GOOD NEWS/BAD NEWS:
ISSUES IDENTIFIED ON THE 2011
AP MACRO TEST
Chris Cannon
Sandy Creek High School
Background
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Info taken from an Arthur Raymond (Chief AP
Macro Reader) Presentation
Original Presentation here:
http://apcentral.collegeboard.com/apc/public/cou
rses/206126.html
This version can be found at:
www.teachercannon.com
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
Pesos per
CAD
Supply
e2
e
Demand2
Demand
Canadian
Dollar
Success 1
Supply2
Pesos per
CAD
Supply
e2
e
Demand
Canadian
Dollar
Success 1 - Continued
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Canadian exports to Mexico will decrease because
appreciation of the Canadian dollar increases the
prices of Canadian goods relative to Mexican
goods.
Success 2
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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 2)
(ii) The current equilibrium output and price levels,
labeled Ye and PLe, respectively. (Labels, AS, AD,
and Ye, PLe) (Success 3)
Success 2 and 3
PL
AS
PLe
AD
Ye
Yf
Y
Success 4
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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 4- Continued
PL
LRAS
SRAS
PL1
PL2
Y2 Y1Y*
AD
AD1
Y
Success 5
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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
Bad News
Less than ~25% of Students Correctly Answered
Content Areas
The Mechanics of Money Creation
Categories of Unemployment
Classical Adjustment to Recession
2011 Test FR #3

3 of the top 5 errors come from this question
 Problem
areas:
3
(b) (ii)
 3 (c)
 3 (e)
 Other
issues:
 Students
using irrelevant data from the question
Economic Concepts at Work
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Reserve requirements
Money Multiplier
Bond Market
Money Supply
Activities 37 and 38
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If you’re not doing this activity, you should be…
Mr. Cannon…
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…How do I know when to multiply by the TOTAL
amount of the deposit and how do I know when to
multiply by the new loan?
Depends on the source…
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If the money is already IN the money supply, then it
can only expand by the amount of the initial loan
 HOWEVER

If the money is NEW to the money supply (a la a
FED bond purchase), then the money supply
increases by the initial injection
Give question 3 a try!
Errors 5 and 4

Macro 3

(a) Based on Sewell Bank’s balance sheet, calculate the required reserve ratio.
Req. Res. Ratio=0.20 (Required Reserves compared to Demand Deposits)

(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 No change in demand deposits. (The purchase increases Sewell
Bank’s reserves and decreases its bond holdings.)

(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 = 5,000 x 5 = $25,000
Error 2
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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.)
Classical Theory
Errors 1 and 3

3rd most common error was on 1 (e) (ii)
 Student’s
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misinterpreting natural unemployment
MOST common error last year was 1 (e) (i)
 Deals
with the long run shift of the SHORT RUN
aggregate supply curve
Error 3
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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.
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Natural = Frictional + Structural
Based on productive resources at that time
Classical Theory Assumptions

Says Law = If a country can generate X GDP, they
can generate enough income to buy X GDP
 Therefore,
the economy should have no inherent trouble
reaching full employment

Nay”sayers” point out that
not all income is spent
Classical Theory Assumptions
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Prices, wages, and interest rates are all flexible in
either direction
Don’t believe me?
Classical Theory Assumptions
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In 2010 TOTAL wages paid to workers was just over
$6 trillion.
Adjusted for inflation, that was the SAME amount
paid to workers in 2005 when the population was
4.2% smaller
WAGES ARE FLEXIBLE!!!!!
Classical Explanation

If a recession, then
 1.
Unemployment (and unemployed resources)
increases
 2.
Workers begin to accept wage cuts
 3.
Decrease in resource prices increase SRAS!!!!!
PL
LRAS
SRAS
SRAS2
PL1
PL2
AD
Y1
Y*
Y
Silly Example that works
Classical Explanation
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If a inflationary gap, then
 1.
Prices increase
 2.
REAL WAGES decrease
 3.
Workers demand higher nominal wages (other input
prices increase as well)
 4.
SRAS shifts left
PL
LRAS
SRAS2
SRAS
PL2
PL1
AD
Y* Y1
Y
Activity 28
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If you’re not doing this activity, you should be!
What are you
doing??!
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.
Why doesn’t this happen?
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Government and FED are tampering with AD
Incomplete knowledge (never know where you are
until you know where you were!)
Takes indeterminant amount of time (people
impatient)
How flexible are wages/prices?