Top 10 Most Common Errors AP Economics 2009

Overview of Trouble Spots 10. Monopolistic Competition and Economies of Scale 9. A Tax Reduces Allocative Efficiency 8. Capital Flight Decreases S LF and Increases r. 7. A Lump-Sum Tax Doesn’t Effect Q* because it Doesn’t Effect MC 6. Elasticity Calculation and Interpretation 5. Money/Deposit Multiplier 4. An Increase in the Money Supply Results (via #3) in a Decrease in Real Wages 3. Real Wages Fall due to an Increase in the Price Level 2. Link between Growth and Capital Formation 1. SRPC Shifts due to Changes in Inflationary Expectations

10. Overseas Micro 1 (e) Question: In the long run, will the [monopolistically competitive] company be operating in a region where economies of scale exist? Explain. Answer: Yes (52 percent answered correctly), because the firm produces a quantity of output on the downward sloping portion of its long-run ATC. (27 percent answered correctly)

Monopolistic Competition $/unit Marginal Revenue Demand Marginal Cost P Q Quantity Long-Run Average Cost

Monopolistic Competition $/unit Marginal Revenue Demand Marginal Cost P Q Quantity Long-Run Average Cost Economies of Scale

9. Micro 2 (d) Question: Assuming no externalities, how does the tax affect allocative efficiency? Explain. Price ($) S D 90 S + Tax 60 $2 $4 $8 $6 $5

Answer: Due to the tax, the outcome is no longer allocatively efficient. The tax creates deadweight loss. OR The total surplus decreases. (22% answered correctly) Price ($) S D 90 S + Tax 60 $2 $4 $8 $6 $5 Deadweight Loss

8. Macro 2 (b) Question: Using a correctly labeled graph of the loanable funds market in Tara, show the impact of this decision by investors [to move their funds out of the country of Tara] on the real interest rate in Tara.

The Graph Real interest rate Loanable funds D LF S LF r Q 40% Correct

The Shift and Change Real interest rate S LF ’ Loanable funds D LF S LF Q’ r' r Q 22% Correct

7. Micro 1 (b) Question: Assume that the government grants CableNow a lump-sum subsidy of $1 million. Will this policy change CableNow’s profit maximizing quantity of cable services? Explain. Answer: No (46% answered correctly—note that guessing would yield 50% correct), because the lump-sum tax will not affect marginal cost (or marginal revenue, the two determinants of Q*). 18% answered correctly

6. Micro 2 (c) Question: Is the demand price elastic, inelastic, or unit elastic between the prices of $5 and $6? Explain.

The Graph Provided Price ($) S Quantity D 90 S + Tax 60 $2 $4 $8 $6 $5

Answer: The demand is price elastic because elasticity is [(60-90)/75]/[(6-5)/5.5] = -2.2 which is less than -1 OR because total revenue decreased from $5 x 90 = 450 to $6 x 60 = $360 when price increased from $5 to $6. (15% answered correctly)

5. Macro 3 (a) ii Question: Assume that the reserve requirement is 20 percent and banks hold no excess reserves. Assume that Kim deposits $100 of cash from her pocket into her checking account. Calculate the maximum change in demand deposits in the banking system. Answer: (The money multiplier of) 5 x $100 = $500. (14% answered correctly.)

3. and 4. Macro 3 (c) Question: Given the increase in the money supply in part (b), what happens to real wages in the short run? Answer: Real wages fall (20% answered correctly) because the increase in the money supply raises the price level (or inflation). (15% answered correctly)

2. Macro 2 (c) Question: Given your answer in part (b) [that interest rates increase], what will happen to Tara’s rate of economic growth? Explain. Answer: The growth rate will fall (61% correct) because investment spending decreases, and as a result, capital formation will decrease. 9% answered correctly

1. Macro 1 (f) i Question: Assume the Federal Reserve action [to reduce inflation] is successful. What will happen to each of the following as the economy approaches a new long- run equilibrium? (i) The short-run Phillips curve. Explain. (ii) The natural rate of unemployment.

The Phillips Curve Inflation Long-Run Phillips Curve Natural Rate SRPC w/High Expected Inflation Unemployment SRPC w/Low Expected Inflation

Answer: The SRPC will shift to the left (28% answered correctly) because the Fed policy will lower inflationary expectations. (2% answered correctly) The natural rate of unemployment will not change. (24% answered correctly)