentina would

decrease Argentina’s net exports which would decrease their AD.

AD = C+I+G+X-M, when M gets larger, GDP gets smaller.

3. (b) The $10 million increase in net exports would cause a flow of $10

million worth of pesos into the U.S. [recorded as a +$10 million]

and would cause a current account balance of ZERO to become a

+$10 million surplus account balance.


2010 FRQ a firm in Argentina,

S2$

S1$

D1$

Answer to 3. (c) (i): If the U.S.

decrease financial investment in Argentina, the U.S. would decrease their supply of dollars to Argentina, resulting in a decrease in demand for the peso.

(c) (ii) As shown on the graph, the dollar would appreciate.

Price

P looking for $’s

$’s looking for P

E2

P100

D

Peso

depreciates

P50

Peso Price ofDollar

E1

(d) The cheaper prices in the U.S. will result in more demand for U.S. goods and therefore the dollar, appreciating the dollar and depreciating the peso.

Quantity of Dollars

A

3. (c) Using a correctly labeled graph of the foreign exchange market for the U.S. dollar,

show how a decrease in the U.S. financial investment in Argentina affects each.

(i) The supply of United States dollars

(ii) The value of the United States dollar relative to the peso

(d) Suppose that the inflation rate is 3% in the U.S. and 5% in Argentina. What will

happen to the value of the peso relative to the United States dollar as a result of

the difference in inflation rates?

Explain.


Econ FRQs a firm in Argentina,

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2010 FRQ

The End