UNIT
3 Macroeconomics
LONG FREE-RESPONSE
SAMPLE QUESTIONS
Answer
Key
Answers to Sample Long Free-Response Questions
1. Assume you are a member of Congress. A member of your staff has just given you the following
economic statistics:
Year Ago
Quarter
Last
Quarter
Estimate for
Quarter Now Ending
$2,789
$2,689
$2,598
Consumer price index
197
201
204
Unemployment rate
5%
8%
10.2%
$312
$300
$287
Real gross domestic product
(in billions of 1997 dollars)
Gross private investment
(in billions of 1997 dollars)
(A) What economic problem is this nation facing? There is a recession. Real GDP is declining and
unemployment is rising. Inflation is moderate, rising 3 percent in the last year.
(B) Identify the fiscal policy actions you would recommend. Policy recommendations are to
decrease personal income taxes, decrease corporate income taxes and/or increase government
spending.
(C) What are the goals of your fiscal policy actions? The goal would be to enact expansionary fiscal
policy actions to raise employment and increase the level of real GDP, but to do so without
causing more inflation.
(D) Explain how each policy action you identified in Question 1(B) will fit the goals you stated in
Question 1(C). Decreasing personal income taxes will provide more disposable income available for consumption and saving. Higher consumption will increase aggregate demand and
raise the level of real GDP and employment and possibly the price level. Because
unemployment is high, the effect on the price level may be small. Some of the savings might
find its way to financial markets and become investment.
Decreasing corporate income taxes will give businesses more money for investment, raising
aggregate demand, real GDP and employment. If businesses undertake purchases of new capital, this could increase the aggregate supply and the price level might fall.
Increasing government spending is an option. Government spending is a direct injection and
none is lost to savings. Additional disposable income as it passes through the income stream
will also add to real GDP and employment.
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UNIT
LONG FREE-RESPONSE
3 Macroeconomics SAMPLE QUESTIONS
Answer
Key
PRICE LEVEL
(E) Use a correctly labeled aggregate demand and aggregate supply graph to show the effects of
your fiscal policy on the economy. Show the changes that will occur in the price level and the
level of real GDP. The rightward movement of aggregate demand results in increases in the
price level and real GDP.
SRAS
P1
P
AD1
AD
Y
Y1
REAL GDP
2. Assume you are a member of Congress. A staff member has just given you the following economic
statistics:
Year Ago
Quarter
Last
Quarter
Estimate for
Quarter Now Ending
$2,356
$2,589
$2,752
Consumer price index
210
240
250
Unemployment rate
10%
6.5%
5.1%
Gross private investment
(in billions of 1997 dollars)
$312
$340
$352
Real gross domestic product
(in billions of 1997 dollars)
(A) What economic problem is this nation facing? The main problem is inflation. Inflation rose
almost 20 percent in the last year.
(B) Identify the fiscal policy actions you would recommend. Policy recommendations are to
increase personal income taxes, increase corporate income taxes and/or decrease government
spending.
(C) What are the goals of your fiscal policy actions? The goal would be to enact contractionary
fiscal policy to lower inflation to a level that is acceptable. The fine line between lowering inflation and not causing lower employment and lower levels of real GDP is the difference between
success and recession.
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Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.
UNIT
3 Macroeconomics
LONG FREE-RESPONSE
SAMPLE QUESTIONS
Answer
Key
(D) Explain how each policy action you identified in Question 2(B) will fit the goals you stated in
Question 2(C). Increasing personal income taxes will decrease disposable income available for
consumption and saving. Lower levels of consumption will decrease aggregate demand to lower
the level of real GDP and employment. If the economy is in the vertical range or upwardsloping range of AS, price levels will fall.
Increasing corporate income taxes will give businesses less money for investment, reducing
aggregate demand, real GDP and employment. Price levels will fall.
Decreasing government spending is an option. Raising taxes and cutting the budget may create
a budget surplus. The loss of disposable income, as it passes through the income stream, will
also lower real GDP and employment, but price levels will fall.
PRICE LEVEL
(E) Use a correctly labeled aggregate demand and aggregate supply graph to show the effects of
your fiscal policy on the economy. Show the changes that will occur in the price level and the
level of real GDP. The leftward movement of aggregate demand results in a decline in the price
level and real GDP.
SRAS
P
P1
AD
AD1
Y1 Y
REAL GDP
3. Assume that the economy has been operating at the full-employment levels of output and
employment but has recently experienced a decrease in consumption spending because of a sharp
decline in stock market indexes that has reduced the wealth of the nation by about 18 percent.
Consumption expenditures have decreased at all levels of income.
(A) Use correctly labeled aggregate demand and aggregate supply graphs to illustrate the shortrun effect of the decrease in consumption expenditures on each of the following:
(i)ii Output
(ii)i Employment
(iii) The price level
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UNIT
LONG FREE-RESPONSE
3 Macroeconomics SAMPLE QUESTIONS
Answer
Key
The decline in consumption expenditures at each and every level of income will create an output gap at the full-employment level of output. As a result of this autonomous change in aggregate demand, the following will occur:
PRICE LEVEL
LRAS
(i)ii Output will decline.
SRAS
P
P1
(ii)i Employment will decline, and the
unemployment rate will rise.
(iii) The price level will decline.
AD
AD1
Y1 Y*
REAL GDP
(B) Identify two fiscal policy actions that could be used to counter the effects of the initial decrease
in consumption spending. Explain, using correctly labeled aggregate demand and aggregate
supply graphs, the short-run effects of each of your policies on each of the following:
(i)ii Output
(ii)i Employment
(iii) The price level
Fiscal-policy measures can include a cut in both personal and business taxes and/or increase in
government spending. Another idea would be to raise taxes and increase government spending
by equal amounts. This would result in an increase in real GDP.
(i)ii Output will increase.
PRICE LEVEL
LRAS
SRAS
P
P2
P1
(ii)i Employment will increase and the
unemployment rate will fall.
(iii) The price level will increase.
AD
AD1
AD2
The decline in consumption moved the aggregate
demand curve from AD to AD1 ; the fiscal policy
shifted the aggregate demand curve back to AD2 .
Y1 Y2 Y*
REAL GDP
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Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.
UNIT
3 Macroeconomics
LONG FREE-RESPONSE
SAMPLE QUESTIONS
Answer
Key
4. Assume that political problems restrict the supply of oil in international markets. Consequently,
increased production costs result in the following economic conditions in the United States:
■
The unemployment rate is 8 percent and rising.
■
The CPI is rising 9 percent annually and accelerating.
■
The annual rate of growth of real GDP is –1.5 percent.
PRICE LEVEL
(A) Identify and describe the major macroeconomic problems in the economy. Using correctly
labeled aggregate demand and aggregate supply graphs, show the condition of the economy.
High rates of unemployment and negative growth rates combined with a high rate of inflation
show that the economy is suffering from stagflation. The graph shows price levels increasing
and unemployment rising.
SRAS1
SRAS
P1
P
AD
Y1 Y
REAL GDP
(B) With a federal budget deficit of nearly $350 billion, fiscal authorities are considering the following policy actions to address the existing economic problems:
Policy 1: Increase government expenditures.
Policy 2: Increase personal income taxes.
Policy 3: Decrease business taxes and regulations.
Describe the effect of each of the policies on the economy, and demonstrate each on an individual aggregate demand and aggregate supply graph. Be sure to include each of the following
in your description:
(i)ii Output
(ii)i Employment
(iii) The price level
Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.
519
UNIT
LONG FREE-RESPONSE
3 Macroeconomics SAMPLE QUESTIONS
Answer
Key
Policy 1: Increased government spending would move the AD curve to the right.
(i)ii Output would increase.
PRICE LEVEL
SRAS
(ii)i Employment would increase.
(iii) The price level would increase.
AD1
AD
REAL GDP
Policy 2: Increased personal taxes would move the AD curve to the left.
PRICE LEVEL
(i)ii Output would decline.
SRAS
(ii)i Employment would decrease.
(iii) The price level would decrease.
AD
AD1
REAL GDP
Policy 3: Decreased business taxes and decreased regulation would move the SRAS curve to the
right.
SRAS
PRICE LEVEL
SRAS1
(i)ii Output would increase if business expectations
are positive.
(ii)i Employment would rise if business
expectations are positive.
(iii) The price level will fall as SRAS increases.
AD
REAL GDP
520
Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.