AP_Krugman_Textbook

and decreasing the interest rate from r 1 to r 2 in the

accompanying figure.

Tackle the Test:

Multiple-Choice Questions

1. e


2. b


3. e


4. a


5. e

Tackle the Test:

Free-Response Questions

Graph answers parts a and b.

2. a.The vertical axis is labeled “Aggregate price level” and the
   horizontal axis is labeled “Aggregate output” or “Real
   GDP.” The ADcurve slopes downward, the SRAScurve
   slopes upward, and the LRAScurve is vertical—all are
   labeled. The equilibrium aggregate price level and aggre-
   gate output are shown on the axes where the ADcurve

Y 1 Y 2

SRAS

LRAS

AD 1

Potential

output

Real GDP

Aggregate

price

level

E 1

E 2

AD 2

P 1

P 2

Interest

rate

S

r 1

r 2

Quantity of

loanable funds

D 1

D 2

and the SRAScurve intersect, which is to the left of the

LRAS curve.

b.The ADcurve shifts to the right. The other curves are

unchanged. The new equilibrium price level and aggregate

output are shown on the axes at the new equilibrium

point. The new equilibrium does not need to be at poten-

tial output.

c.Axes are labeled “Interest rate” and “Quantity of loanable

funds.” The demand curve slopes downward, the supply

curve slopes upward, and the curves are labeled. The equi-

librium interest rate and quantity are shown on the axes

at the point where the curves intersect. The demand for

loanable funds shifts to the right and the new equilibrium

values are shown on the axes. The interest rate is higher.

d.Axes are labeled “Exchange rate” and “Quantity of U.S.

dollars.” The demand curve slopes downward, the supply

curve slopes upward, and the curves are labeled. The equi-

librium exchange rate and quantity are shown on the

axes at the point where the two curves intersect. The sup-

ply of U.S dollars decreases, shifting the supply curve to

the left, because the higher interest rate in the United

States decreases the outflow of capital to countries with a

relatively low interest rate.

e.The value of the U.S. dollar has increased (it has appreci-

ated). U.S. exports will decline, and aggregate demand

will decline.

Interest

rate S

r 1

r 2

Quantity of

loanable funds

D 1

Q 1 Q 2

D 2

S 2

E 2

Q 1 Q 2

XR 1

XR (^2) E 1
D
Exchange rate
0
Quantity of U.S. dollars
S 1
SOLUTIONS TO AP REVIEW QUESTIONS S-27