Advanced Placement© Annual Conference, 2011 San Francisco, CA Session: Meet the Development Committee Arthur Raymond Chief Reader, Macroeconomics Muhlenberg College

Bad News and Good News from the 2011 Advanced Placement© Macroeconomics Exam

Bad News Less than ~25% of Students Correctly Answered Content Areas The Mechanics of Money Creation Categories of Unemployment Classical Adjustment to Recession

Error 5 Macro 3 (b) (ii) (b) Suppose that the Federal Reserve purchases $5,000 worth of bonds from Sewell Bank. What will be the change in the dollar value of each of the following immediately after the purchase? (i) Excess reserves (ii) Demand deposit* No change in demand deposits. (The purchase increases Sewell Bank’s reserves and decreases its bond holdings.)

Error 4 Max. Change in Money Supply = (1/(a))•b(i) = $25,000 Macro 3 (c) Sewell Bank has the simplified balance sheet below (not shown). (a) Based on Sewell Bank’s balance sheet, calculate the required reserve ratio. Req. Res. Ratio=0.20 (b) Suppose that the Federal Reserve purchases $5,000 worth of bonds from Sewell Bank. What will be the change in the dollar value of each of the following immediately after the purchase? (i) Excess reserves. $5,000 (ii) Demand deposit (c) Calculate the maximum amount that the money supply can change as a result of the $5,000 purchase of bonds by the Federal Reserve. (Error 4) Max. Change in Money Supply = (1/(a))•b(i) = $25,000

Error 3 Macro 1 (e) (ii) (e) Now assume instead that the government and the Federal Reserve take no policy action in response to the recession. (ii) In the long run, what will happen to the natural rate of unemployment? The natural rate of unemployment will not change.

Error 2 Macro 3 (e) (e) Suppose that instead of the purchase of bonds by the Federal Reserve, an individual deposits $5,000 in cash into her checking (demand deposit) account. What is the immediate effect of the cash deposit on the M1 measure of the money supply? No effect. There is no change in the M1 measure of the money supply. (Demand deposits increase by the same amount that cash holdings fall.)

Error 1 Macro, Question 1 (e) (i) (e) Now assume instead that the government and the Federal Reserve take no policy action in response to the recession. (i) In the long run, will the short-run aggregate supply increase, decrease, or remain unchanged? Explain. In response to the recession and no policy action, the short-run aggregate supply curve will increase (shift to the right) because the recession will eventually lead to lower wages and or other factor costs.

Good News More Than ~50% of Students Answered Correctly Content Areas Foreign Exchange Market Fiscal Policy Effect on AD

Success 1 Macro 2 (b) (ii) b) Suppose in a different part of the world, the real interest rate in Canada increases relative to that in Mexico. (i) Using a correctly labeled graph of the foreign exchange market for the Canadian dollar, show the effect of the change in real interest rate in Canada on the international value of the Canadian dollar (expressed as Mexican pesos per Canadian dollar). (ii) How will the change in the international value of the Canadian dollar that you identified in part (b)(i) affect Canadian exports to Mexico? Explain.

Success 1 - Continued Canadian exports to Mexico will decrease because appreciation of the Canadian dollar increases the prices of Canadian goods relative to Mexican goods.

Success 2 Macro 1 (c) To balance the federal budget, suppose that the government decides to raise income taxes while maintaining the current level of government spending. On the graph drawn in part (b), show the effect of the increase in taxes. Label the new equilibrium output and price levels Y2 and PL2, respectively. On AS-AD diagram of part (b),AD shifts to the left, decreasing Y to Y2 and PL to PL2.

Success 3 Macro 1 (d) (i) (d) Assume that the Federal Reserve uses monetary policy to stimulate the economy. (i) What open-market policy should the Federal Reserve implement? Buy Bonds

Success 4 and 5 Macro 1 (b) (b) Draw a correctly labeled graph of aggregate demand and aggregate supply in the recession and show each of the following. (i) The long-run equilibrium output, labeled Yf (Success 5) (ii) The current equilibrium output and price levels, labeled Ye and PLe, respectively. (Labels, AS, AD, and Ye, PLe) (Success 4)

Successes 4 and 5- Continued PL AS PLe AD Y Ye Yf