APMacro: Practice FRQ


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Assume that the United States economy is currently operating below the full-employment level of real gross domestic product with a balanced budget. Draw a correctly labeled graph of aggregate demand, short-run aggregate supply, and long-run aggregate supply, and show each the current output and price level, labeled as Y1 and PL1, respectively. Label full-employment output as Yf. The United States government increases spending on goods and services by $100 billion, which is financed by borrowing. How will the increase in government spending affect cyclical unemployment and the natural rate of unemployment? If the marginal propensity to consume is equal to 0.75, calculate the maximum possible change in real gross domestic product that could result from the $100 billion increase in government spending. Using a correctly labeled graph of the loanable funds market, show the effect of the $100 billion increase in government spending on the real interest rate. Based on the real interest rate change, what is the effect on the long-run economic growth rate? Now assume that instead of financing the $100 billion increase in government spending by borrowing, the United States government increases taxes by $100 billion. With this equal increase in government spending and taxes, will the real gross domestic product increase, decrease, or remain the same?

Arrows-02-june

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