AP Macroeconomics 2008 FRQ form BThree days ago students all over the world sat for the Macro and Microeconomics Advanced Placement exams. 48 hours later, the College Board released the free response questions on their website. Being at an international school SAS students took “Form B” of the exam.

In this post I will reflect on the FRQs from the macroeconomics exam.

First, question 1: An imaginary country operating at full employment experiences a deficit financed increase in government spending.

Part (a) asks students what the impact of the new government spending will be on aggregate demand and aggregate supply. Easy enough! Since “G” is a component of AD, an increase in government spending will shift AD out while (In macroeconomics): The period of time over which wages and prices are relatively inflexible. A fall in aggregate demand will lead to unemployment and recession in the short-run. Due to the inability of the nation's producers to reduce wages paid to worker, they must lay workers off to reduce costs as demand falls.');" onmouseout="tooltip.hide();">short-run aggregate supply remains the same.

Part (b) is simply a graphical representation of the answer to part (a), asking students to show the effect on output and price level. The new government spending will increase output and the price level.

So far, the question has been very straightforward and what I’d consider easy for even weaker students. In part (c), the question asks students to show the impact that the government’s borrowing from the public has on the real interest rate and the market for loanable funds. Here I am guessing the AP readers will accept either a leftward shift of supply or a rightward shift of demand. The question does not ask students to explain the shift, only “show”. Either demand or supply can shift when the government increases its deficit through issuing new bonds, as I explained HERE.

Finally, parts (d) and (e) broaden the scope of this question to international economics, a section of the syllabus that was not traditionally included in the long free response questions, but has been for two years now, and I expect it will continue to be a theme of the FRQs in the future.

Part (d) asks what effect higher real interest rates will have on supply of the country’s currency on foreign exchange markets and the value of the currency. My answer would be that as real interest rates rise households will save more, spend less on imports, thus supply less of their currency, causing it to appreciate on foreign exchange markets. This question may have stumped some kids. I typically teach that higher real interest rates will increase demand for a country’s currency, as foreigners direct their financial capital into the country’s financial markets in pursuit of higher real returns on their investments.

Finally, part (e) is simple enough, asking the impact of the now appreciated currency on net exports. As the country’s goods become more expensive to foreigners, net exports will decline, possibly offsetting the initial increase in government spending.

Overall I’d say that FRQ number 1 was FAR easier than last year’s FRQ on which students had to illustrate the impact of rising exports from New Zealand on the country’s money market and its real interest rates, also involving an explanation of how Australia’s economy might recover from a recession without any government action, requiring an understanding of the neo-classical theory of flexible wages, vertical aggregate supply, and self-correction… overall a MUCH tougher question than this year’s!

Stay tuned for my impression of numbers 2 and 3 of the 2008 form B FRQs!

Tim Schilling over at MV=PQ blog quotes Adam Smith, the father of economics, who over 200 years ago hypothesized about how the typical Westerner would respond to a catastrophic earth quake in China.

Smith’s observations of man’s moral sentiments form a sharp critique of our so-called humanity. Smith asks whether a man would willingly accept the deaths of millions in a far off land in order to prevent the slightest injury upon himself. If so, then what is it that motivates man to strive to relieve the suffering of the victims of disasters in far off places such as Sichuan Province in China and the Irrawaddy Delta in Mayanmar.

“Let us suppose that the great empire of China, with all its myriads of inhabitants, was suddenly swallowed up by an earthquake, and let us consider how a man of humanity in Europe, who had no sort of connection with that part of the world, would be affected upon receiving intelligence of this dreadful calamity.

He would, I imagine, first of all, express very strongly his sorrow for the misfortune of that unhappy people, he would make many melancholy reflections upon the precariousness of human life, and the vanity of all the labours of man, which could thus be annihilated in a moment. He would too, perhaps, if he was a man of speculation, enter into many reasonings concerning the effects which this disaster might produce upon the commerce of Europe, and the trade and business of the world in general. And when all this fine philosophy was over, when all these humane sentiments had been once fairly expressed, he would pursue his business or his pleasure, take his repose or his diversion, with the same ease and tranquility, as if no such accident had happened.

The most frivolous disaster which could befall him would occasion a more real disturbance. If he was to lose his little finger to-morrow, he would not sleep to-night; but, provided he never saw them, he will snore with the most profound security over the ruin of a hundred millions of his brethren, and the destruction of that immense multitude seems plainly an object less interesting to him, than this paltry misfortune of his own.

To prevent, therefore, this paltry misfortune to himself, would a man of humanity be willing to sacrifice the lives of a hundred millions of his brethren, provided he had never seen them? Human nature startles with horror at the thought, and the world, in its greatest depravity and corruption, never produced such a villain as could be capable of entertaining it. But what makes this difference? When our passive feelings are almost always so sordid and so selfish, how comes it that our active principles should often be so generous and so noble? When we are always so much more deeply affected by whatever concerns ourselves, than by whatever concerns other men; what is it which prompts the generous, upon all occasions, and the mean upon many, to sacrifice their own interests to the greater interests of others?

It is not the soft power of humanity; it is not that feeble spark of benevolence which Nature has lighted up in the human heart that is thus capable of counteracting the strongest impulses of self-love. It is a stronger power, a more forcible motive, which exerts itself upon such occasions. It is reason, principle, conscience, the inhabitant of the breast, the man within, the great judge and arbiter of our conduct. It is he who, whenever we are about to act so as to affect the happiness of others, calls to us, with a voice capable of astonishing the most presumptuous of our passions, that we are but one of the multitude, in no respect better than any other in it; and that when we prefer ourselves so shamefully and so blindly to others, we become the proper objects of resentment, abhorrence, and execration.

It is from him only that we learn the real littleness of ourselves, and of whatever relates to ourselves, and the natural misrepresentations of self-love can be corrected only by the eye of this impartial spectator. It is he who shows us the propriety of generosity and the deformity of injustice; the propriety of resigning the greatest interests of our own, for the yet greater interests of others, and the deformity of doing the smallest injury to another, in order to obtain the greatest benefit to ourselves.

It is not the love of our neighbour; it is not the love of mankind, which upon many occasions prompts us to the practice of those divine virtues. It is a stronger love, a more powerful affection, which generally takes place upon such occasions; the love of what is honourable and noble, of the grandeur, and dignity, and superiority of our own
characters.”

Any thoughts?

Candidates running for President in the United States often campaign to potential voters that “the United States has 7.5 million Americans out of work”, which is very true. But I say, “Wow, where does the U.S. pick up its’ first-place trophy for being so excellent at employment.” To me, having only 7.5 million out of work is like getting a 5 on yesterday’s AP Macro test! Of course, 7.5 million unemployed in the United States is only 5.0% of our 150 million labor force, and the unemployed workers consist almost entirely of “frictionally” and “structurally” unemployed workers. Frictionally unemployed workers are those workers who are transitioning between jobs or entering the job market. This transitional unemployment is a normal and desirable occurrence in any market-based economy as it evidences free choice. Structurally unemployed workers are also a by-product of a successful, market-based economy as workers are only temporarily unemployed, for the long-run benefit of the economy, as new automated technologies are replacing manual labor, and/or trade agreements are implemented allowing a country’s citizens to purchase less expensive, but still high-quality imported products. Let me be sarcastic for a moment: maybe we can get the U.S. Government to pass two new laws to lower their unemployment rate; one law to outlaw new technology so they can reduce their structural unemployment, and a second law to prevent their citizens from quitting their current jobs so the country can reduce the frictional portion of the unemployment rate as well. Maybe after that (I’m still being sarcastic if you hadn’t noticed!) the U.S. Government will then establish a new goal of 0% unemployment, which is what I hear the unemployment rate is in the US prison work camps!

Another specific example of this “180 degree moment” relating to unemployment is that manufacturing in the U.S. is somehow declining. This misperception has been created primarily on the large loss in U.S. manufacturing jobs and the declining share of manufacturing jobs as a percentage of total U.S. jobs over the last 20 years. It is widely believed that the U.S. global share of manufactured products has decreased which is an incorrect belief. Basically, the misperception has been created because: 1) employment in manufacturing is at an all time low, and 2) the U.S. has increased their share of imports from countries like Japan and China.

The reality, however, is that U.S. Manufactured real product has more than doubled over the last 20 years and they have accomplished this feat with an amazing increase in worker productivity via technology. U.S. manufacturing output per employee has increased markedly due to technology and the effective use of capital.

Yes, I believe “down often really is up”, and “black often really is white”!

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