Download Common Error - Frost Middle School

National Advanced Placement
Economics Conference
Washington D.C. 2010
James Chasey
Homewood-Flossmoor High School
1969-2002
College of DuPage 1985-present
[email protected]
Common Errors on the
2006 AP Economics Exam
Arthur Raymond
Muhlenberg College
Chief Reader, Economics
Common Errors on
the 2006 Exam
Macro 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 Exam
Macro 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 on
the 2006 Exam
Macro 1, Part (d) – Cont’d.
Yen/$
S’$
S$
E2
E1
D$
Q of Dollars
Common Errors: Mislabeled graph, inability to link reduced
output with reduced imports and supply of dollars.
Common Errors on
the 2006 Exam
Macro 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 Exam
Macro 2, Part (a)-Continued
i
Ms
i2
i1
M’d
Md
Quantity of Money
Common
Errors: Mislabeled Graph, shift of Ms to right.
Common Errors on
the 2006 Exam
Macro 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 on
the 2006 Exam
Macro 2, Part (b) – Cont’d.
r
SLF
S’LF
r1
r2
DLF
Quantity of LF
Common Errors: General unfamiliarity with the loanable funds framework.
Many used the money supply and money demand framework.
Common Errors on
the 2006 Exam
Macro 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 Exam
Macro 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 Exam
Macro 3, Part (c) - Cont’d
inf
LRPC LRPC
un’nat
unnat
un
Common Error: Use of a downward sloping Phillips curve.


Arthur Raymond
Chief Reader
Muhlenberg College
Meet the Test Development Committee
APAC, Las Vegas, 2007
Top Ten Errors on the
2007 Economics AP Exam
Macro 2 (c)


(3)
Assume that the open-market
operation that you indicated in part
(b) (purchase) is equal to $10
million. If the required reserve ratio
is 0.2, calculate the maximum
change in loans throughout the
banking system.
$40 million
Macro 2 (e)


(5 and 10)
Assume that the Federal Reserve’s
action results in some inflation.
What would be the impact of the
open market operation (purchase)
on the real rate of interest?
Real rate falls because nominal rate
decreases and inflation increases.
Macro 2 (a)


Define the Federal Funds Rate
It is the interest rate banks charge to
other banks for borrowed reserves.
(7)
Macro 1 (b)
(9)

Using a correctly labeled graph of
the foreign exchange market for the
US dollar to show the impact of the
change in relative price levels (PUS
falls relative to Japan) on each of
the following.
(i) Demand for the dollar
(ii)

D shifts up


Top 10 AP Econ Mistakes
2008
Overview
11. Compare MSC, MSB
10. Tax → ↑MC → ↓Q
9. Foreign Exchange Market
with Shift
8. Automatic Stabilizers
7. Optimal Consumption
Rule
6. Number of Firms Can’t
Increase in SR
5. Currency Appreciation
from Real Interest Rate ↑
4. Current Account Changes
Resulting from Real
Income Changes
3. Link between Growth and
Capital
2. Elements of the Current
and Capital Account
1. Effects of a Lump Sum
Subsidy
The Graph (not required for part b)
$/unit
S = MSC
MSB
D
Qmarket
Quantity of Vaccinations
The Graph (not required for part c)
$/unit
$/unit
S
MC
ATC
SMB
D
Q1 Qs
Quantity
Quantity
9. Macro 2 (c)
Question: 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
dollar relative to the rupee.
Answer: In the dollar market, the supply of dollars
will increase as dollars are exchanged for
rupees, shifting the dollar supply curve to the
right and decreasing the value of the dollar.
33% drew the graph correctly
29% shifted S correctly
The Graph
rupees/
dollar
Supply
New Supply
e
e’
Demand
Q Q’
Quantity of Dollars
8. Macro 1 (b)
Question: [Starting with a balanced budget] What
is the impact of the recession on the federal
budget?
Answer: There will be a deficit because
government spending / transfer payments
increase and/or taxes fall due to automatic
stabilizers (for example, unemployment
insurance). Discretionary fiscal or monetary
policy not accepted, for such answers violate the
ceteris paribus assumption.
81% correctly indicated a deficit
27% indicated awareness of automatic stabilizers
5. Overseas Macro 1 (d) ii
Question: Given the [increase] in the real
interest rate in part (c), what will be the
effect on the value of Z’s currency?
Answer: Z’s currency will increase in value
(because the higher real interest rate
attracts more financial investment in Z,
thus increasing the demand for Z’s
currency and decreasing the supply).
23% answered correctly
4. Macro 2 (b)
Question: How would an increase in the real
income of the United States affect the U.S.
current account balance? Explain.
Answer: The current account balance will
decrease or move toward a deficit
(15 percent answered correctly)
because the increase in real income
causes imports to increase relative to
exports. (33 percent answered correctly)
3. Macro 1 (e)
Question: How will the real interest rate
[increase] in part (d) affect the growth rate
of the U.S. economy?
Answer: The growth rate will fall
(49 percent answered correctly)
because a higher real interest rate
discourages investment and as a result,
capital formation will decrease.
(12 percent answered correctly)
2. Macro 2 (a) ii
Question: Two major subaccounts in the
balance of payments accounts are the
current account and the capital account.
In which of these subaccounts will the
following be recorded?
(ii) A U.S. manufacturer buys computer
equipment from Japan.
Answer: Current Account
10 percent answered correctly
Top 10 Most Common Errors
AP Economics
2009
Overview of Trouble Spots
10. Monopolistic
Competition and
Economies of Scale
9. A Tax Reduces
Allocative Efficiency
8. Capital Flight Decreases
SLF and Increases r.
7. A Lump-Sum Tax Doesn’t
Effect Q* because it
Doesn’t Effect MC
6. Elasticity Calculation and
Interpretation
5. Money/Deposit Multiplier
4. An Increase in the Money
Supply Results (via #3) in a
Decrease in Real Wages
3. Real Wages Fall due to an
Increase in the Price Level
2. Link between Growth and
Capital Formation
1. SRPC Shifts due to
Changes in Inflationary
Expectations
Monopolistic Competition
Marginal Cost
$/unit
Long-Run
Average Cost
P
Demand
Q
Quantity
Marginal
Revenue
Monopolistic Competition
Marginal Cost
$/unit
Economies of Scale
Long-Run
Average Cost
P
Demand
Q
Quantity
Marginal
Revenue
8. Macro 2 (b)
Question: Using a correctly labeled graph of
the loanable funds market in Tara, show
the impact of this decision by investors [to
move their funds out of the country of
Tara] on the real interest rate in Tara.
The Graph
Real
interest
rate
SLF
r
DLF
Q
Loanable funds
40% Correct
The Shift and Change
Real
interest
rate
SLF’
SLF
r'
r
DLF
Q’
Q
Loanable funds
22% Correct
5. Macro 3 (a) ii
Question: Assume that the reserve requirement is
20 percent and banks hold no excess reserves.
Assume that Kim deposits $100 of cash from her
pocket into her checking account. Calculate the
maximum change in demand deposits in the
banking system.
Answer: (The money multiplier of) 5 x $100 =
$500.
(14% answered correctly.)
3. and 4. Macro 3 (c)
Question: Given the increase in the money
supply in part (b), what happens to real
wages in the short run?
Answer: Real wages fall (20% answered
correctly) because the increase in the
money supply raises the price level (or
inflation).
(15% answered correctly)
2. Macro 2 (c)
Question: Given your answer in part (b) [that
interest rates increase], what will happen
to Tara’s rate of economic growth?
Explain.
Answer: The growth rate will fall (61%
correct) because investment spending
decreases, and as a result, capital
formation will decrease.
9% answered correctly
1. Macro 1 (f) i
Question: Assume the Federal Reserve
action [to reduce inflation] is successful.
What will happen to each of the following
as the economy approaches a new longrun equilibrium?
(i) The short-run Phillips curve. Explain.
(ii) The natural rate of unemployment.
The Phillips Curve
Inflation
Long-Run
Phillips
Curve
SRPC
w/High Expected Inflation
SRPC
w/Low Expected Inflation
Natural
Rate
Unemployment
Answer: The SRPC will shift to the left (28%
answered correctly) because the Fed policy
will lower inflationary expectations.
(2% answered correctly)
The natural rate of unemployment will not
change. (24% answered correctly)