3 Practice Free Response Questions Have Fun!

100, ,000 Computers Cars Computers BRAZIL MEXICO Opportunity Cost Table (give-up) (gain) BRAZIL MEXICO 1 Car = ____ Computer 1 Car = _____ Computer 1 Computer = ____ Car 1 Computer ____ Car /4 400,000 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

LRAS 1 Price Level Real GDP AD 1 Practice Problem #2 SRAS 1 Japanese economy booms => Japanese buy more imports (some from USA) USA exports more (NX ↑) => AD ↑ => GDP ↑ & Price Level ↑ Event: Japanese Economy booms American Economy P1P1 Y1Y1 E1E1 AD 2 P2P Y2Y2 E2E2

Dollar Price of a Yen Qty of Yen D1D1 S1S P1P1 Q1Q1 Market for Yen Yen Price of a dollar Qty of Dollars D1D1 S1S P1P1 Q1Q1 Market for Dollars Japanese disposable income rises => buy more imports from USA: => Japanese must exchange Yen for dollars: They demand dollars & they supply Yen S2S2 D2D2 Dollar Appreciates Yen Depreciates 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