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Free-Response Questions

  1. Question

    Consider an economy operating at full employment.



    1. Draw a correctly labeled aggregate supply and aggregate demand graph for the economy. On your graph, show each of the following:



      1. equilibrium price level, labeled P1



      2. equilibrium output level, labeled Y1





    2. Assume the government increases transfer payments to families with dependent children.



      1. Show the effect of the increase in transfer payments on your graph.



      2. Label the new short-run equilibrium price level P2 and the new short-run equilibrium output level Y2.





    3. Refer to the new short-run equilibrium shown on your graph in response to part b.



      1. The new short-run equilibrium illustrates what type of output gap?



      2. What type of fiscal policy would be appropriate for an economy facing a persistent gap of the type you identified in part i? (7 points)

    Rubric for FRQ (7 points)

    1 point: A graph with “Aggregate price level” or “Price level” and “Real GDP” on the vertical and horizontal axes; a labeled, downward-sloping AD curve; and a labeled, upward-sloping SRAS curve

    1 point: A vertical LRAS curve that passes through the intersection of the AD and SRAS curves

    1 point: Showing P1 on the vertical axis and Y1 on the horizontal axis, both at the intersection of the AD and SRAS curves

    1 point: Showing a labeled, downward-sloping AD curve to the right of the original AD curve

    1 point: Showing P2 on the vertical axis and Y2 on the horizontal axis, both at the intersection of the new AD and original SRAS curves

    1 point: Inflationary gap

    1 point: Contractionary policy

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