Transcript 10- Practice Free Respons Answers

Unit #3 Key Graphs
AS/AD Model
PPF
Qty
Food
.
(0,100)
.
.
C
B
(50,50)
A
(100, 0)
Qty
Shelter
Practice Free Response
Answers
QUESTION #1
1b)
1a)
LRAS1
Price
Level
SRAS1
SRAS2
P2
-----------
1c)
Actual Price level at (P1) is LOWER than
expected price level (which lags!)
E1
---------
P1
----------------- E2 AD1
Y1
Prices & Wages are sticky in the short run.
So quantity supplied rises and falls as the price
level rises or fall (positive relationship)
Example:
Price Level ↑  => Nominal Wages unchanged
but Real Wages ↓ => So Qty Supplied rises 
Y*
Real
GDP
Expected price level lags actual price level in
both directions (actual price level is the one you
are graphing => so if AD shifts left => actual falls
immediately…)
1d) Expected price level eventually falls to
“catch up” to actual price level => SRAS shifts
right to full employment output level (E2)
QUESTION #2
2 a,d)
2b) Contractionary Fiscal Policy
2c)
Raise income taxes
=> (C↓)
Decrease Gov’t Spending => (G↓ )
Gov’t Budget=> Gov’t revenue ↑ & Gov’t
Spending ↓ So overall, deficit shrinks.
Could lead to balanced budget or budget
surplus in the extreme
P2 -------- E2
AD2
Y2
End result: AD shifts left, deficit falls,
output returns to full potential (on PPF),
2d)
unemployment ↑ price level ↓ R-GDP ↓
3c)
Public savings rises (becomes less
negative) so National Savings ↑ 
QUESTION #3
So Loanable Funds Supply Shifts Right
3c) graph
Real
Interest
Rate
r2
S2
-------------- E1
------------------ E2
---------------------
R1
3d)
S1
Q1
Q2
AD shift is indeterminate:
G ↓ (Gov’t spending ↓) => AD left
BUT Lower real interest rates => increase
in Investment ( I↑ ) AD right
D1
Increase in Investment ( I↑ ) today
mean in the long run:
3e)
Qty
Loanable Funds
PPF: Capital Investment shifts PPF to right
in long run
3a) Demand Curve = Investors (business)
Investors borrow money for capital goods to
expand business…
SRAS & LRAS: both shift right as PPF
went right
UNEMPLOYMENT: r-GDP rises =>
unemployment rate must fall