AP Macroeconomics : Equilibrium

Study concepts, example questions & explanations for AP Macroeconomics

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Example Questions

Example Question #1 : How To Find Inflation Rate

Deflation, the increase in value of a currency over time, is much rarer than inflation. Although it can seem like a good thing, what is a problem caused by deflation?

Possible Answers:

It causes the value of debt to increase over time, harming borrowers. 

Savings are worth more. 

Wages decrease faster than prices. 

Consumers' purchasing power increases. 

Correct answer:

It causes the value of debt to increase over time, harming borrowers. 

Explanation:

When money becomes more valuable over time but debts do not change, the money owed on debts will be worth much more than the amount borrowed. This is damaging to borrowers as they must pay back loans that are effectively much more expensive than they agreed to. 

Example Question #2 : How To Find Inflation Rate

The consumer price index is the key measure that helps to calculate ________.

Possible Answers:

the gross domestic product

the inflation rate

net exports

net imports

the unemployment rate

Correct answer:

the inflation rate

Explanation:

The consumer price index is a government published tool calculated by collecting the prices of various retail items periodically. This snapshot view of current prices is one of the chief measures of inflation, as the inflation rate is simply the measure of the change in the consumer price index.

Example Question #1 : Inflation Rate

Which of the following is not one of the three main causes of inflation?

Possible Answers:

Hyperinflation

Demand pull inflation

Cost push inflation

Built-in inflation

Correct answer:

Hyperinflation

Explanation:

Hyper inflation has to do with the rate of inflation, and is not a cause of inflation. Therefore, hyperinflation is not one of the three main causes of inflation.

Example Question #1 : Money Supply

Which of the following are considered open-market activities?

Possible Answers:

Decreasing Taxes

Selling Government Bonds

Raising Bank Reserve Requirements

Increasing Government Spending

None of these would be considered Open Market Activities

Correct answer:

Selling Government Bonds

Explanation:

Selling Government Bonds would be considered open market activities. When the Federal Reserve wants to adjust interest rates, they conduct open market operations - which involves selling government bonds (which raises interest rates by decreasing the money supply) or buying government bonds (which lowers interest rates by increasing the money supply.)

Example Question #1 : Money Supply

If the Federal Reserve is trying to head off a recession, which of the following is the most likely action that it will take?

Possible Answers:

Cut taxes in order to increase aggregate demand.

Decrease the reserve requirement for banks.

Increase government spending in order to increase aggregate demand.

Buy bonds via open market operations.

Increase the discount rate.

Correct answer:

Buy bonds via open market operations.

Explanation:

The correct answer is that the Federal Reserve would be most likely to buy bonds via open market operations.

Here's why: The most common tool that the Federal Reserve uses to manage recessions is to expand the monetary supply, which makes it cheaper for businesses to borrow money and make capital expenditures, which has a net effect of increasing aggregate demand. In order to increase the money supply, the Federal Reserve buys bonds on the open market (and pays cash for these bonds). The cash that the Federal Reserve pays for these bonds expands the money supply, which has the net effect of decreasing interest rates.

If you understand the theory behind this, but answered "Decrease the Reserve Requirement for Banks", pat yourself on the back - you most likely understand the theory behind the Federal Reserve quite well. However, this is still not a correct answer - the reason is that the question was what would the Federal Reserve be most likely to do. Decreasing Reserve Requirements is a major move by the Federal Reserve, and the Federal Reserve would be much less likely to adjust Reserve Requirements than to adjust interest rates via open market operations.

Example Question #1 : Money Supply

At a particular bank, the reserve ratio is 10% and excess reserves are $300. The maximum expansion of the money supply that can be generated by that bank is ________.

Possible Answers:

$300

$3000

$30

$30,000

Correct answer:

$3000

Explanation:

The money multiplier is equal to 1/r, where r is the reserve ratio. In this example, the money multiplier is 1/.1 = 10. 

Since the bank has $300 in excess reserves, it can loan out the entire $300, which we then multiply by the money multipler to find the total expansion of the money supply:

The maximum expansion of the money supply generated by that bank is therefore $3000.

If you selected $300, you may have forgotten to multiply by the money multipler.

If you selected $30, you may have multiplied by r rather than 1/r.

If you selected $30,000, you may have thought that the reserve ratio was 1 percent rather than 10 percent.

 

Example Question #1 : Equilibrium

Which of the following is not a part of M1?

Possible Answers:

A check that has been written but not yet deposited

Money in a personal savings account

Paper money

All of these are a part of M1.

Traveler's checks

Correct answer:

Money in a personal savings account

Explanation:

Money in a personal savings account would not be considered a part of M1. The reason for this is that money in a savings account is considered to be lacking in liquidity - as a result, money in a savings account is considered to belong to M2.

Example Question #5 : Money Supply

An increase in the money supply curve would most likely result in which of the following situations?

Possible Answers:

An increase in the real interest rate

No effect on the real interest rate

A decrease in the real interest rate

A decrease in the quantity of money available

Correct answer:

A decrease in the real interest rate

Explanation:

As with any supply curve increase, price decreases and quantity increases.

Since in the market for money, price is referred to as the interest rate (i.e. the price of borrowing money), the decrease in price is interpreted as a decrease in the interest rate.

An increase (not a decrease) in the quantity of money available would be expected after an increase in the money supply curve.

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