What is AP Macroeconomics?
AP Macroeconomics is a high school course designed to teach students the fundamentals of economics at a macro level. It covers GDP, unemployment, inflation, monetary and fiscal policies, and international trade. A major component of the course includes understanding aggregate supply and demand, and tools for analyzing economic fluctuations. The course culminates in the AP exam, which features multiple-choice and free response questions, including scenarios involving aggregate supply and demand. Mastering these topics can help students earn college credit and better prepare for advanced economics courses.
Where did we get these AP Macroeconomics free response questions on aggregate supply and demand?
The AP Macroeconomics free response questions on aggregate supply and demand provided here are sourced from official College Board exams and teacher-developed practice materials. These questions are carefully selected to align with key concepts covered in the AP Macroeconomics curriculum. Each question focuses on scenarios analyzing aggregate supply, aggregate demand, or shifts in either curve due to various economic changes. By practicing with these real and high-quality examples, students can enhance their understanding, test-taking skills, and overall readiness for the AP exam.
How to use these AP Macroeconomics free response questions
Use these AP Macroeconomics free response questions on aggregate supply and demand to maximize your learning as timed practice. Start by reading the question carefully, then outline your answer with clear labels and diagrams where necessary. Focus on explaining shifts in aggregate supply or demand and the resulting impact on equilibrium output, price levels, and the economy. Review the scoring rubric to understand how points are awarded. Practicing consistently with these questions will boost your confidence and help you ace the AP exam.
What are Fiscal Policies?
Fiscal policies refer to the strategies and actions taken by a government to influence its economy through changes in taxation and public spending. These policies aim to achieve economic goals like controlling inflation, reducing unemployment, and promoting growth. Expansionary fiscal policy, involving increased spending or tax cuts, stimulates economic activity, while contractionary policy reduces spending or raises taxes to cool down an overheated economy. Fiscal policies are crucial for managing economic stability and addressing both short-term and long-term challenges.
You might find it helpful to check out our detailed AP Macro Notes on Government Spending and Fiscal Policies.
AP Macroeconomics Free Response Questions on Government Spending and Fiscal Policies
Question 1
Assume Malaysia’s economy is in a recession and its government currently has a balanced budget.
(a) Identify a specific fiscal policy action that the government of Malaysia would implement to address the recession.
(b) How will the fiscal policy action identified in part (a) affect the real interest rate in Malaysia? Explain
Question 2
Assume that Jamaica has a cyclical unemployment rate of 4% and a balanced capital and financial account (CFA).
(a) Identify a specific fiscal policy action that Jamaica’s government would take to bring its economy to full employment.
(b) Based solely on the short-run change in real output resulting from the fiscal policy action identified in part (a), what will happen to Jamaica’s net exports? Explain.
Question 3
Assume the economy of Vanderlandia is in short-run equilibrium with a real GDP of $500 million. The full-employment level of real GDP is $550 million.
(c) Assume instead that policymakers in Vanderlandia are considering changing government spending to restore full employment in the short run and that the marginal propensity to save is 0.2. (i) Calculate the minimum change and state the direction of change in government spending required to completely close the output gap in the short run. Show your work. (ii) On your graph in part (a), show the short-run effect of the change in government spending in part (c)(i), labeling the new equilibrium price level PL2.
(d) Draw a correctly labeled graph of the loanable funds market, and show the effect of the change in government spending in part (c)(i) on the equilibrium real interest rate.
(e) Based on the change in the real interest rate shown on your graph in part (d), what will happen to each of the following? (i) The price of previously issued bonds (ii) The rate of economic growth in the long run. Explain.
Question 4
Assume the United States economy is in short-run macroeconomic equilibrium at an output level greater than potential output.
(a) Draw a correctly labeled graph of the aggregate demand, short-run aggregate supply, and long-run aggregate supply curves, and show each of the following. (i) The current equilibrium real output and price level, labeled as Y1 and PL1, respectively (ii) The full-employment output, labeled as YF
(b) Assume government spending increases by $100 billion. On your graph in part (a), show the short-run effect of the change in government spending on the equilibrium real output and price level. Label the new equilibrium output as Y2 and the new equilibrium price level as PL2.
(c) Assume the marginal propensity to consume is 0.8. As a result of the increase in government spending, what is the numerical value of the maximum change in each of the following in the short run? (i) Real output (ii) Household savings
(d) Draw a correctly labeled graph of the money market and show the effect of the change in real output identified in part (c)(i) on the equilibrium nominal interest rate.
(e) Based on the change in the nominal interest rate shown in part (d), what will happen to the prices of previously issued bonds in the short run?
(f) The United States and the European Union are trading partners with flexible exchange rates. The currency in the United States is the dollar, and the currency in the European Union is the euro. Assume the inflation rate in the United States increases relative to the inflation rate in the European Union. As a result of the change in the United States inflation rate, what will happen to each of the following in the foreign exchange market? (i) The demand for dollars. Explain. (ii) The international value of the dollar
(g) Suppose the Federal Reserve attempts to keep the value of the dollar constant in the foreign exchange market. Based on the change in the value of the dollar in part (f)(ii), should the Federal Reserve buy or sell each of the following? (i) The euro (ii) The dollar
Question 5
The table below shows macroeconomic data for Country A. Year Nominal GDP GDP Deflator Population 2020 40,000 100 100 2021 88,000 200 110
(a) Calculate each of the following for Country A in year 2021. Show your work. (i) Real GDP (ii) Real GDP per capita
(b) Based solely on the data provided, has the standard of living for the average person in Country A increased, decreased, or stayed the same between 2020 and 2021 ? Explain.
(c) How would an increase in government spending on education affect economic growth in Country A? Explain.
(d) Assume that Country A produces consumer goods and capital goods. Draw a correctly labeled production possibilities curve for Country A, and show the effect of the increase in government spending on education on your graph.
Question 6
Assume a country’s economy is currently operating below full employment.
(a) Identify a fiscal policy action the country’s government could implement to restore full employment.
(b) Draw a correctly labeled graph of the loanable funds market, and show the effect of the fiscal policy action identified in part (a) on the equilibrium real interest rate.
(c) Based solely on the real interest rate change shown in part (b), what will happen to each of the following? (i) Net exports. Explain. (ii) The stock of physical capital. Explain.
Question 7
Assume Smithland is in short-run equilibrium at a level of output that exceeds the full-employment level of output.
(a) Draw a correctly labeled graph of the aggregate demand, short-run aggregate supply, and long-run aggregate supply curves, and show each of the following. (i) The current equilibrium real output and price level, labeled Y1 and PL1, respectively (ii) The full-employment output, labeled YF
(b) Assume Smithland’s government cuts individual income taxes. On your graph in part (a), show the short-run effect of the tax cut on equilibrium real output, labeling the new short-run equilibrium real output Y2.
(c) Based solely on the change in real output on your graph in part (b), what will happen to each of the following in the short run? (i) The natural rate of unemployment (ii) Nominal interest rates. Explain.
(d) Assume instead the central bank intervenes to correct an inflationary output gap. What open-market operation should the central bank take?
(e) Draw a correctly labeled graph of the money market, and show the effect of the open-market operation identified in part (d) on the nominal interest rate.
(f) Based solely on the interest rate change identified in part (e), what will happen to the international value of Smithland’s currency in the foreign exchange market? Explain.
(g) Based solely on the exchange rate change identified in part (f), will Smithland’s imports increase, decrease, or remain the same? Explain.
Question 8
An economy is currently in short-run equilibrium with a recessionary output gap of $600 billion.
(a) Draw a single correctly labeled graph with both the short-run and long-run Phillips curves. Label the initial short-run equilibrium point X.
(b) Suppose the government implements fiscal policy in order to achieve full-employment output and the marginal propensity to consume is 0.75. (i) Calculate the minimum change in government spending required to increase aggregate demand by the amount of the output gap of $600 billion. Show your work. (ii) Suppose instead the government wants to change taxes rather than government spending. Calculate the minimum change in taxes required to increase aggregate demand by the amount of the output gap of $600 billion. Show your work.
(c) Assume instead the government takes no policy action to close the output gap shown in part (a). Explain how the economy will adjust in the long run.
Question 9
The government budget of the country of Geeland is currently balanced. The government budget is composed of tax revenues (T), transfer payments (TR), and government spending (G).
(a) Assume the economy moves into a recession and there is no discretionary policy action. (i) Will the government budget move into a deficit or a surplus in the short run? Explain using the appropriate components of the government budget identified above. (ii) Based on your answer to part (a)(i), what will happen to the government debt?
(b) Based on your answer to part (a)(i), identify one specific fiscal policy action that will balance the budget.
(c) How will the fiscal policy action from part (b) affect the actual unemployment rate in the short run? Explain.
(d) Did the government efforts to maintain a balanced budget make Geeland’s recession more severe or less severe in the short run? Explain.
Question 10
Assume the economy of Artland is currently operating above full employment.
(a) Draw a correctly labeled graph of the short-run aggregate supply, long-run aggregate supply, and aggregate demand curves, and show each of the following. (i) The current equilibrium real output and price level, labeled as Y1 and PL1, respectively (ii) The full-employment output, labeled as Yf
(b) Assume the central bank and the government do not take any policy actions to close the output gap. (i) On your graph in part (a), show how the economy automatically adjusts in the long run and label the new equilibrium price level PL2. (ii) Explain the cause of the adjustment shown in part (b)(i).
(c) Alternatively, suppose the government wants to close the output gap using fiscal policy. (i) Identify a fiscal policy action the government could implement to close the output gap. (ii) How will the fiscal policy action identified in part (c)(i) affect the following? – The unemployment rate – The natural rate of unemployment (iii) In closing the output gap, will the automatic adjustment identified in part (b)(i) produce a higher, a lower, or the same price level compared to the fiscal policy identified in part (c)(i) ?
(d) Draw a correctly labeled graph of the market for loanable funds. Show the effect of the fiscal policy action identified in part (c)(i) on the equilibrium real interest rate.
(e) Given the interest rate change identified in part (d), will the long-run aggregate supply curve shift to the right, shift to the left, or remain the same in the long run? Explain.
Question 11
Assume the United States economy is in recession.
(a) Draw a correctly labeled graph of the long-run aggregate supply, short-run aggregate supply, and aggregate demand curves, and show each of the following. (i) Current price level, labeled PL1 (ii) Current output, labeled Y1
(b) Now assume the euro zone, a major trading partner of the United States, enters into a recession. (i) What will be the effect on United States exports to the euro zone? Explain. (ii) On your graph in part (a), show the effect of the change identified in part (b)(i) on real output in the United States. (iii) What will be the effect of the change identified in part (b)(ii) on unemployment in the United States?
(c) Assume the euro zone recession causes a decrease in the demand for United States dollars in the foreign exchange market. (i) Will the euro appreciate, depreciate, or remain unchanged against the dollar? Explain. (ii) Draw a correctly labeled graph of the foreign exchange market for dollars, and show the effect of the decrease in the demand for dollars on the exchange rate for dollars.
(d) Assume the United States implements a combination of expansionary fiscal and monetary policies. In the absence of complete crowding out, what will be the effect of these policies on each of the following? (i) Aggregate demand in the United States (ii) The price level in the United States. (iii) Interest rates in the United States. Explain.
Question 12
Assume that the economy of Country X has an actual unemployment rate of 7%, a natural rate of unemployment of 5%, and an inflation rate of 3%.
(a) Using the numerical values given above, draw a correctly labeled graph of the short-run and long-run Phillips curves. Label the current short-run equilibrium as point B. Plot the numerical values above on the graph.
(b) Assume that the government of Country X takes no policy action to reduce unemployment. In the long run, will each of the following shift to the right, shift to the left, or remain the same? (i) Short-run aggregate supply curve. Explain. (ii) Long-run Phillips curve
(c) Identify a fiscal policy action that could be used to reduce the unemployment rate in the short run.
(d) Draw a correctly labeled graph of aggregate demand and short-run aggregate supply, and show the impact on the equilibrium price level and real gross domestic product (GDP) of the fiscal policy action identified in part (c).
(e) Based on the change in real GDP identified in part (d), will the supply of Country X’s currency in the foreign exchange market increase, decrease, or remain the same? Explain.
(f) Based on your answer to part (e) and assuming a flexible exchange rate system, will Country X’s currency appreciate, depreciate, or remain the same in the foreign exchange market?
Question 13
Assume that the United States economy is operating below full employment.
(a) Draw a correctly labeled graph of long-run aggregate supply, short-run aggregate supply, and aggregate demand, and show each of the following. (i) Current equilibrium output and price level, labeled as Y1 and PL1 (ii) Full-employment output, labeled as Yf
(b) Assume that the Federal Reserve targets a new federal funds rate to reach full employment. Should the Federal Reserve target a higher or lower federal funds rate?
(c) Given the Federal Reserve action you identified in part (b), draw a correctly labeled graph of the money market and show the effect on the nominal interest rate.
(d) The policy makers pursue a fiscal policy rather than the monetary policy in part (b). Assume that the marginal propensity to consume is 0.8 and the value of the recessionary gap is $300 billion. (i) If the government changes its spending without changing taxes to eliminate the recessionary gap, calculate the minimum required change in government spending. (ii) If the government changes taxes without changing government spending to eliminate the recessionary gap, will the minimum required change in taxes be greater than, smaller than, or equal to the minimum required change in government spending in part (d)(i) ? Explain.
(e) Assume the government lowers income tax rates to eliminate the recessionary gap. Will each of the following increase, decrease, or stay the same? (i) Aggregate demand. Explain. (ii) Long-run aggregate supply. Explain.
Question 14
Exchange rates and interest rates are important for macroeconomic decision making.
(a) How does an increase in Japan’s government budget deficit affect each of the following? (i) The real interest rate in the short run in Japan. Explain. (ii) Private domestic investment in plant and equipment in Japan
(b) Draw a correctly labeled graph of the foreign exchange market for the euro, and show the effect of the change in the real interest rate in Japan from part (a)(i) on each of the following. (i) Supply of euros. Explain. (ii) Yen price of the euro
(c) To reverse the change in the yen price of the euro identified in part (b)(ii), should the European Central Bank buy or sell euros in the foreign exchange market?
Answer Key
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Mark is an A-Level Economics tutor who has been teaching for 6 years. He holds a masters degree with distinction from the London School of Economics and an undergraduate degree from the University of Edinburgh.