The AP Macroeconomics Exam you will take is comprised of two parts, a multiple choice portion, which counts 60 points for 60 questions, or roughly 2/3 of your overall grade (students have 70 minutes to complete the 60 questions) and an FRQ portion, which is worth 30 points or approximately 1/3 of your overall score.  You will have 10 minutes to plan and 50 minutes to write in this section.

Common AP Econ Mistakes

Define the Federal Funds Rate It is the interest rate banks charge to other banks for borrowed reserves.

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

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.

Macro 2, Part (b) – Cont’d. Common Errors: General unfamiliarity with the loanable funds framework. Many used the money supply and money demand framework.

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.

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.

Macro 3, Part (c) - Cont’d Common Error: Use of a downward sloping Phillips curve.

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

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)

(15 percent answered correctly) 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) Explain point for wrong current account change was accepted because the order of these two parts of the question was not important.

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