Free Response 2014

Scoring Guidelines 2014

Question 1 (b)

  • Increase in government spending will reduce the Cyclical Unemployment and have no effect on the Natural Rate of Unemployment

  • Cyclical Unemployment

    Cyclical Unemployment • • eve When the economy goes into a recession and tota output falls, the unemployment rate rises Since it arises from conditions in the overall economy, cyclical unemployment is a problem for macroeconomic policy It is caused by the business cycle hence called 'cyclical' Macroeconomists say we have reached full employment when cyclical unemployment is reduced to zero But the overall unemployment rate at full employment is greater than zero Because there are still positive levels of frictional, seasonal, and structural unemployment

  • Natural rate of unemployment

    RELATIONSHIPS BETWEEN THE TYPES OF UNEMPLOYMENT NATURAL UNEMPLOYMENT = FRICTIONAL UNEMPLOYMENT + STRUCTURAL UNEMPLOYMENT ACTUAL UNEMPLOYMENT CYCLICAL UNEMPLOYMENT NATURAL UNEMPLOYMENT + The NRU is also called the full employment rate of unemployment. Full employment does not mean zero unemployment. It is reached when labor rnarkets are in balance; the number of job seekers equals the number of job vacancies. At this point the economy's potential output is being achieved. The natural rate of unemployment is not fixed; it changes over time and is affected by economic policies.

Question 1 (d)

  • The effect of increase in government spending on the real interest rate

    • Upward-sloping Supply

    • Downward-sloping Demand

    • Increase in Demand ≈ Decrease in Supply

    Q Q' OR QUANTITY OF LOANABLE FUNDS Q' QUANTITY OF Q LOANABLE FUNDS

Question 1 (e)

  • The economic growth rate will fall with higher interest rate, because it will slow down capital formation

Question 2 (a)

  • Buy bonds --> Shift demand of bonds to the right --> Increase the price of bonds

    Panel (a) Quantity of bonds per period Panel (b) 2 Quantity of money per period Panel (c) SRAS AD2 AD Real GDP per year

Question 2 (b)

  • Label MS and MD instead of S and D for graph of the money market

  • NOMINAL interest rate at the y-axis

    MSI MS MD QUANTITY OF MONEY

Question 2 (d)

  • Discount rate

    • The interest rate that the Federal Reserve charges banks for borrowing from its discount window

    The discount window is an instrument of monetary policy (usually controlled by central banks) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions. Discount window - Wikipedia https://en.wikipedia.org/wiki/Discount\_window

    THE FEDERAL DISCOUNT UTE IS THE RATE AT WHICH ELIGIBLE BANKS CAN BORROW EVERY DAYS FROM A FEDERAL RESERVE BANK

Question 3 (a)

  • If inflation does fall then there will be other benefits from having a low inflation rate such as:

    • More competitive exports (UK goods rise less than other countries)

    • More certainty and less confusion encouraging investment

    • Lower menu costs (though quite insignificant at the moment)

Question 3 (b)

  • Import > Export --> Current Account Deficit

  • Import < Export --> Current Account Surplus

    Current Account A Formula for Calculating Current Accounts NCT CA is the Current Account. X and M the Export and Import of Goods and Services respectively. NY the Net Income from Abroad NCT the Net Current Transfers.

  • Y=C+I+G+NX

    • Higher US exports increased AD

    • Production increases to meet the increased export demand from other countries

Question 3 (c)

  • Lower inflation rate for US dollar --> Higher demand for US dollar

    QUANTITY OF US DOLLARS

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