## Thursday, March 26, 2009

### Data Response Exam Preparation: HL P3Q Q2 May 2006

IB Economics - Higher Level - Data Response Question - May 2006, Paper 3, Question 2
(What follows can be soon found as a file -including the diagrams- at our wikispace here)

This one is a macro data with questions (a), (b) and (c) very easy and with (d) somewhat demanding but manageable.

Question (a)(i) asks you to define the unemployment rate. It’s the number of unemployed individuals in an economy expressed as a proportion of the labor force (the number of unemployed divided by the labor force). That’s it! No need to explain who is considered unemployed (BTW, it’s the individual actively searching for a job and unable to find one) or to define the labor force (the sum of those employed and unemployed).
Question (a)(ii) asks you to define the business (or, trade) cycle. A precise and concise definition is that the business cycle refers to the short run fluctuations of real GDP around its long run trend. Again, there is no need to define real GDP or trend output here. Mind you that you could sketch a diagram with real GDP on the vertical and time on the horizontal illustrating these ups and downs which could help you earn the 2 points if the definition you gave was vague.

Question (b) asks you to explain using an appropriate diagram how a government may attempt to close a deflationary gap. Well, the diagram here could be an AD / AS diagram with average price level (P) on the vertical and real output/income (Yr) on the horizontal. A vertical long run aggregate supply curve at the full employment level of output (Yfe) is necessary, an upward sloping short run aggregate supply and an aggregate demand that intersects the SRAS at some level of real output to the left of the full employment level of real output Yfe (below that is full employment; left of the vertical LRAS)). The distance on the vertical axis between the equilibrium level of real output and the full employment level of output is the deflationary gap (also referred to as the recessionary gap). You should also draw a second AD (call it AD’) such that it intersects the SRAS and the point the SRAS intersects the LRAS (so that the equilibrium level of output coincides with the full employment level of output). Remember the (correctly drawn and labeled) diagram earns you 2 points automatically. Now, for the remaining 2 points you could explain that a deflationary gap results when the economy is at equilibrium at a level of output/income below the full employment level (refer to the diagram at this point) and that it is a result of insufficient aggregate demand. It follows that if somehow aggregate demand increased to AD’ the gap would close. The government could thus use either expansionary fiscal policy (increasing government spending and/or lowering taxes) and/or easy monetary policy (lowering interest rates)