AP® Macroeconomics · Free response

Deficit spending at full employment in Tamsin: AD-AS, loanable funds and growth

write it first, then score yourself point by point

Long free-response question · four-function calculator · 10 points · about 25 minutes

Start writingAll 18 questions

The question

Name: ______________________   Date: ____________   Deficit spending at full employment in Tamsin: AD-AS, loanable funds and growth (10 points)

Tamsin, an invented country, is in long-run equilibrium at full employment. Its government raises spending on public services by 60 billion dollars a year and pays for it by borrowing, so its budget deficit grows. Assume Tamsin's central bank takes no action.

  1. (A) Draw a correctly labeled AD-AS graph showing Tamsin's long-run equilibrium, with LRAS, PL1 and YF. Show the short-run effect of the rise in government spending, labeling the new price level PL2 and real output Y2. [3 points]

  2. (B) Identify how Tamsin's unemployment rate in the short run compares with its natural rate. [1 point]

  3. (C) Draw a correctly labeled graph of Tamsin's loanable funds market. Show the effect of the government's borrowing on the real interest rate, and label the new real interest rate r2. [3 points]

  4. (D) Explain how the change in the real interest rate you showed in part C affects private investment and the growth of Tamsin's capital stock. [2 points]

  5. (E) Compared with what would have happened without the borrowing, will Tamsin's production possibilities curve shift outward by more, by less or by the same amount in the future? Explain. [1 point]