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AP Macroeconomics › Unit 4
AP Macroeconomics Unit 4: Financial Sector
18 to 23% of the exam · 180 practice questions · 12 free-response questions
Unit 4 follows money through the financial system. You learn what makes something money, how bonds and interest rates relate, and how banks create money by lending out excess reserves. Expect money market and loanable funds graphs, plus calculations of required reserves and the money multiplier. You will also explain how central bank tools move interest rates. Two traps stand out. Bond prices and interest rates move in opposite directions. And the multiplier applies to excess reserves, not to the full amount of a new deposit.
Practice this unit
White belt covers core terms and foundational ideas, Regular is set at exam level, and Black belt has harder multi-step questions.
Topics in this unit
- 4.1 Financial Assets (20 questions)
- 4.2 Nominal vs. Real Interest Rates (21 questions)
- 4.3 Definition, Measurement, and Functions of Money (21 questions)
- 4.4 Banking and the Expansion of the Money Supply (30 questions)
- 4.5 The Money Market (25 questions)
- 4.6 Monetary Policy (40 questions)
- 4.7 The Loanable Funds Market (23 questions)
Free-response questions
- Open-Market Purchases and the Money Market (Long question, 10 points)
- Interest on Reserves and the Policy Rate (Long question, 10 points)
- A Bank’s Balance Sheet and Money Creation (Short question, 5 points)
- Real and Nominal Interest Rates (Short question, 5 points)
- Government Borrowing and the Loanable Funds Market (Short question, 5 points)
- Measuring the Money Supply (Short question, 5 points)
- Fighting Inflation with Open-Market Sales (Long question, 10 points)
- Shifts in Money Demand and Money Supply (Short question, 5 points)
- Fighting a Recession with Ample Reserves (Long question, 10 points)
- Bond Prices and Interest Rates (Short question, 5 points)
- Hitting an Interest Rate Target with Open-Market Operations (Short question, 5 points)
- Foreign Lending, Domestic Saving, and Interest Rates (Short question, 5 points)
Sample questions
These are taken from the Regular set, with the answer and explanation shown.
Topic 4.2 Nominal vs. Real Interest Rates
1. A lender wants to earn a real interest rate of 4 percent and expects inflation of 6 percent. What nominal interest rate should she charge?
- A−2%
- B2%
- C4%
- D6%
- E10%
Answer: E. Nominal interest rate = real interest rate + expected inflation = 4% + 6% = 10%. Charging only 4% would give her a real return of −2% once inflation is taken into account.
Common trap: Subtracting instead of adding. 4% − 6% = −2% is the real return she'd get if she charged only 4%, not the nominal rate she should charge.
Topic 4.4 Banking and the Expansion of the Money Supply
2. When a bank makes a loan by crediting the borrower's checking account, the money supply
- Aincreases, because new checkable deposits are created
- Bdecreases, because the bank's reserves fall
- Cdoes not change, because loans are not money
- Dincreases by the amount of the bank's required reserves
- Edecreases, because the borrower now owes the bank
Answer: A. Checkable deposits are part of M1, so creating a new deposit for the borrower adds to the money supply. This is how banks create money when they lend excess reserves.
Common trap: Thinking loans aren't money. The loan itself isn't money, but the deposit it creates is.
Topic 4.6 Monetary Policy
3. In a limited-reserves system, which of the following would increase the money supply?
- Lowering the required reserve ratio
- Lowering the discount rate
- Buying government bonds
- AI only
- BIII only
- CI and II only
- DII and III only
- EI, II, and III
Answer: E. All three are expansionary. A lower reserve ratio frees up reserves and raises the multiplier, a lower discount rate makes it cheaper for banks to borrow reserves, and buying bonds adds reserves directly.
Common trap: Leaving out the discount rate. Cheaper borrowing from the Fed also adds reserves.