3 Practice Free Response Questions

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100,000

400,000Computers

Cars Cars

Computers

BRAZIL

MEXICO

Opportunity Cost Table

(give-up) (gain) BRAZIL MEXICO

1 Car = ____ Computer 1 Car = _____ Computer

1 Computer = ____ Car 1 Computer ____ Car

4

1

1

1/4

400,000

400,000

Absolute Advantage in Cars: Mexico

Equally efficient at Computers

Comparative Advantage Computers: Brazil: Cost of computer = 1/4 car vs. 1 car

Comparative Advantage Cars: Mexico: Cost of car = 1 computer vs. 4 computers

Practice Problem #1

Ranges for Efficient Trade(Terms of Trade)

Brazil must buy cars at a ratio above 1/4 car per computer

Mexico must sell cars at a ratio below 1 computer per car

Terms of Trade: > ¼ & less than 1 car per computer or

> 1 & less than 4 computers per car

(give-up) (gain)BRAZIL MEXICO

1 Car = ____ Computer 1 Car = _____ Computer

1 Computer = ____ Car 1 Computer ____ Car

4

1

1

1/4

BRAZIL MEXICO

1 Car = ____ Computer 1 Car = _____ Computer

1 Computer = ____ Car 1 Computer ____ Car

4

1

1

1/4

LRAS1PriceLevel

RealGDP

AD1

Practice Problem #2

SRAS1

Japanese economy booms => Japanese buy more imports (some from USA)

USA exports more (NX ↑) => AD ↑ => GDP ↑ & Price Level ↑

Event: Japanese Economy booms

American Economy

---------------P1

Y1

E1

AD2

P2 ----------------------------------------

Y2

E2

Dollar Priceof a Yen

Qty of Yen

D1

S1

-----------------------------------------

P1

Q1

House ofMoney

Market for YenYen Priceof a dollar

Qty of Dollars

D1

S1

------------------- ----------------------

P1

Q1

Market for Dollars

Japanese disposable income rises => buy more imports from USA:

=> Japanese must exchange Yen for dollars: They demand dollars & they supply Yen

S2

D2

DollarAppreciates

YenDepreciates

Practice Problem #2

skip question #2 part d => not on Final Exam

Practice Problem #3

a) The Federal Funds rate is the interest rate Banks can lend or borrow money from each other

b) The Fed would use purchase Treasury bonds/securities in the open-market. This would inject money into the financial system, thereby increasing MS ↑. An increase in MS would shift MS to the right which leads to a lower nominal interest rates

Practice Problem #3 continued

c) The multiplier is 1/r.r. so 1/.20 = 5 multiplier. -Therefore, a 10 million purchase of bonds would lead to a 50 million ↑ MS. -However, only 8 million could be loaned out….Therefore, Loans could increase by $40 million

d) Nominal Interest rates = Real Interest Rates + Expected Inflation If inflation rises and is expected to be permanent then inflation expectations nominal interest rates ( think long term) would rise.

Real interest rates would remain unchanged based on rising inflation expectations and the equation above