Free AP Macroeconomics Free-Response (FRQ) Practice Exam (PDF)

This free AP Macroeconomics free-response practice set follows the current Section II format: one long question worth 10 points and two short questions worth 5 points each, answered in 60 minutes including a 10-minute reading period. The long question covers an inflationary gap, open-market operations, the money market and the Phillips curve; the short questions cover inflation and real interest rates, and the loanable funds market. The answer version gives point-by-point scoring guidelines, so you can mark every graph and explanation yourself.

1. Question 110 marks · AD–AS, monetary policy, money market, Phillips curve
   Monetary policy and the output gap. Veridia is currently in short-run equilibrium with an unemployment rate of 3 percent. The natural rate of unemployment in Veridia is 5 percent. Assume that the banking system has limited reserves and that the central bank conducts monetary policy through open-market operations.
   $u = 3\%, \qquad u_n = 5\%$
   (a)

   Draw a correctly labeled graph of aggregate demand, short-run aggregate supply and long-run aggregate supply for Veridia. Show each of the following: (i) the current equilibrium price level and real output, labeled $PL_1$ and $Y_1$; (ii) full-employment output, labeled $Y_f$.

   [2]
   (b)

   (i) Identify the open-market operation the central bank should use to move real output toward full employment. (ii) Draw a correctly labeled graph of the money market and show the effect of the open-market operation you identified in part (b)(i) on the nominal interest rate.

   [3]
   (c)

   Based on your answer to part (b)(ii), what will happen to aggregate demand in Veridia? Explain.

   [1]
   (d)

   Now assume instead that the central bank takes no policy action. Explain how the short-run aggregate supply curve will adjust in the long run, and state what will happen to the price level and to real output relative to $PL_1$ and $Y_1$.

   [2]
   (e)

   Draw a correctly labeled graph of the short-run and long-run Phillips curves. Plot a point labeled A that shows Veridia's current situation described in the question, and show the numerical value of the natural rate of unemployment on your graph.

   [2]
2. Question 25 marks · Price indices, real vs nominal interest rates
   Inflation and real interest rates. On January 1, Harbor Bank lends 20,000 dollars to a small business for one year at a fixed nominal interest rate of 7 percent. When the loan is signed, both the bank and the business expect the inflation rate over the year to be 3 percent. The table shows the consumer price index (CPI) at the start and at the end of the year.
   $$\begin{array}{l|c} \hline \text{Date} & \text{Consumer price index} \\ \hline \text{January 1} & 150 \\ \text{December 31} & 159 \\ \hline \end{array}$$
   (a)

   Using the CPI values in the table, calculate the actual inflation rate for the year. Show your work.

   [1]
   (b)

   Calculate the real interest rate that the bank and the business expected when the loan was signed. Show your work.

   [1]
   (c)

   Calculate the actual real interest rate on the loan. Show your work.

   [1]
   (d)

   Does the unanticipated inflation benefit the bank or the business? Explain.

   [1]
   (e)

   For a new one-year loan, the bank now expects inflation of 6 percent and wants to earn the same real interest rate that it expected in part (b). What nominal interest rate should it charge? Show your work.

   [1]
3. Question 35 marks · Loanable funds, investment & long-run growth
   The loanable funds market. The government of Marovia initially has a balanced budget. Households in Marovia become more concerned about saving for retirement and increase the amount they save at every real interest rate.
   (a)

   Draw a correctly labeled graph of the loanable funds market and show the effect of the increase in household saving on the equilibrium real interest rate.

   [2]
   (b)

   Based on your answer to part (a), what will happen to the level of private investment in physical capital in Marovia? Explain.

   [1]
   (c)

   Explain how the change in investment you identified in part (b) will affect Marovia's long-run economic growth.

   [1]
   (d)

   Suppose that at the same time as households increase their saving, the government of Marovia begins to run a budget deficit financed by borrowing. Compared with the original equilibrium, will the real interest rate increase, decrease, or is the change indeterminate? Explain.

   [1]

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