MACROECONOMICS FRQ

1
MACROECONOMICS FRQ
2008
Question 1 11 pts 22322
Question 2 6 pts 222
Question 3 6 pts 1221
2
FRQ 2008
Question 1 11 pts 22322

• Assume the U.S. economy is operating at
  full-employment output and the government has
  a balanced budget. A drop in consumer
  confidence reduces consumption spending, causing
  the economy to enter into a recession.
• (a) Using a correctly labeled graph of the
  short-run Phillips curve, show the effect
• of the decrease in consumption spending.
  Label the initial position A and the
• new position B.
• (b) What is the impact of the recession on the
  federal budget? Explain.

SRPC
2 pts 1 pt for correctly labeled SRPC graph.
1 pt for initial new pt on SRPC
graph.
Inflation
A
4
B
2
A. W. Phillips 1914-1975
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Unemployment
5
Answer to 1. (b) The decrease in
consumption would result in a decrease in AD and
a decrease in GDP. This would result in an
increase in unemployment and an increase in
transfer payments. Due to the job losses,
there would be a decrease in tax revenues,
resulting in an increase in government red ink
for the federal budget. So a federal budget
deficit would increase or a federal budget
surplus would decrease.
2 pts - 1 pt for budget deficit and 1 pt for
explanation.
3
FRQ 2008
(c) Assume current real GDP falls short of
full-employment output by 500 billion
and the MPC is 0.8. (i) Calculate the
minimum increase in government spending that
could bring about full employment.
Answer to 1. (c) (i) The expenditure
multiplier ME would be 5 1/.2 ME of 5.
Because current output falls short by 500
billion, it would take a minimum increase in
government spending of 100 billion to get
to full employment. 5 X 100 500
(ii) Assume that instead of
increasing government spending, the government
decides to reduce personal income taxes.
Will the reduction in personal income
taxes required to achieve full employment
be larger than or smaller than the
government spending change you calculated in
part (c) (i)? Explain why.
Answer to 1. (c) (ii) Because the
tax multiplier MT is smaller, or MPC/MPS
.8/.2 4, it will take a larger tax cut
then the increase in government spending.
Because current output is 500 bil. short
of FE Y, and the MT is 4, it would take a tax cut
of 125 billion. 4 X 125 500
3 pts 1 pt 100 1 pt larger
Tax reduction 1 pt smaller MT or
not all increased Y spent.
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(d) Using a correctly labeled graph of the
loanable funds market, show the impact of
the increased government spending on the real
interest rate in the economy.
Answer to 1. (d) As can be seen
on the LF graph, the RIR would increase as the
government has to borrow more than
previously, increasing demand in the LFM, which
pushes up the RIR.
D2
S
D1
2 pts 1 pt correctly labeled LFM graph
1 pt rightward shift of D curve
or leftward supply shift.
Borrowers
Lenders
(e) How will the real interest rate change in
part (d) affect the growth rate of the U.S.
economy? Explain.
rir8
Real Interest Rate, (percent)
E2
Answer to 1. (e) The increase in RIR will
decrease real Ig, decreasing capital stock.
This will decrease AD and decrease GDP or
growth rate in the U.S. economy.
rir6
E1
2 pts 1 pt growth rate falls 1 pt
Ig decreases, slowing capital formation.
2.1 Tril. after 100 B increase
2 T
2 T
T
G
F1
F2
Quantity of Loanable Funds
Balanced Budget GT2 Tr.
5
FRQ 2008
Question 2 6 pts 222

• 2. Balance of payments accounts record all of a
  countrys international transactions during a
  year.
• Two major subaccounts in the balance of payments
  accounts are the current account and the
• capital account.
• In which of these subaccounts will each of the
  following transactions be recorded?
• (i) A United States resident buys chocolate
  from Belgium.

Answer to 2. (a) (i) Chocolate from Belgium
would go in the current account as it includes
the import of goods.
1 pt current account
(ii) A United States manufacturer buys
computer equipment from Japan.
Answer to 2. (a) (ii) Computer equipment by
a U.S. manufacturer would also be classified as
an import so it would also go on the current
account.
1 pt current account
(b) How would an increase in the real income in
the United States affect the United States
current account balance? Explain.
Answer to 2. (b) An increase in real income
would make U.S. citizens richer. We would buy
more imports, decreasing net exports, and
increasing the deficit on the current account.
2 pts - 1 pt imports increase or Xn decrease.
1 pt current account balance
decreases or current account balance goes into
deficit.
6
FRQ 2008
D1
S1
Price
R looking for s
s looking for R
R100
S2
R50
Rupee Price of Dollar
E1
Rupee appreciates
A
R25
E2
Quantity of Dollars
D
(c) Using a correctly labeled graph of the
foreign exchange market for the U.S. dollar, show
how an increase in U.S. firms direct investment
in India will affect the value of the U.S. dollar
relative to the Indian currency (the rupee).
Answer to 2. (c) The increase in investment
in India will increase demand for the rupee
appreciate that currency. This would result
in an increase in supply of the U.S. dollar for
more rupees, depreciating the dollar.
2 pts - 1 pt correctly labeled foreign
exchange graph for the dollar. 1 pt
rightward shift in supply and depreciation of the
dollar.
7
FRQ 2008
Question 3 6 pts 1221

• 3. The PPCs for Artland Rayland are shown.
  Using equal
• amounts of resources, Artland can produce 600
  hats or 300
• bicycles, Rayland can produce1,200 hats or 300
  bicycles.
• Calculate the opportunity cost of a bicycle in
  Artland.
• (b) If the two countries specialize and trade,
  which country
• will import bicycles? Explain.
• (c) If the terms of trade are 5 hats for 1
  bicycle, would trade
• be advantageous for each of the following?
• (i) Artland
• (ii) Rayland

Answer to 3. (a) The Domestic Comparative
(opportunity cost) of a bicycle in Artland
is 2 units of hats. 1 bicycle 2 hats or
600/3002
1 pt for 1 B 2 H
DCC Rayland DCC Artland 1 B 4 H
1 B 2 H ¼ B 1 H ½ B 1 H
Terms of Trade 1 B 3 H
1/3 B 1 H
Answer to 3. (b) Rayland will import
bicycles. Domestically, they have to give up 4
hats to get a bicycle but with trade they have to
give up only 3 hats.
2 pts for Rayland will import bicycles
1 pt for Yes, 5 H is better than 2 H
Answer to 3. (c) (i) Yes, 5 hats is better than
2 hats they are getting domestically.
Answer to 3. (c) (ii) No, Rayland is going to
export hats so opportunity cost is ¼ bicycle. So
1/5 of a bicycle would not benefit them.
1 pt for No
Answer to 3. (d) 300 bicycles would become 900
and 600 hats would become 1,800, so the DCC
would still be 1 bicycle 2 hats, same as
before. Rayland still has a C.A. in hats.
1 pt for No change, so Rayland still has a
comparative advantage in hats
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Finished
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