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AP Economics:
International Review FRQs
May 2016
International FRQs
1. Assume that an increase in government spending increases the budget deficit in
Country A.
a) Using a correctly labeled graph of the loanable funds market, show the effect
of the increase in Country A’s budget deficit on the real interest rate.
Correct labels; downward sloping Demand for Loanable Funds curve;
upward sloping Supply for Loanable Funds curve; D shifts to right;
increasing quantity and real interest rates.
b) Given your answer in a), what is the effect on business investment in
Country A? Increase in real interest rates causes decrease in Investment
c) The exchange rate between Country A’s dollar and Country B’s peso is
determined in a flexible exchange market. Using a correctly labeled
graph of the foreign exchange market for Country A’s dollar, show how
the interest rate change you identified in a) affects the international
value of Country A’s dollar.
Correct labels; increase in real interest rates increases demand for
Country A’s dollar, exchange rate increases
d) Given your answer to c), explain how the competitiveness of Country A’s
goods changes relative to Country B’s goods. The appreciation in the
Dollar makes exports more expensive to consumers in other nations,
hurting their competitiveness.
2. Due to an internal financial crisis, Canada experiences a significant outflow of funds to
other countries. Explain the effect that this outflow of funds will have on the following:
a) the international value of the Canadian dollar Outflow of funds increases
demand for other currencies and increases the supply of the Canadian
dollar (CAD), causing value of CAD to depreciate
b) Canadian net exports Depreciation of CAD causes Canadian products to
look less expensive to consumers in other nations, causing increase in
exports (this is why many nations attempt to depreciate their own
currency, to increase XN and thus AD…Japan is notorious for this …)
c) the real interest rate in Canada Outflow of funds causes decrease in
supply of funds, causing real interest rates to increase
d) the level of investment in Canada Increase in real interest rates causes
decrease in investment
3. Assume an economy is in recession.
a) Identify one monetary policy action and one fiscal policy action that could
be used to help the economy out of the recession. Explain the effect of
each policy on the price level and the equilibrium level of output.
Expansionary monetary policies: 1) Buying securities increases MS,
causing decrease in interest rates, causing increase in Investment,
causing increase in AD, causing increase in both price level and output.
2) Reduce discount rate, causing decrease in interest rates, followed by
same cause and effect as in (1). 3) Reduce reserve requirement,
causing increase in MS, followed by same cause and effect as in (1).
Expansionary fiscal policies: 1) Increase spending, increases AD,
causing increase in price level and output. 2) Decrease taxes, increases
disposable income, causing increase in C, causing increase in AD,
causing increase in price level and output.
b) Given your answer in part a) on the price level effect, explain the effect
the policy actions you identified in part a) would have on the economy’s
imports and its exports. The increase in price level makes products
more expensive to consumers in other nations, decreasing exports.
Imports will increase as products in other nations are relatively
cheaper.
c) Given your answer in part a) on the output effect, explain the effect the
policy actions you identified in part a) would have on the economy’s
imports and exports. Imports will increase as the increased AD will
increase demand for imports as well as domestic goods.
d) Given your answers above, explain what effect the policy actions would
have on the international value of the dollar. The decrease in exports will
decrease the demand for the dollar and the increase in imports will
increase the supply of the dollar. Both cause depreciation of the dollar.
4.
Year
1
2
Dollar
1
1
Exchange Rates
Yen
350
350
Franc
4.0
5.8
Mark
1.8
2.3
a) Given the change of the value of the dollar between Year 1 and Year 2, as
indicated in the table above, describe the effects this will have on United
States tourism overseas. The appreciation of the dollar will increase US
tourism to France and Germany
b) Using an aggregate demand – aggregate supply graph, show and explain
the impact of the change in the value of the dollar on the price and
output levels in the United States.
Correct labels; downward sloping AD curve; upward sloping SRAS curve;
increase in value of dollar causes decrease in net exports, causing AD to
shift to the left, decreasing both price level and output
(more on next page)
c) Explain what impact the change in the value of the dollar will have on the
United States balance of trade. Moves toward deficit. Appreciation of
dollar will cause exports to become relatively more expensive to
consumers in other nations, and for imports to become relatively
cheaper for US consumers, so balance of trade declines.