AP Macroeconomics Unit 3: National Income and Price Determination

Learn how aggregate demand and aggregate supply determine output and prices, and how multipliers, fiscal policy, automatic stabilizers, and self-adjustment affect the economy.

Covered syllabus points

3.1 Aggregate Demand (AD)3.2 Multipliers 3.3 Short-Run Aggregate Supply (SRAS)3.4 Long-Run Aggregate Supply (LRAS)3.5 Equilibrium in the Aggregate Demand–Aggregate Supply (AD–AS) Model 3.6 Changes in the AD–AS Model in the Short Run 3.7 Long-Run Self-Adjustment 3.8 Fiscal Policy 3.9 Automatic Stabilizers

[Maximum number: 7]

Figure for Question Unit 3: National Income and Price Determination question 1 — AP Macroeconomics

Assume that the United States economy is operating below full employment.

(a)

Draw a correctly labeled graph of long-run aggregate supply, short-run aggregate supply, and aggregate demand, and show each of the following.

[ 2 ]

2 points:

- One point is earned for drawing a correctly labeled graph showing AD, SRAS, $\mathrm{Y}_{1}$ and $\mathrm{PL}_{1}$ .

- One point is earned for drawing a vertical LRAS at $\mathrm{Y}_{\mathrm{f}}$ to the right of $\mathrm{Y}_{1}$ .

(i)

Current equilibrium output and price level, labeled as $\mathrm{Y}_{1}$ and $\mathrm{PL}_{1}$

[ 1 ]

(ii)

Full-employment output, labeled as $\mathrm{Y}_{\mathrm{f}}$

[ 1 ]

(b)

The policy makers pursue a fiscal policy rather than the monetary policy in part (b). Assume that the marginal propensity to consume is 0.8 and the value of the recessionary gap is $300 billion.

[ 3 ]

(i)

If the government changes its spending without changing taxes to eliminate the recessionary gap, calculate the minimum required change in government spending.

[ 1 ]

(ii)

If the government changes taxes without changing government spending to eliminate the recessionary gap, will the minimum required change in taxes be greater than, smaller than, or equal to the minimum required change in government spending in part (d)(i) ? Explain.

[ 2 ]

(c)

Assume the government lowers income tax rates to eliminate the recessionary gap. Will each of the following increase, decrease, or stay the same?

[ 2 ]

(i)

Aggregate demand. Explain.

[ 1 ]

(ii)

Long-run aggregate supply. Explain.

[ 1 ]

[Maximum number: 3]

The table provided shows the quantities and unit prices of shirts, bread, and pants, the only

three goods produced in the country of Middleland in 2021 and 2022. Assume that 2021 was the

base year.

Table for Question Unit 3: National Income and Price Determination question 2 — AP Macroeconomics

(a)

Assume that Middleland was in short-run equilibrium in 2022 and that POTENTIAL real

GDP was $1,150 in 2022. Draw a correctly labeled graph of the aggregate demand, short-run

aggregate supply, and long-run aggregate supply curves for Middleland in 2022, and show

each of the following.

[ 2 ]

(i)

The equilibrium real output and price level, labeled $\mathrm{Y}_{1}$ and $\mathrm{PL}_{1}$ , respectively

[ 1 ]

(ii)

The full-employment output, labeled $\mathrm{Y}_{\mathrm{F}}$

[ 1 ]

Point 2	Calculate the real GDP in Middleland in 2022 as \$1,190 and show your work. $\text { Real GDP }=(\$ 11 \times 50)+(\$ 4 \times 70)+(\$ 12 \times 30)=\$ 1,190$	1 point
C\nPoint 3	Draw a correctly labeled aggregate demand-aggregate supply graph that shows $\mathrm{PL}_{1}$ and $\mathrm{Y}_{1}$ at the intersection of the aggregate demand (AD) and short-run aggregate supply (SRAS) curves.	1 point
Point 4	The graph must show a vertical long-run aggregate supply (LRAS) curve to the left of $\mathrm{Y}_{1}$ and label the full-employment output as $\mathrm{Y}_{\mathrm{F}}$ .	1 point
D\nPoint 5	Calculate the minimum change in government spending as a decrease of \$8 and show your work. $\text { Min Change }=\frac{\text { Output Gap }}{\text { Spending Multiplier }}=\frac{(\$ 1,150-\$ 1,190)}{\frac{1}{(1-0.8)}}=\frac{-\$ 40}{5}=-\$ 8$	1 point

(b)

Assume the marginal propensity to consume in Middleland is 0.8. Calculate the minimum

change and state the direction of change in government spending required to close the

output gap in the short run in Middleland. Show your work.

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[ 1 ]

[Maximum number: 4]

The economy of Northland is in short-run equilibrium with an actual unemployment rate of 7% and an actual inflation rate of 1\%. The natural unemployment rate in Northland is 5\%.

(a)

Assume the marginal propensity to consume is 0.9.

[ 2 ]

(i)

If the government decreases income taxes by $20 billion, calculate the maximum change in aggregate demand. Show your work.

[ 1 ]

Calculate the maximum change in aggregate demand as $180 billion and show your work.
$\text { Maximum } \Delta \text { in } \mathrm{AD}=-\$ 20 \text { billion } \times \frac{-0.9}{1-0.9}=-\$ 20 \text { billion } \times-9=\$ 180 \text { billion }$

1 point

(ii)

If instead the government increases spending by $20 billion, calculate the maximum change in aggregate demand. Show your work.

[ 1 ]

Calculate the maximum change in aggregate demand as $200 billion and show your work.
$\text { Maximum } \Delta \text { in } \mathrm{AD}=\$ 20 \text { billion } \times \frac{1}{1-0.9}=\$ 20 \text { billion } \times 10=\$ 200 \text { billion }$

1 point

Total for part (c) 2 points

(b)

How would an increase in unemployment compensation affect aggregate demand in the short run? Explain.

[ 1 ]

(c)

Assume instead the government takes none of the preceding policy actions. (Northland is still in short-run equilibrium; the actual unemployment rate is 7%, the actual inflation rate is 1%, and the natural unemployment rate is 5\%.) What will happen to each of the following in the long run?

[ 1 ]

(i)

The short-run aggregate supply curve. Explain.

[ 1 ]

[Maximum number: 1]

Classical economists believe that the economy moves toward full employment because

government spending supplements private investment to keep aggregate demand in balance with aggregate supply

households spend all of their disposable income to purchase the full-employment output

wages and prices are flexible

private investment is constant and independent of national income

the money supply grows at a constant rate to generate sufficient demand to purchase the full-employment output

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Covered syllabus points

Unit 3: National Income and Price Determination question 1

Question (a)

Question (i)

Question (ii)

Question (b)

Question (i)

Question (ii)

Question (c)

Question (i)

Question (ii)

Unit 3: National Income and Price Determination question 2

Question (a)

Question (i)

Question (ii)

Question (b)

Unit 3: National Income and Price Determination question 3

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Question (i)

Question (ii)

Question (b)

Question (c)

Question (i)

Unit 3: National Income and Price Determination question 4