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 is Monetary Policy?
Monetary policy is the process by which a central bank, such as the Federal Reserve or the European Central Bank, manages the money supply and interest rates to achieve economic objectives. These goals often include controlling inflation, stabilizing the currency, and promoting economic growth. Central banks use tools like adjusting interest rates, conducting open market operations, and setting reserve requirements. Monetary policy is categorized as expansionary, to stimulate the economy, or contractionary, to curb inflation and slow down growth when necessary.
You might find it helpful to check out our detailed AP Macro Notes on Monetary Policy.
What is Quantitative Easing?
Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the economy when traditional tools like lowering interest rates are insufficient. Under QE, the central bank purchases long-term government bonds and other financial assets to inject liquidity into the economy, lower interest rates, and encourage borrowing and investment. QE is typically used during economic downturns or financial crises but may risk inflation if applied excessively. It aims to support economic recovery and stabilize financial markets.
AP Macroeconomics Free Response Questions on Monetary Policy
Question 1
The economy of Alpha is in short-run equilibrium with a cyclical unemployment rate of 3%, a frictional unemployment rate of 4%, and an actual unemployment rate of 8%.
(d) Assume instead that Alpha’s central bank is considering using monetary policy to close a recessionary output gap. The banking system in Alpha has ample reserves. Identify a specific monetary policy action the central bank of Alpha would take to close the output gap in the short run.
(e) Draw a correctly labeled graph of the reserve market in Alpha, and show the effect of the action taken by the central bank identified in part (d) on the policy rate.
(f) Based on the change in the policy rate shown in part (e), what would happen to each of the following in the short run in Alpha? (i) The price of previously issued bonds (ii) The price level. Explain.
Question 2
The economy of Noralandia is in short-run equilibrium with an actual inflation rate that is currently higher than the expected inflation rate.
(b) The banking system in Noralandia has ample reserves. Identify a specific monetary policy action that the central bank of Noralandia would take to bring the inflation rate closer to the expected inflation rate.
(c) Noralandia has an open economy and a flexible exchange rate. Based solely on the effect of the monetary policy action identified in part (b) on interest rates in Noralandia, will there be an increase, a decrease, or no change in the flow of international financial capital into Noralandia? Explain.
(d) Based on your answer to part (c), what will happen to the international value of Noralandia’s currency? Explain.
Question 3
Assume that the economy of Moneyland is in equilibrium with an actual unemployment rate equal to the natural rate of unemployment.
(d) The central bank of Moneyland is concerned about the short-run effects of the decrease in consumer spending on the broader economy and is considering taking action rather than waiting for the long-run adjustment process. Assuming the banking system in Moneyland has ample reserves, identify a specific monetary policy action the central bank of Moneyland would take to increase consumer spending.
(e) Draw a correctly labeled graph of the reserve market in Moneyland, and show the effect of the monetary policy action identified in part (d) on the policy rate.
(f) How would the change in the policy rate shown on your graph in part (e) affect each of the following in Moneyland in the short run? (i) The quantity of national savings (ii) Unemployment. Explain.
Question 4
Assume that the economy of country Zen is in long-run macroeconomic equilibrium.
(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) On your graph in part (a), show the short-run effect of an increase in consumer confidence. Label the new equilibrium real output Y2 and the new equilibrium price level PL2.
(c) Assume that the banking system in Zen has ample reserves. Suppose that the central bank’s goal is to maintain a stable price level at PL1. Based on the change in the price level shown in part (b), identify one specific monetary policy action the central bank would take to achieve its goal.
(d) Based on the monetary policy action identified in part (c), will real output increase, decrease, or stay the same in the short run? Explain.
Question 5
Assume that commercial banks must hold a minimum of 20% of their deposits as reserves. Now suppose that the central bank of the country sells $100,000 of government bonds to commercial banks.
(a) Calculate the maximum change and state the direction of change in the money supply as a result of the central bank bond sale. Show your work.
(b) Draw a correctly labeled graph of the money market and show the effect of the change in the money supply identified in part (a) on the nominal interest rate.
(c) Given the change in the money supply in part (a), if the velocity of money is constant, what will happen to the nominal gross domestic product? Explain.
(d) Based on the change in the nominal gross domestic product in part (c), what happens to the price level if the real gross domestic product is constant?
Question 6
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 7
Assume the economy of Sweden is in long-run equilibrium and has a surplus in its current account.
(a) Is the Swedish capital and financial account in deficit, in surplus, or in balance? Explain.
(b) Draw a correctly labeled graph of short-run aggregate supply, long-run aggregate supply, and aggregate demand curves for Sweden, and show the current equilibrium real output, labeled Y1, and the current equilibrium price level, labeled PL1.
(c) Assume the United Kingdom decreases its imports from Sweden. On your graph in part (b), show the new equilibrium real output, labeled Y2, and the new equilibrium price level, labeled PL2, as a result of this change.
(d) As a result of the decrease in the United Kingdom’s imports from Sweden, would policy makers in Sweden be more concerned about cyclical unemployment or inflationary pressures in the short run? Explain.
(e) If the Swedish central bank’s goal is to return the economy to long-run equilibrium, what open-market operation should it use?
(f) The currency of the United Kingdom is the pound, and the currency of Sweden is the krona. Draw a correctly labeled graph of the foreign exchange market for the krona, and show the impact of the decrease in the United Kingdom’s imports from Sweden on the value of the krona in the foreign exchange market.
(g) If the Swedish central bank’s goal is to reverse the exchange rate change shown in part (f) by changing the interest rate, what open-market operation should it use?
(h) Explain how the open-market operation identified in part (g) would reverse the change in the exchange rate.
Question 8
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 9
Canada is an open economy that is currently in a recessionary output gap.
(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) The current equilibrium real output and price level, labeled as Y1 and PL1, respectively (ii) Full-employment output, labeled Yf
(b) The central bank and the government do not take any policy actions to close the output gap. (i) Explain how the economy will adjust to full employment in the long run. (ii) On your graph in part (a), show how the economy adjusts to full employment in the long run.
(c) Suppose the Canadian government is unwilling to wait for the long-run adjustment process. The marginal propensity to consume is 0.8. The equilibrium real output is $500 billion and the full-employment output is $540 billion. (i) Calculate the minimum change and indicate the direction of change in government spending required to shift the aggregate demand curve by the amount of the output gap. (ii) Calculate the minimum change and indicate the direction of change in taxes required to shift the aggregate demand curve by the amount of the output gap.
(d) Assume instead that the Canadian central bank takes actions to restore the economy to full-employment output by influencing investment spending. Draw a correctly labeled graph of the money market, and show the effect of the actions taken by the central bank on the equilibrium interest rate.
(e) Canada and Mexico are trading partners. Draw a correctly labeled graph of the foreign exchange market of the Canadian dollar, and show the effect of the change in the interest rate in part (d) on the value of the Canadian dollar with respect to the Mexican peso
Question 10
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 11
Assume that an economy is in long-run equilibrium. Assume that consumers wish to hold less money because they use credit cards more frequently to purchase goods and services than cash.
(a) Draw a correctly labeled graph of the money market and show the effect of the reduced holdings of money on the equilibrium nominal interest rate in the short run.
(b) Based on the change in the interest rate in part (a), what will happen to each of the following in the short run? (i) Prices of previously issued bonds (ii) The price level and real income. Explain.
(c) With a constant money supply, based on your answer to part b(ii), will the velocity of money increase, decrease, or remain the same, or is the change indeterminate?
(d) If the central bank wishes to reverse the change in the interest rate identified in part (a), what open market operation would it use?
Question 12
Assume that the United States economy is currently in a short-run equilibrium with the actual unemployment rate above the natural rate of unemployment.
(a) Draw a single correctly labeled graph with both the long-run Phillips curve and short-run Phillips curve. Label the current short-run equilibrium point P.
(b) Assuming no policy actions are taken, will the short-run Phillips curve shift to the right (upward), shift to the left (downward), or remain the same in the long run? Explain.
(c) If the Federal Reserve Bank wants to lower unemployment, what expansionary open-market operation should it use?
(d) How will the open-market operation you identified in part (c) affect each of the following? (i) Federal funds rate. Explain. (ii) Real interest rate in the short run.
(e) Given your answer in part (d)(ii), what is the effect on real gross domestic product (GDP) in the short run? Explain.
(f) Japan and the United States are major trading partners. Indicate how the change in real GDP you identified in part (e) will affect the demand for the Japanese yen in the foreign exchange market.
(g) Draw a correctly labeled graph of the foreign exchange market for the Japanese yen, showing the effect of the change in demand identified in part (f) on the value of the Japanese yen relative to the United States dollar.
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.