Download National Income and Price Determination Mr. Bordelon Review

National Income and Price Determination
Review Problem Set
Mr. Bordelon
AP Macroeconomics
Aggregate Demand and Aggregate Supply
1. Define and give examples of the determinants of aggregate demand (AD).
AD is the relationship between APL and aggregate output (real GDP) demanded by consumers,
producers, and governments. Determinants include:
 Change in expectations
 Change in wealth
 Changes in size of existing stock (inventories, physical capital).
2. Define and give examples of the determinants of aggregate supply (AS).
AS is the relationship between APL and aggregate output (real GDP) supplied by producers.
Determinants include:
 Change in commodity prices
 Change in nominal wages (short run)
 Change in productivity.
3. Define flexible vs. sticky wages and prices.
Sticky wages and prices are found in the short run, and are slow to change. Flexible wages and
prices are found in the long run, and are more responsive to change. Note: Nominal wages refer to
short run. Simply the wages paid not adjusted for inflation (which is why it’s short run), vs. real
wages which adjust for inflation (long run).
4. Construct an accurate AD/AS model with correctly labeled axes and including AD, SRAS
and LRAS.
GRAPH
Important Concepts
Define and explain each concept and give specific examples.
5. Multiplier effect and spending multiplier.
 Multiplier effect
o Book answer: Ratio of total change in real GDP caused by autonomous change in
aggregate spending to the size of that autonomous change.
o English: Ratio of change in real GDP caused by changes in spending to the size of
that spending. Cascade!
 Spending multiplier: 1/(1 – MPC) or 1/MPS
6. Crowding out.
Government borrowing from banks which in turn drives up interest rates. Government becomes
banks’ biggest customer, crowding out businesses and customers from lenders. (Keep this? It’s
going to come up but in Financial Sector?)
7. Automatic stabilizers.
Automatic stabilizers are spending and taxation rules that cause fiscal policy to automatically kick in
either through contractionary measures (e.g., increased tax rates) or through expansionary measures
(e.g., decreased tax rates). Unemployment and progressive income tax rates.
Macroeconomic Equilibrium
Provide a cause for each of the following:
8. An increase in AD. Value of assets increases. AD shifts right. Any combination of the
changes. Refer students to p. 176 and study guide.
9. A decrease in AD. Value of assets decreases. AD shifts left.
National Income and Price Determination
Review Problem Set
Mr. Bordelon
AP Macroeconomics
10. An increase in AS. Oil gets cheaper (commodity prices). SRAS shifts right. Refer students
to p. 184 and study guide.
11. A decrease in AS. Oil gets more expensive (commodity prices). SRAS shifts left. Highlight
stagflation.
Fiscal Policy
12. Explain the difference between expansionary and contractionary fiscal policies. Explain
their goals and give specific examples.
 Expansionary fiscal policy is using government spending, transfers, and taxation to
encourage aggregate demand and close recessionary gaps/reduce unemployment.
 Contractionary fiscal policy is using government spending, transfers, and taxation to
discourage aggregate demand and close inflationary gaps/reduce inflation.
13. To support your answer to #12, draw an AD/AS graph to demonstrate a recessionary gap
and an inflationary gap. Use the graph to help explain how fiscal policy is used to close the
gaps.
GRAPH
FRQ #1 2005B #2, 7 points
Labor productivity is output per unit of labor. An increase in labor productivity is a source of
economic growth.
a. Identify two sources of increase in labor productivity. (2 points)
 Increase in quality/quantity of resources.
 Increase in technology.
 Increase in capital.
 Increase in any input except labor (increased labor doesn’t mean they’re more productive).
b. Assume that a country’s economy is at full employment. Productivity has been rising. Using a
correctly labeled graph of aggregate demand and aggregate supply, show the long-run effect of
the growth in productivity on each of the following.
GRAPH—emphasize positive supply shock and increase in LRAS. (3 points).
 Correctly labeled graph.
 LRAS shift to the right.
 APL decreased and real GDP increased. (Real GDP is real output).
 NO points for any shift of AD.
i. Real output
ii. Price level
c. Assume that the economy produces only two goods, good X and good Y. Using a correctly
labeled production possibility diagram, show the effect of the increase in labor productivity.
GRAPH—PPC. (2 points)
 Correctly labeled graph.
 Outward shift of PPC.
National Income and Price Determination
Review Problem Set
Mr. Bordelon
AP Macroeconomics
FRQ #2 2006B #1(a)-(b)
Assume that a country’s economy is operating at less than full employment.
a. Draw a correctly labeled graph of aggregate demand and aggregate supply, and show each of the
following. (3 points)
GRAPH
 Correctly labeled.
 LRAS curve drawn to right of current output and price level (recessionary gap)
 Current output and price level.
i. Long-run aggregate supply curve.
ii. Currentouput and price level.
b. Assume that policymakers take no policy action and that prices and wages are flexible. Explain
what will happen to each of the following. (4 points)
 SRAS shifts right (1) because as nominal wages decrease, production costs go down. (1)
 Employment will increase (1) because real output/GDP is increasing (OR recessionary gap
is closing (though former answer is stronger)). (1) NOTE: emphasize that “employment” is
term used, not “unemployment.”
i. Short-run aggregate supply.
ii. Employment.