Topic 5.1 Fiscal and Monetary Policy Action in the Short Run 279 1. Using an aggregate supply/oggregete demand diagram, show an economy experiencing an ‘unemployment rate grocer than the netuel rote of unemployment. Label the Intel equitbvivm Ys, PL and label full employment output Price eas. Uovel RAS te ‘ Pa 1 Aba aD Yow Real GOP ws 2. Identify an appropriate Fiscal policy response tothe economic canltion you idenifed in (1). Increase government purchores and/or transfers, and/or deeroase taxes 3. Identify an appropriate monetary policy response assuming omple reserves to address the economic condition in (1) Decrease administered interest rates ‘4. Explain how each policy will afc! output and price level Fiscal: Increased government purchaces increase aggregate demand, ovlput, and pice level Increased transfers or decreased foxes retut in mcreaeed disposable income, consumption, aggregate demend, oulpul, and price level. Monetary: Decreased administered rates, decreasos the policy rate, which resis in incrocsed interest sensitive sponding, aggregate damand, oufpu, and price level, 5. Show the effect ofthe combined fecal end monetary palcy onthe graph in 1.) Label the new aulbriom Ya, PlaTopic 5.1 Fiscal and Monetary Policy Actions in the Short Run 281 1, Canaan open economy that is curently in recesionary output ep. (0) Draw correct labeled rapt ofthe long-run aggregate supply, short-unaggeaae supply. and agpegste demand curves, nd show each ofthe folowing. (@ Thecarrentequiiia real output and price lev Iabeled as Y, 6 Pottemployment utp, Inbeled Y (©) The cena bank andthe goverment do not ake any policy ations to cos the output gap: @ Bplainhow he economy wll aust ofl employment inthe Lag ew. i) On your graph in pt (show how dhe economy adj ofl eplayment inthe ong ran (© Suppone th Canadian gowomnent nang wo wa fos ong-run jestnent process. The marae ‘roensty to conte 08, The eqlitm res opti $500 billion abl the ful employment op = $540 bin (© Calculate te mininam change and inet the drction of change in govemeat spending required ‘0 shift the apgepate demand carey the smount ofthe opt G0 Calcuatthe mini change and indeate he direction of change in taxes required to hit the sgurepite demand cae by the amount of the tpt gap. (© Assume instead ta the Canadian cent ban takes ction 1 eos the econony to fl-mploymnt ‘ouput by nfivncing invement pending, Dra correctly labeled raph af he money mart, nd thow Ue effect ofthe stions taken by the cet baal om the equiv ners ra i PL. tepecivey (a) (bf) Inthe long run inpet prices decracte and SRAS increases (bVfi)_s00 graph above fe) MPC= 0.8, MPS =0.2, fll omploymant output = $540 bilion,curent oulput ~ $500 billion, ‘output gap ~ $540 billon - $500 billion = $40 bilion. {Al spending multpfr = 1/MPS = 1/0.2 = 5; {$40 billion output gap/5 = $8 billion minimum increase in government spending fi) Tax decrease mubiplior = MPC/MPS = 0.8/0.2 = 4; $40 billion output gap/4 = $10 billion minimum decrease in taxos oa © 2019°The College Boar Vist the Colege Boa on the webs eollageboand.ongTopic 5.1 Fiscal and Monetary Policy Actions in the Short Run 283 1. Assume Smithland isin short-un equilibrium at fevel of output tha exceeds the full-employment level of coup (©) Draw a cone labeled graph ofthe aggrepate demand, shorn aggrogst supply, and long-run aggregate supply curves, and show each ofthe following. See AS/AD Diagram below (Te current equilibrium eal output an price lve, labeled Y, and PL, espectively The fllemployment ouput, labeled Yp See AS/AD Diagram below () Assume Smtland’s government cuts individual income taxes. On your graph in par (a, show the ‘horton fe: ofthe tet on equ alot, abi i ew seta equiva real opt - "Soe ABS Bitar below se (Based solely onthe change in rel outpt on your graph in part (0), what will happen to each ofthe following in the short run? () The natural rte of unemployment No change in NRU i) Nomina interetrates. Explain, Nominal Interest Rates increase because demand for money increased becoure ofthe increase in oulpu (@) Assume instead the central bank intervenes to coret an ifatonary outpat gap. Assuming smple reserves, ‘what monetary policy ation shouldbe taken by central bank policymakers? Increase administered rates, (e) Draw a conecty labeled graph ofthe reserve matket, and show the effect ofthe change in administered rates Kentified in pat (4 0a the policy rte seni ot fm nando \ wa wae onto (© 2021 College Board, ‘Visit College Board on the web: collegeboard.org,“Prom o4 cauTom suTES POE | DUN om sorvaxoNT sry "suoMAO[duIeTN 50 | o/pire TemOMOKY swoare yer FuTMATY SD Tojuozs0y a4; UO (%%8) geaang sdimud Uny-Su07 e syTyS YEU seen | sso os a a wok Seeley aera span aus tO ces SVB Jo woRDeATP onsoddo omy wm eaou 04 spua3 QguS ou ‘OSTY 9404 voyoyur | srvosoep smoneinadxe women | worm pseaerso preamp suraeogus | { esear0UT suoTeyoedxe wOREpUT | 2} Ul yueULAC|dUISUN PUY TOTFeTUT WeeMyeq SySTZO cum ‘toqan paearedys 20 preaun sure Dae drqsuoneres ou ‘gueurdoduromn jo evex Tengen ou ay “TH PUOT sumpeoodxg UORETU suowforduroun, Tengoe pure wonepur ueemoq drysuonstes szaamt wy Tt MOUS saaano sma ume 420s 2 Soaou yeuAN = geamg said 8 SeGM, geamo sara ea DEB = aang sdiyjiyg ous zg doyTopic 5.2 ‘The Philips Curve aos 1,_ Dafne the following Philips curve persistent adolf bahveen the cole f inflation and unemployment observed inthe cory fo mid 20th entry shortcun Philips curve (SRPC) short run trade of between the rales of inflaton and unemployment os long as expacted inflation remains constant. longrrun Philips eve (LRPC) no lado between the cass of inflaton and unemployment inthe Tongan ofthe natural rate of unemployment 2. Draw a diagram of SRPC ond LRPC in a longeun equilibriom, Lobel the expected inflation ree os mt and the natural rata of unemployment anu Infation a ‘Unemployment Rave 2, Show the effects of « decrease in aggregate demand onthe inflation rate and unemployment rate fn your diagram in (2). Label the new inftion rat i nd the new unemployment rate vx 4 Explin how the aconomy will adjust to « new long-run aquirium using the concept of nlation ‘expecations in your explanation. Inflation expectation wll decrease to the new inflation rate, decreasing the SRPC, and ‘unemployment will elura tothe notral rate of unemployment 5. Provide an example ofa policy which would shit the [RPC othe right, Explain your reasoning, Extending he longth of ime unemployed incividvols con receive unemployment benefis would result in longer job search time, inreasing fiional unemployment and the natural rate of unemploymentTopic 5.2 The Phillips Curve 298 3. Assume that the table blow shows the unemployment and inflaton data in Country X as a result ofa shift in aggregate demand, Peviod_—[-Uneimployment Rate | —Taflation Rate —] 2 8% | Thisyear_[____$% 46) (@) Draw acorrecly labeled graph ofa shortsun Philips curve for County X, showing the atu ‘unemployment and inflation rates foe both year. Label the Philips cuve as SRPC. () Now assume that she shortsun aggregate supply curve has shifted tothe let (0) Tent one factor that could cause the aggregate supply curve to shift the lft i) On the graph, show how this shift would affect the shor-xun Pili curve (6) Assume that the natura ate of unemployment in County X is 5 percent. Draw a conetly labeled graph ofthe long-zun Philips curve and label tas LRPC, (4) Whatis the relationship between the unemployment rate and the inflation rte i he long cu? ene (@X marwasod mut pics oe dasrensed produoivty i ‘Sorened inflationary oxpecauoaa (D)no relationship eins batweon the unemployment ‘ate andthe ination rate late long fan, anre Neneos ro 8 OuNMPLorNaNT Copyright © 2005 by Calee tance Examination Board Al ih ese hi scenes fr AP telat) an we colepeoacttapadets er AP stents dpe).Topic 5.2 The Phillips Curve 300 3. Inflation and expected inflation are important determinants of economic activity (@) Draw a correctly labeled graph ofa short-run Phillips curve. (©) Using your graph in part (a, show the eect of a inrease in the expected eae of inflation, (©) Whats the effect ofthe increas in he expected rate of inflation on the long-run Philips curve? (@) Given the increas in the expected rate of inflation from pat (b), will the nominal interest rate on new loans increase, decrese, or remain unchanged? (i) will he real interest ate on new loans increase, decrease, or remain unchanged? (©) Assume thatthe nominal interest rates 8 percent. Borrowers and enders expect the rate of inflation to be 3 percent andthe growth ate of real gross domestic product is percent. Calculate the real intrest ate (©) uoshauge >) © wim nm «nur, co MP oeronens, then NT (©) GH Ren mn - We, ost and INP InereNb by tho ? Same amount, then BIR romana unchenesd = 0} Ma 0%, = 3%, co RRO 2-0 Unemployment’Topic 5.2 The Phillips Curve 302 2 Assume the expected inflation rate in a country i 34%, the curent unemployment sate it 6, and the natural rate ‘of unemploymeat i 4% (@) Draw a coretl labeled graph ofthe short-run and long-run Phillips curves, Label the current short-run auilisium as point X and plot the numerical valves above onthe graph (6) Ts the actual inflation rate greater than, less than, or equal othe expected inflation rte of 3%? (6) Assume Jans were made taking into account the expeced inflation rate of 3%. Will lenders be better off of ‘worse of after they realize the actual inflaton rat identified in par (b)? Explain (@ Based on te elatonship between the actual and th expected inflaton rates identified in pat), what will happen to the natural rate of unemployment in te fong ran? unre (®) actual inflation is less than. ‘oxpected inflation (©) lenders are better off because they experience a higher real interest rate enee (@) no change L | cxmeerornners as Oe © 2019 The Calege Board Vie the College Board on the webs clageboardorg. *Topic 5.2 The Phillips Curve 304 2. An economy is curently in short-run equilibrium with recessionary output gap of S600 bilion (a) Draw a single conecly labeled graph with both the short-run and long-cun Phillips curves. Label the iil shor-ran equltxium point X. SRPG UNEMPLOYMENT % KZA MAH NRU © 2021 College Board Visit College Board onthe web: eollegeboard.org, GO ON TO THE NEXT PAGE,