MATT ROMANO: Welcome to AP Daily Practice.
My name is Matt Romano.
I'm coming to you from Mary's School in Atlanta, Georgia.
And today we're going to work on some multiple choice questions
primarily from unit 4, the financial sector.
Now if you've watched these before,
you know you have access to a PDF
through the link that you can go ahead and use and answer
the questions as you go.
You can pause the video, answer the questions
before we get started or simply follow along
as we go and pause the video at the appropriate times.
All right, let's get started.
Question number one, a commercial bank
is facing the conditions given below.
If the reserve requirement is 12%
and the bank does not sell any of its securities,
the maximum amount of additional lending this bank can undertake
is?
All right, if you recall from my first video,
we always want to define the problem first.
Answer before answering.
So to define the problem here let's
consider, what are we given?
What are we being asked and what can I do with it?
Well, this is a question about T accounts.
Boom, there's your T account right there.
So they gave you a T account.
We're dealing with limited reserves.
We know that because there's a greater than 0
reserve requirement.
They're not selling any securities.
We want to know how much they're able to lend.
So what exactly is the question asking?
The question is simply asking how much do they
have in excess reserves?
Because that's where the money comes from to lend.
Looking at the T account, the total reserves
is both excess and required in this case.
Securities, that's an asset obviously
that they've purchased, and the loans, that money's gone,
that's the money they already let someone else
borrow and they're going to get that back plus interest down
the road.
So we've got to figure out of the $15,000 in total reserves,
how much of that is available to lend, how much of that
is excess reserves?
So what do I have?
I know that we have a 12% reserve requirement.
That's important.
That's going to be helpful.
That 12% comes from demand deposits.
Remember, that's where the reserve requirement is applied.
They've got to keep 12% of demand deposits on reserve.
Right now they've got $15,000 on reserve.
We're going to come back to that.
What do I need?
You don't need the securities and the loans.
Those numbers are irrelevant.
In this particular situation, this particular question,
those numbers are irrelevant.
We don't need them.
We're only dealing with demand deposits, the reserve
requirement and total reserves of 15,000.
So required reserves are 12,000.
That's your 12% of the $100,000 on demand deposits.
Excess reserves then are going to be
the total reserves minus required reserves, 15,000
minus 12,000.
Now I have my answer.
Look at your options and you can see the detractors
when you look at those options.
You can see where they're trying to get you.
The answer is pretty simple, 15,000 minus 12,000, 3,000.
The answer is C.
Number two, if investors feel that business conditions will
deteriorate in the future, the demand
for loans and real interest rate in the loanable funds market
will change in which of the following
ways in the short run?
OK.
So we're in the loanable funds market.
If I'm writing this down, I'm going to draw the graph.
I'm going to think about the graph itself
and how this is going to really play out.
The key term here is deteriorate.
The business conditions are going to deteriorate.
Investors are concerned.
They're not very optimistic.
So if that's the case, they really
don't want to be borrowing any money.
So how is that going to affect our loanable funds market?
Specifically how is going to affect demand for loans?
How is it going to affect the real interest
rate as a result of the change in demand for loans?
Well, the first thing we can do, and I
wanted to look at this question intentionally
because of the two columns.
Go through the first column first and determine an answer
there to narrow things down.
If investors are concerned about future business conditions,
they don't want to borrow more money so A and B cannot be
the correct answer because demand for loans is going
to decrease.
So now we're down to C, D and E. Again, draw your graph.
Shift your demand curve and see what happens as a result.
What's going to happen to your equilibrium real interest rate?
Well, it's not going to increase and it's not
going to not change.
The real interest rate is going to decrease.
Again, use the graph because it's
a tool that's going to help you answer questions
and that's what they're supposed to be.
These aren't just things we memorize
for the sake of memorizing.
They're tools that we use to help us understand the world.
Draw a graph.
Question number three.
During a mild recession, if policymakers
want to reduce unemployment by increasing investment,
which of the following policies would be most appropriate?
All right, so again, stop and think.
We're in a recession.
That means we need some sort of an expansionary policy.
It didn't specify whether it's going to be fiscal or monetary,
but it's got to be expansionary.
But they want to increase investment spending, which
means they're going to have to decrease interest rates to do
so.
So we need a policy that can do both of those things.
It can be expansionary in direction in nature
but also decrease interest rates.
Now let's bring on the options see which ones fit these two.
All right.
A equal increases in government expenditures and taxes.
Well, if there are equal increases in government
expenditures and taxes, are we going
to get both expansionary policy and a decrease
in interest rates?
I'm not so sure that's going to happen.
Scratch that one.
That's not your correct answer.
An increase in government expenditures only.
Well, again, increase in government expenditures.
Expansionary yes, but could that lead to a government deficit?
Could that lead to an increase in demand for loanable funds?
Increase in interest rates?
It could.
I don't think that's the correct answer either.
C, an increase in transfer payments.
Transfer payments are another form
of government expenditures.
Transfer payments also in this case could lead to a deficit,
could lead to higher interest rates.
Can't go with C.
D, increase in the reserve requirement.
Obviously that's not going to do it.
Increase in reserve requirement is a contractionary policy.
That first qualification is not met there.
How about E?
A decrease in administered interest rates.
Now think through this one just a second here.
That's going to be your monetary policy.
Picture a reserve market graph.
Draw it if you need to.
Draw your reserve market.
Decrease administered interest rates
that decreases the cost of borrowing,
increases investment spending, AD shifts to the right,
potentially closing the gap through an increase
in investment spending.
Looks good to me.
Correct answer to number three is E.
Question number four, country's economy
is in equilibrium at point H. Which of the following policies
would be most effective to reduce
price level in the short run?
So we're at point H. Identify point H. There it is.
Point H is telling us we have an inflationary gap
and what we're trying to do is utilize a policy that's
going to lower the price level.
That means we need, if we're going monetary policy,
a contractionary monetary policy.
And typically again, we're in unit 4 here
we're thinking monetary policy when
we talk about trying to reduce price level.
So we're looking for a contractionary policy,
we're looking to shift AD to the left.
What are our options?
Increase minimum wage, increase government expenditures,
increase interest on reserves, decrease required reserve
ratio, decrease income tax rates.
Which of these is going to be a contractionary policy which
also has the effect of bringing down the price level?
It's going to be option C, increasing
the interest on reserves.
Once again, think in terms of the reserve market,
think about increasing interest on reserves,
increasing the cost of borrowing therefore decreasing interest
sensitive consumption investment spending
shifting AD to the left.
Question number five, the country of Agronomia--
I don't know if that's how you pronounce it or not
but let's go with it, Agronomia.
Banks charge 10% interest on all loans.
If the general price level has been increasing
at a rate of 4% per year, the real rate
of interest in Agronomia is?
All right, so what did they tell us?
They told us what they're charging,
they told us the nominal rate.
They told us increase in price level, inflation rate.
We're looking for real interest rate.
What does that sound like?
That's a Fisher Equation question.
That's an ex poste Fisher Equation question.
In other words, we're determining real interest rate
after money has been paid back, after we know what was charged,
the nominal rate, little i and we know the inflation rate,
which is represented by pi.
Now what do we have to do?
Determine what goes where, plug our numbers in and solve
for the real interest rate.
You have a nominal interest rate of 10%,
you have an inflation rate of 4%, 10 minus 4, 6%.
The real interest rate is 6%.
Now look at your options.
Again, if you look at the numbers
and you look at the numbers in the question,
you can see where the incorrect answers come from.
You've got to make sure you're putting the right numbers
in the right places.
Based on the work we've done the correct answer is C, 6%.
Number six, country H's current domestic output
is lower than its potential domestic output.
They're telling you something there.
Assume the central bank now decreases
administered interest rates, what
will be the short run effects of the central bank's actions
on cyclical unemployment and real income?
So what has happened here?
They're operating below full employment.
Central bank decreases administered interest rates
as an expansionary monetary policy,
which is going to lead to an increase in aggregate demand.
And we have to make a conclusion about what
that's going to do to cyclical unemployment and real income.
Option A can't be your answer.
Cyclical unemployment increase, real income increase.
Now, AD shifted to the right.
If AD shifts to the right, output goes up,
unemployment goes down, specifically
cyclical unemployment goes down.
A is not your right answer.
B, once again, starts off by telling us
cyclical unemployment will increase.
No, it won't.
Cyclical unemployment's going to decrease
because of the rightward shift in AD
and the increase in output.
Scratch that one.
Option C, cyclical unemployment remain the same.
No, not if the policy has the effect it's desired to.
Option C is not correct.
Scratch that one.
Option D. Once again, cyclical unemployment remained the same.
No, we know it's going to fall.
Can't be option D, so option E. Let's check it out.
Make sure it's correct.
Cyclical unemployment will decrease,
real income will increase.
Yes, that is correct.
Again, the decrease in borrowing costs
is going to shift AD to the right
as interest sensitive spending goes up.
As AD shifts to the right, output increases,
unemployment goes down, real income is increased.
Again, use your knowledge of models,
use your knowledge of models to help you answer these questions
and everything else becomes that much easier.
All right.
I want to thank you for coming along and viewing this video.
I want to make sure that you keep coming back to watch more.
As I've said before, you've got to practice this stuff.
And as I'll say again, a problem well defined is half solved.
Thank you, and have a great day.