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Name: _____________________
Unit 4 FRQ Review
Per: _____
Question 1
Assume the United States economy is operating at full-employment output and the government has a balanced budget. An increase in consumer
confidence skyrockets consumption spending, causing the economy to enter into rapid expansion.
Using a correctly labeled graph of the short-run Phillips curve, show the effect of the increase in consumption spending. Label the initial
position “A” and the new position “B.”
What is the impact of the economic change on the federal budget? Explain.
Question 2
Assume an expansionary/inflationary gap in output of $100 billion and the marginal propensity to save is 0.4.
Draw a correctly labeled AS/AD graph showing the inflationary gap with the following:
a. Long run aggregate supply curve
b. Current output and price level
How much would the government need to decrease spending to close the gap (show work)?
Assume that instead of changing government spending, the government decides to change personal income taxes. Will the change in
personal income taxes required to achieve full employment be larger than or smaller than the government spending change you calculated in
part 1 (show work)? Explain.
Using a correctly labeled graph of the loanable funds market, show the impact of an increase in government spending on the real interest rate
in the economy.
Name: _____________________
Unit 4 FRQ Review
Per: _____
How will the real interest rate change affect the growth rate of the United States economy? Explain.
Question 3
Assume that a country’s economy is operating at less than full employment.
Draw a correctly labeled graph of aggregate demand and aggregate supply, and show each of the following.
a. Long run aggregate supply curve
b. Current output and price level
Assume policy makers are classically trained and take no policy action. Explain what will happen to each of the following on a new graph.
Explain (in words) why classical economists would believe this shift would happen.
a. Short run aggregate supply
b. Employment
Now assume that instead of taking no policy action, the government implements an investment tax break for business. How will this effect
demand for investment? Show on a loanable funds graph what happens to the real interest rate.
Given your answer in part 3, explain how aggregate supply is affected in the short/medium run and long run.
Question 4
Suppose that the following statements describe the state of an economy:
The unemployment rate is 3.5 percent
Inflation is at an annual rate of 29.1 percent
The prime interest rate is 16.5 percent
The annual growth rate of real gross domestic product is 15 percent
Identify the major problem(s) the economy faces.
Describe two fiscal policy actions that could be used to alleviate the problem(s) – one should be automatic and one discretionary. Describe
why each one is discretionary or automatic. Determine their effects on:
a. Output and employment
b. Price level