One Shock, Every Graph: A Full Trace

You’ll be able to

Carry a single policy change through AD–AS, the money market, loanable funds and forex
Maintain consistency of direction across four diagrams
Identify which graph a given sub-question requires

The four graphs and their order

Long free responses walk a single shock through several diagrams, and the order is almost always the same. AD–AS establishes what happened to real GDP and the price level. Money market gives the nominal interest rate. Loanable funds gives the real rate and investment, and is where crowding out appears. Forex gives the exchange rate and net exports. Answer them in that order and each step supplies what the next one needs.

The consistency checks

real GDP ↑ ⇒ unemployment ↓, money demand ↑, nominal rate ↑ · real rate ↑ ⇒ investment ↓, capital inflow, currency appreciates, Xn ↓

If any two of your answers violate these, one of them is wrong. Use it as a self-check before moving on.

Deciding which graph a sub-question wants

The wording tells you. "Real GDP and the price level" is AD–AS. "Nominal interest rate" or anything about the Fed and the money supply is the money market. "Real interest rate", "private investment", "national saving" or "crowding out" is loanable funds. "Exchange rate", "the value of the currency" or "net exports" is forex. Ambiguity is rare, because the exam names the variable it wants.

Where students break consistency

The commonest inconsistency is having output rise while the interest rate falls in a fiscal question — those cannot both happen from a demand expansion, because higher income raises money demand. The second commonest is having the currency appreciate while net exports rise, which reverses the definition. A ten-second check against the consistency rules above catches both, and both are otherwise full-mark answers thrown away.

Worked example

Congress passes a large deficit-financed spending increase while the economy is near potential. Trace it through all four graphs.

1.AD–AS: G rises, so AD shifts right. Real GDP rises, the price level rises, unemployment falls.
2.Money market: higher real GDP raises money demand; with money supply fixed, the nominal interest rate rises.
3.Loanable funds: government borrowing shifts demand right; the real interest rate rises and private investment falls — crowding out.
4.Forex: the higher real rate attracts foreign capital, so demand for the currency shifts right and it appreciates. Net exports fall.
5.Net effect: output rises by less than the multiplier alone predicts, because both investment and net exports fell.

Answer: AD right; GDP and price level up; unemployment down; nominal and real rates up; investment down; currency appreciates; net exports down. The two offsets — domestic crowding out and the exchange rate channel — are why the realized output gain falls short of the multiplier calculation.

Watch out

Each diagram needs its own labeled axes. Four graphs sharing one set of labels, or a forex graph borrowed from the money market with "interest rate" on the vertical axis, will lose the labeling points on every diagram at once.

Checkpoint

A student concludes that expansionary fiscal policy raises real GDP and lowers the nominal interest rate. This is inconsistent because:

Checkpoint

A sub-question asks about the effect on private investment and the real interest rate. The required graph is the:

Checkpoint

A student writes that the currency appreciated and net exports rose. This is inconsistent because appreciation:

On the exam

Before writing the final part, reread your earlier answers and check them against the consistency rules. Multi-graph questions are scored part by part, but an inconsistency usually means one part is simply wrong and can still be fixed.

Answer the 3 checkpoints as you read.