ABOUT THE EXAM

Multiple Choice Questions-two thirds of total score:

• 60 questions, 70 minutes to complete

• 1 point each; no penalty for wrong answer
• Many of the questions are similar to the frqs; for questions involving changes in interest
rates, exchange rates, price levels, GDP, money supply, bank lending, etc. students
should sketch graphs or use bank T-accounts to answer the questions

Free Response Questions-one third of total score:

• 3 questions-one long and two short, 10 minute planning period, then 50 minutes to
complete the questions
• Each question has multiple parts and should be answered in order and labeled with the
correct number/letter (for example, l.a.(i), l.a.(ii), l.b., etc.). It's easier to read if they
skip lines between each part.
• The students should read each question carefully, answer the question (the student should
not restate the question), and then quit. Extra verbiage does not gain the student any
extra points, and may cause him to lose points if he contradicts himself. He should then
reread the question to make sure that he has, in fact, answered what was being asked.
• Complete sentences are not necessary, but students should pay attention to the verbs:
o "indicate" just requires a simple answer
o "explain" requires a reason (because ....)
o "show" means the reader is looking for the answer on a graph; the student does
not have to explain the graph and sometimes risks contradicting himself when he
tries to do so
• Graphs should be LARGE and fully labeled; all curves and axes should be clearly labeled,
and old and new equilibrium points should be shown on each axis, with directional
changes clearly indicated
• If the question asks for a calculation, it is very helpful to the reader if the student boxes
his final answer. Calculators are not allowed; therefore the students can expect very
simple numbers.
• Common abbreviations are acceptable, and it is fine to use 1' to indicate increase
and -I, for decrease.
• Consistency points are generally awarded, but if the student contradicts himself, he will
lose the point.
 Page 1 of 1

AP Macroeconomics Free Response Questions 1999 - 2011 by topic

1 2 3
2011 FRQ / Rubric Phillips Curve, Loanable Funds, FOREX Bank Balance Sheet,
AS/AD,Monetary Policy, Multiple Deposit Expansion,
Long Run Adjustment Money
2011 B FRQ / _Rubric AS/AD, Phillips Curve, FOREX, AS/AD, Monetary GDP, Inflation
Automatic Stabilizers, Policy
Loanable Funds, Long Run
Adjustment
2010 FRQ / Rubric AS/AD, Fiscal Policy, Long Money Market, Bond Balance of Payments,
run adjustment, Loanable Market, Monetary Policy FOREX,
Funds, Economic Growth
2_010 B_E!ill / Rubric AS/AD, Phillips Curve, Monetary Policy, Multiple Determinants of AS/AD
Loanable Funds, PPC Deposit Expansion, Money
Market, Inflation, Interest
Rates, FOREX
2009 FRQ / Rubric Phillips Curve, Real Interest FOREX, Loanable Funds, Multiple Deposit Expansion,
Rate, Monetary Policy, Economic Growth Inflation
Money Market, AS/AD
2009 B FRQ / Rubric AS/AD, Phillips Curve, Multiple Deposit Expansion, FOREX, Loanable Funds
Fiscal Policy, Long Run Inflation, Money Market
Adiustment
2008 FRQ / Rubric Phillips Curve, Budget, Balance of Payments, Trade
Multipliers, Loanable Funds, FOREX
Growth
2008 B FRQ / Rubric AS/AD, Fiscal policy, Trade Barriers, Balance of GDP, Inflation
Loanable Funds, FOREX Payments
2007 FRQ / Rubric Money Market, FOREX, Monetary Policy, Multiple GDP
AS/AD Deposit Expansion,
Nominal v. Real Interest
rates
2007 B FRQ / Rubric AS/AD, Money Market, Loanable Funds, Growth Balance of Payments,
Lona run adiustment FOREX
2006 FRQ / Rubric AS/AD, FOREX Money Market, Loanable Unemployment, Phillips
Funds, Nominal v. Real Curve
interest rates
2006 B FRQ / Rubric AS/AD, Long run Multiple Deposit Expansion FOREX
adjustment, Loanable
Funds, Growth
2005 FRQ / Rubric AS/AD, Monetary Policy, Loanable Funds, FOREX Phillips Curve
Nominal v. Real interest
rates
2005 B FRQ / Rubric Policy Mix, AS/AD, Phillips Growth Loanable Funds, FOREX
Curve
2004-__IBQ / Rubric AS/AD, Monetary Policy, Interest rates, FOREX Multiple Deposit Expansion
Long run adjustment
2004 B FRQ / Rubric AS/AD, Phillips Curve, Balance of Payments, Trade
Monetary Policy, Supply - FOREX, interest rates,
side investment
2003 FRQ / Rubric 'AS[AD, Policy Mix Inflation Trade
2003 B FRQ / Rubric AS/AD, Fiscal Policy, Trade Phillips Curve
Loanable Funds, FOREX,
Growth
2002 FRQ / Rubric Policy Mix, AS/AD Growth Balance of Payments,
FOREX
2002 B FRQ / Rubri~ AS/AD, Policy Mix, FOREX Consumption & Saving, Balance of Payments,
Loanable Funds, Growth FOREX
2001 FRQ / Rubric AS/AD, Fiscal Policy, Interest rates, FOREX Multiple Deposit Expansion
Suooly-side, Growth
2000 FRQ / Rubric AS/AD, Fiscal Policy, FOREX Money Market, AS/AD
Investment
1999 FRQ / Rubric Interest rates, FOREX, GDP, Growth Growth
AS/AD, Policy Mix

/9 J_,
httn- //tur nP:1~'1 nP:t/w-P:hn::u:res/clm:wer/files/ A P¾20Macroeconomics%20Free%20Resnonse... 3/14/2012
 THINGS TO REMEMBER:

What shifts AD? Changes in C, I, G, Xn (X-M)

What shifts AS? Changes in input costs or input availability, changes in

productivity, or legal/institutional changes

GDP (output), incomes, employment, money demand, imports, tax revenues move in
same direction

Fiscal policy: changes in G (government spending) or T (taxes).

• changes AD
• impacts the demand for loanable funds (and thus real interest rates)
• impacts nominal GDP growth and thus money demand (and nominal interest
rates)

Monetary policy: what the Fed does (primarily open market operations to change the
federal funds rate)

• changes the money supply (and thus nominal interest rates)

• in short run will impact interest-sensitive spending (C, I) and thus AD and
GDP
• in short run will increase the supply ofloanable funds

Interest: the price of money

• Higher interest rates discourage investment (spending on capital) because

borrowing costs increase, so fewer investments will be profitable.
• Higher interest rates encourage inflows of (financial) capital because the
higher rates ofretum on financial assets (like bonds) will attract more lenders.

FIX market: an increased demand for currency A means an increased supply of

currency B seeking A; decreased demand for currency A means decreased supply of
currency B seeking A

Nominal minus inflation equals real (real+ inflation= nominal)

MWolters/UT AP Macroeconomics Institute

ONLINE RESOURCES FOR ECONOMICS

• AP central: apcentral.collegeboard.com and look at the course home pages; check out all materials
available, including exam questions; join the EDG

• Reffonomics.com . This is a student friendly interactive site for both macro and micro. Steve Reff and
Dick Brunelle, the authors, are constantly updating and adding to the various lessons, and the site also
includes quizzes and a practice exam.

• Youtube for one minute microeconomics reviews with Jacob Clifford:

http://www.youtube.com/user/ACDCLeadership

• David Mayer'website: http://tw.neisd.net/webpages/dmayer/teacher.cfm?subpage=195888

David has a link for teachers and you can view his ppts and lessons.

• The blog of Margaret Ray, http://mrayapecon.umwblogs.org/2011/07 /06/web-based-resources-for­

teaching-ap-economics/
On her blog she has a compilation of internet resources useful in teaching AP Econ. Also, check out her
power point from the 2011 AP National Conference which discusses various web-based sources.

• Go to PBS: Making Sense with Paul Solman: http://www.pbs.org/newshour/economy/makingsense/

• Welker's wikinomics-a teacher's website with downloadable study guides:

http://welkerswikinomics.wetpaint.com/

• Hayek/Keynes video on you tube: http://www.youtube.com/watch?v=dOnERTFo-Sk

• PBS Frontline videos: http://www.pbs.org/wgbh/pages/frontline/view/

• Economics USA is a video series. The website is http:ljwww.learner.org/resources/series79.html

• The Federal Reserve has comic books, videos, lesson plans: federalreserveeducation.org

• Although this video was made in 1994, I still show the "Eye of the Storm" which depicts the day-to-day
functions of the Fed. You can download this at http://www.archive.org/details/gov.frb.fr62.01

• Econedlink.org/lessons Lesson plans by topic and grade level.

• Stosselintheclassroom.org Sign up for a free dvd, teacher guides, and streaming video.

• lzzit.org Sign up for a free DVD and daily current events service.

• Planet Money on NPR, http://www.npr.org/blogs/money/. Podcasts on economic topics.

/q 4-
M.Wolters/AP Macro

AP MACROECONOMICS REVIEW
BASIC CONCEPTS AND GRAPHS

I. INTRO CONCEPTS

A. SCARCITY, OPPORTUNITY COSTS, FACTORS OF PRODUCTION (land, labor, capital,

entrepreneurship)

B. PRODUCTION POSSIBILITIES - A shift to the right of the production possibilities curve is

equivalent to a rightward shift of the LRAS curve. In other words, potential GDP (output) has
increased, or the productive capacity of the economy has increased. This could be achieved through an
increase in resources, particularly capital (increases in NET investment, resulting in an increase in the
nation's capital stock), as well as increases in productivity, decreases in input prices and increases in
human capital. Remember that it is in increase in our potential output, or long-run aggregate supply,
that will bring about increased real income per capita, or in other words, an increase in the standard of
living.

lI&
Capital~. Price

Goods L:SL Level

y y
Consumer Goods real GDP

C. CIRCULAR FLOW OF ECONOMIC ACTIVITY (closed economy, with government)

----7DESOURCE (FACTOR)---
---MARKET
I, p
Ext. / L, ,
\ Retmrces
:..--- Public G&S - - - . ~ Public G&s----.
____.. GOVT.,....-- ,_,/ HOUSEHOLDS
--- l \,- Net Truces ./'

Exl \&S
PRODUCT
MARKET

In an expanded circular-flow diagram, "leakages" would include household savings,which flow into the
financial markets, and money spent on imports.
Additional "injections" into the domestic circular flow include the money earned from exports and foreign
savings which flow into the financial markets.

1
 D. DEMAND, SUPPLY, AND MARKET EQUILIBRIUM
1. Factors that shift demand--changes in consumer income, tastes, prices of related goods,
future expectations, number of buyers
2. Factors that shift supply--changes in production costs, number of sellers, expectation of
future prices, taxes or subsidies, technology, prices of other goods
3. Difference in changes in quantity demanded or supplied vs change in demand or supply
4. Price ceilings--set below equilibrium price, result in shortages
5. Price floors--set above equilibrium price, result in surpluses

Price
Price Floor
pe 1 - - - - - - i X -

Price Ceiling
D

Qe Quantity

II. ECONOMIC MEASUREMENTS

A. MEASURING PRODUCTION
1. GDP - gross domestic product
a. Expenditure approach = C + lg + G + Xn (household spending + business
spending on capital, inventories, construction+ govt spending + exports minus
imports)
--excludes purely financial transactions, transfer payments, used goods, do-it­
yourself, underground economy
b. Income approach= (wages+ rents+ interest+ profits= national income)+
depreciation + net foreign factor income

2. NDP - net domestic product : C +In+ G + Xn (= GDP minus the consumption of

fixed capital, or GDP minus the amount spent to replace depreciated capital)

B. MEASURING PRICE LEVELS

1. Inflation - increase in the average price level. Unanticipated inflation hurts lenders,
savers, fixed-nominal income receivers. Helps borrowers with fixed nominal i.r. loans.
a. Demand-pull -too many dollars chasing too few goods; increase in AD in
intermediate or vertical range of AS curve. Expectations of inflation may bring about demand­
pull inflation--consumption increases, and savings decrease.
b. Supply-side (cost-push, supply-shock), caused by increase in per-unit production
costs-decrease of AS curve; this causes stagflation

2. Deflation - decrease in the average price level (hurts borrowers)

3. Disinflation - decrease in the inflation rate

C. ADJUSTING FOR INFLATION/DEFLATION

1. Real numbers - adjusted for inflation or deflation, using an index like the CPI or GDP
deflator (core indexes exclude food and oil prices)

Price index =[current-year cost of market basket")

base-year cost of market basket J x 100

Real GDP =[ no~in~l GDPJ

pnce mdex x 100

2
8

2. Nominal numbers - current prices; not adjusted for inflation or deflation

3. Real interest rates= nominal interest rate minus inflation. Lender's nominal interest
rate will include an inflation premium to compensate for expected inflation-if actual inflation exceeds
this premium, real rate will decline.
4. To calculate percentage changes: new number - old number
old number X 100
D. EMPLOYMENT
1. Unemployment rate= unemployed (seeking work) divided by labor force (labor force=
unemployed+ employed, 16 and over)

2. Kinds of unemployment
a. Frictional- shorter-term, betweenjobs,just starting out
b. Structural - obsolete job skills, results from changes in consumer demand or
technology, or shifts ofjobs to other regions, countries
c. Cyclical -- deficient-demand unemployment--not included in our "natural" rate
of unemployment

3. Full employment- no cyclical unemployment; natural rate of unemployment about 5%

4. Labor-force participation rate-the percentage of working-age population in the

labor force

E. BUSINESS CYCLE - EXPANSION, PEAK, CONTRACTION, TROUGH

1. recession loosely defined as two consecutive quarters of declining GDP
2. inflation more likely to occur in expansions than contractions

III. NATIONAL INCOME AND PRICE DETERMINATION

A. AGGREGATE DEMAND (AD) Shifts in AD caused by changes in

1. Consumption (C), caused by a change in wealth, expectations, indebtedness, or personal

taxes. Consumption on durables will be affected by changes in interest rates because of
borrowing costs.
2. Investment spending (I), caused by a change in interest rates (borrowing costs), profit
expectations, business taxes, technology, or excess capacity (an increase in excess
capacity will decrease I)
3. Government spending (G). Remember G spending not based on interest rates, but
interest payments on debt are impacted by interest rate changes.
4. Net exports (Xn) caused by a change in national income abroad or exchange rates
(which can be affected by relative real interest rates-which can be caused by fiscal or
monetary policy) Other reasons listed in V.C. l.

B. AGGREGATE SUPPLY (AS) Shifts in SRAS caused by changes in

1. Input prices for land, labor, capital, entrepreneurship (rent, wages, interest, profits)­
influenced by domestic resource availability and prices of foreign inputs (positive and
negative supply shocks)
2. Productivity
3. Legal-institutional environment (govt. policies like taxes, business regulations)

C. LONG RUN AGGREGATE SUPPLY (LRAS)

1. LRAS will shift to right with increases in productivity of labor, increases in technology,
increases in capital formation (due to increased In) and improvements in human capital.

) ql
3
 2. LRAS could shift to left if negative supply shock resulted in a permanent decrease in
resources.

D. EQUILIBRIUM

Price Price Price

Level SRAS Level RAS Level
P,____-?l'~I pit-----+-~

AD AD AD

Real GDP Real GDP Real GDP

Economy in a RECESSION Economy at FULL EMPLOYMENT Economy in INFLATION

E. CLASSICAL THEORY - Assumes flexible prices, theorizes that a laissez-faire economy will
self-correct back to full employment in long run through responsiveness of SRAS curve to long-run price
changes.

F. RATIONAL EXPECTATIONS THEORY argues that fully anticipated price level changes
result in very quick or even instantaneous self-correction, so there will be no change in real output.

G. FISCAL POLICY - Changes in government spending and taxing policies (by Congress and the
Administration) designed to achieve a full-employment and non-inflationary level of GDP. Fiscal policy
created by John Maynard Keynes, who contended that prices were sticky in a downward direction and
economy would not automatically self-correct from recession to full employment

1. EXPANSIONARY-Gt, TJ. causes movement toward a budget deficit, may cause

increase in real interest rates due to increased demand by government for loanable funds­
crowding out results, which may reduce long-run growth. Also adds to our
national debt, requiring substantial interest payments, some going abroad.
Real i.r.
r2 ...,.__ _ _~..,
rl ,....__ _ ~

QI .Q2
Quantity of loanable funds

2. CONTRACTIONARY-G J., Tt causes movement toward a budget surplus, may

cause decrease in real interest rates due to decreased demand by governmentfor loanable funds

Real i.r.
rl1-r'-c---"'v'

DI

Q2 QI
Quantity of loanable funds

4
 3. MULTIPLIER EFFECT: Changes in C, I, G, and Xn have multiplied impact on GDP.
The following multipliers show how much a change in these will change GDP, assuming no
inflation and no leakages-in other words, assuming the economy is operating in the horizontal
(Keynesian) range of the AS curve:

ME= 1/MPS or 1/(1-MPC) (This is the expenditure, or spending, multiplier.)

MT= ME - 1 (Tax multiplier)

Me= ME - MT= 1 (Balanced budget multiplier)

For example: Assume an MPC of .90. The ME would then be 1/MPS = 10. If G
increases by $2 million, then GDP could increase by as much as $2 million x 10 = $20 million.

Using the same MPC of .90, the MT would be ME minus I= 9. If taxes decreased by $2
million, then GDP could increase by as much as $2 million x 9 = $18 million.

To close a recessionary gap of $20 million while maintaining a balanced budget, the
government could increase both G and T by $20 million.

H. PHILLIPS CURVE - relationship showing the tradeoff between inflation and

unemployment.

1. Short-run - movement along the SRPC depicts short-run impact of an shift of AD

along the SRAS; for example, increased AD brings about increased GDP and thus
reduced unemployment, but also brings about an increase in the inflation rate.

I
Ratn t l
PC.
~. The short-run Phillips Curve will shift left if there is a shift rightward of the
SRAS curve, and it will shift right if the SRAS shifts left.
SRPC
2. Long-run - a vertical line at full-employment (NRU). This curve would
n.r.u. shift if the natural rate of unemployment (NRU) changed.
Unempl. Rate

I. SUPPLY-SIDE ECONOMICS

1. Goal to increase LRAS

2. Achieved by reduction in marginal tax rates( which increase supply of loanable funds and
thus lower real interest rates), elimination of unnecessary govt regulations to stimulate
work, savings, and investment incentives

IV. FINANCIAL SECTOR

A. MONETARY POLICY - changes in the rate of growth of the money supply (MI includes
currency and demand deposits held by the public) by the Federal Reserve to assist the economy to achieve a full­
employment, noninflationary level of GDP.

1. EXPANSIONARY - Open Market Ops (OMO): Buy securities (to lower federal funds
rate-bank to bank overnight lending rate); lower discount rate (Fed to bank lending
rate); lower reserve requirement (which is a% of demand deposits)

2. CONTRACTIONARY - OMO: Sell securities (to raise federal funds rate); raise
discount rate; raise reserve requirement

5
B. CREATION OF MONEY THROUGH BANK LENDING PROCESS

1. Banks can lend excess reserves (total reserves minus required reserves).

2. An increase in excess reserves can have a multiplied impact in the banking system as a
whole equal to the deposit multiplier (I/reserve ratio) times the change in excess reserves,
assuming all excess reserves become loans, and all loans become new demand deposits.

C. MONEY MARKET
Nomir
1. Changes in demand (MD) caused by change in nominal GDP
(money demand varies directly with nominal GDP),
financial innovations (ATMs, credit cards), precautionary motives ir1 +-----"!..

2. Changes in Supply (MS), caused by central bank's monetary policy: MD

Ql
Quantity of Money

a. MS will increase if Fed enacts expansionary monetary policy and both nominal and
real int rates will decrease in short run (in long run, inflation could cause an increase
in nominal i.r., and eventually real i.r. will return to long-run level).

b. MS will decrease if Fed enacts contractionary monetary policy and both nominal and
real int. rates will increase in short run (in long run, reduction of inflation could
result in decrease in nominal i.r. and real rates will return to long-run level).

D. LOANABLE FUNDS MARKET - supply influenced in the short run by money market, but
NOT the same market

1. Supply ofloanable funds determined by availability of savings--household savings,

business savings, and government savings (if they ran a surplus and paid back some of
their debt), as well as foreign savings. By controlling bank lending activity Fed also
influences supply ofloanable funds in the short run, but not in the long run because
prices adjust in the long run, leaving real money supply unchanged (long-run money
neutrality). ·

2. Demand for loanable funds from businesses (investment demand), households borrowing
for durables, and the government borrowing to finance deficit.

Real i.r.
s

QI
Quantity of loanable funds

1.oo
6
 E. IMPACT OF MONETARY POLICY ON OUTPUT AND PRICE LEVEL (example shows
impact of easy monetary policy in the short run)

Norn.
i.r.. r. PL PL21--.----"..,.......-'l<'
i' l-r---"1....----+--------+.....----,, PL 1
i2 I-L-~1-------------+-'----+-~
MD
QI Q2 Q' Q2 yl y2

Q of Money Q of Investment Real GDP

• Interest-sensitive consumption (on durable goods) will also be impacted by changes in interest rates.
• Net exports will be impacted through changes in demand for the dollar resulting from interest rate changes.
• Government spending will be largely unaffected by interest rate changes.

F. MONETARISM (based on MV=PQ)

• Inflation caused by too much money in economy; Fed should stick to monetary "rule"­
steady growth of the money supply consistent with real GDP growth
• Fiscal policy results in complete crowding out-so useless in the long run

G. OTHER FINANCIAL ASSETS

1. Stocks (Equities) -a source of equity financing for corporations
2. Bonds-a source of debt financing for corporations and governments
a. Current bond yield= annual interest payment of bond divided by the market
price of bond (annual rate ofretum on bond)
b. Interest rates and bond prices vary inversely.
c. Bond yields move with other market interest rates

H. TIME VALUE OF MONEY

• Present value= Future value/(1 +rt
• Future value= Present value (1 +r)"

V. INTERNATIONAL TRADE
A. ABSOLUTE ADVANTAGE: can produce more with same inputs, or requires fewer inputs to
produce

B. COMPARATIVE ADVANT AGE: nation has lower opportunity cost; should specialize in this
and trade for rest. (Output model- over; Input model -under). Favorable terms of trade will fall
between the opportunity costs of each nation.

C. FOREIGN EXCHANGE MARKET - An increase in the demand for the dollar will increase the
price of the dollar relative to other currencies. And an increase in the demand for the dollar
implies an increase in the supply of other currencies seeking dollars (and an increase in quantity
supplied of the dollar). Decreased demand for dollar means decreased supply of other currencies
seeking dollars.
USO/Yen

QI Q2 Q' Q2
QofUSD QofYen

~0-i
7
 l. Increased demand for the dollar caused by the following (and decreased demand by the
opposite of the following):
a. Relatively higher real interest rates in the US (resulting from expansionary fiscal
or contractionary monetary policy) which increases financial capital flows to the
US to buy dollars to buy US securities which offer higher returns
b. More demand for US goods/services due to changing tastes or higher incomes
abroad
c. Relatively lower inflation rates in the US (so cheaper US goods)
d. Political/economic instability abroad, making the US a safe haven
e. Speculation

2. Impact of stronger dollar (weaker dollar has opposite impact)

a. Decrease ofXn
b. Lower costs for U.S. producers who use imported inputs
c. Helps keeps U.S. price level lower because of cheaper imports
d. Hurts multinationals because of reduced foreign income when converted to $

D. TRADE BARRIERS - protectionism (tariffs, quotas, embargoes)

1. Reduce amount and raise price of imported goods

2. Allow domestic producers to raise prices
3. Fail to consider comparative advantage, resulting in less efficient allocation of resources

E. BALANCE OF PAYMENTS

1. Balance of trade
2. Current account -exports and imports of goods and services, net investment income
3. Financial (formerly Capital) account- purchase and sale of real and financial assets
4. In the absence of governmental or central bank intervention, current account balance and
financial/capital account balance must sum to zero (a current account deficit will be
matched by a financial/capital account surplus)