Economics Level N - AP Macroeconomics

Economics Level N (AP Macroeconomics)

Chapter 1 - The Nature of Macroeconomics
Section 1 Understanding the Principles of Economics
(1) 1. Explain and provide an example of each category of resources.
(2) 2. Classify each of the following examples according to the types of resources:
a) Time spent cooking a meal at a restaurant
b) A crane
c) An artificial water canal
d) Timber
(3) 3. What is the most important problem addressed by economics?
(4) 4. For each of the following, state whether the statement is positive or normative. Explain your

answer.
a) Society should take measures to reduce littering on the streets.
b) People who smoke impose higher costs on society through higher medical costs and
pollution.
(5) 5. Define the economic resources and explain their characteristic that results in the need to

make choices.
(6) 6. [G] What does scarcity mean and what does it result in?
(7) 7. [G] What are the four economic resources?
(8) 8. [T] Classify each of the following as either a microeconomic or a macroeconomic question:

a) How much should a family buy as optimal amount of health insurance policies?
b) Is the Greek economy facing a recession?
c) What is the aggregate output of goods and services in Turkey?
d) How does technology affect the decisions of farmers?
(9) 9. [T] Classify each of the following as positive or normative economic analysis:

a) Inflation and unemployment are related.

b) The government’s involvement in business decisions should be decreased.
c) If the government increases its spending, the unemployment rate might decrease.
d) Income tax decreases the purchasing power of consumers.

Section 2 The Production Possibilities Curve (PPC)

(10) 10.
Tom makes $50,000 per year at his current job. He is considering a job offer from
a new company that would pay him $55,000 per year. Which of the following is
an element of the opportunity cost of accepting the new job at the new company? Explain your
answer.
a) The additional time spent commuting to Tom’s new job
b) The $50,000 salary from Tom’s old job
c) The bigger office at Tom’s new job

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(11) 11. An economy can choose between producing food and producing clothes at a
constant opportunity cost. Draw a correctly labelled PPC for the economy to show each of the
following:
a) Efficient production labelled as point A
b) Possibility of unemployment labelled as point B
c) A point that is not attainable labelled as point C
(12) 12. The table below shows the maximum annual output combinations of books and bags that

can be produced by a country. Given the scarcity of resources and limited technology, while
more resources are used to produce books, fewer resources are available for the production of
bags.

a) Draw a PPC to show the combinations of yearly output. Place books on the horizontal
axis and bags on the vertical axis.
b) Would the country be able to produce 500 bags and 800 books? Explain and state
where this point lies relative to the PPC.
c) What is the opportunity cost of increasing the output of books from 400 to 600?
d) What does the output imply about the slope of the PPC?

(13) 13. Consider the following PPC:

a) Explain why the PPC has a concave shape.

b) Explain what each of the points R, V, S, U, and T imply.

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(14) 14.

a) France produces toys and cars. Show the effect of an increase in investment on
the country’s PPC.
b) Italy produces food and machines only, and its economy is in recession. Use a
PPC to determine the current position of the country. Label the point “X”.
(15) 15. [G] What does the PPC represent?
(16) 16. [G] Analyze a given PPC and determine the opportunity cost.
(17) 17. [G] Consider the following PPC to identify each of the following:

a) Efficient production
b) Inefficient production
c) Unattainable production
(18) 18. [T] Determine the opportunity cost involved in each of the following decisions:

a) Sally is considering attending medicine school to become a surgeon.

b) The president of a country is considering building a university.
c) A full-time employee decides to quit his job.
(19) 19. [T] Consider the following production possibilities curve of a nation that produces books

and videogames:

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a) Suppose the nation wants to produce combination C instead of combination B. What

will be the effect of this change?
b) What is necessary for this nation to be able to shift to a production at point D instead
of point E?
c) Suppose the production possibilities frontier of a nation has moved outwardly as
shown above. What comments can you make on the productive efficiency of points B, C,
and D?
d) Based on the figure, which movement would be considered as economic growth where
output increases?

Section 3 Comparative Advantage and Gains from Trade

(20) 20. Consider the graph below to answer the following questions.

a) Calculate the opportunity cost of producing one computer in both countries.

b) Which country has absolute advantage in bicycle production? Explain your answer.
c) Which country has comparative advantage in computers production? Explain your answer.
d) If both countries specialize, which good will be imported by Country A?
e) What is the minimum price Country A will accept to export computers to Country B?

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(21) 21.
Countries A and B are producing cars and textile using equal amounts of resources as
follows:

a) What is the opportunity cost of producing one car in each country?

b) Which country has the absolute advantage in the production of cars? Explain your
answer.
c) Which country has the comparative advantage in the production of textile? Explain
your answer.
(22) 22. Countries A and B produce pizza and chips. Each month, Country A can produce on its

own either 30 pizzas and no chips, or 50 packs of chips and no pizzas, or any combination in
between. Each month, Country B can produce 40 pizzas and no chips, or 50 packs of chips and
no pizzas, or any combination in between.
a) Assume that the PPCs in Countries A and B are straight lines. Draw one diagram to
show the monthly production (PPCs) by the two countries.
b) Which country has comparative advantage in the production of chips? Which country
has comparative advantage in the production of pizza? Explain your answer.
c) Which country has absolute advantage in the production of chips? Which country has
absolute advantage in the production of pizza? Explain your answer.
d) Assume that Country B discovers a new technique for making chips that doubles the
quantity of chips the country can produce each month.
i. Draw a graph to show the old and new PPCs for Country B.
ii. After this innovation, which country will have absolute advantage in producing
chips? Which country will have comparative advantage in producing pizzas?
Explain your answer.
(23) 23. The following table shows the combination of the production of two goods, tables and

computers, for two countries, A and B.

a) Which country has absolute advantage in the production of tables and which country has
absolute advantage in the production of computers?
b) Calculate Country A’s opportunity cost of tables in terms of computers.
c) If the two countries were to specialize and trade, which country would import tables?
d) Assume that the two countries specialized and traded based on the terms of 3 tables per 1
computer. Explain whether these terms are beneficial for each of the countries, A and B.

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(24) 24. How may two countries involved in free trade benefit?
(25) 25. A worker in Italy can produce three times more bags than a worker in Germany,
using the same amount of resources. What can be concluded from this statement?
(26) 26. The PPCs of two countries, A and B, are represented in the graph below to show the

various combinations of bags and machines.

a) Identify the country that has an absolute advantage in the production of bags.
b) Identify the country that has an absolute advantage in the production of machines.
c) Identify the country that has a comparative advantage in producing bags.
d) Assuming trade occurs, which country will import machines?
e) Determine favorable terms of trade between the two countries.
f) Assuming trade occurs, would a country be able to produce and consume beyond its PPC?
(27) 27. [G] What is the difference between absolute advantage and comparative advantage?
(28) 28. [G] What is the difference between comparative advantage and absolute advantage?
(29) 29. [G] Consider the following data taken from two trading countries A and B.

Cars Machines
Country A 40 10
Country B 50 25

What are the acceptable terms of trade if the two countries decide to specialize and why would
they benefit?
(30) 30. [G] Consider the following data related to the PPCs of two countries A and B.

Country Steel (tons) Coal (tons)

A 1,000 500
B 1,200 300

Suggest beneficial terms of trade for the countries.

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(31) 31. [T] Refer to the graphs below to answer the questions that follow:

a) Which country has a comparative advantage in the production of:

i. Phones
ii. Cars
b) Which country has an absolute advantage in the production of:
i. Phones
ii. Cars
(32) 32. [T] Refer to the graphs below to answer the questions that follow:

a) What would be the efficient level of production for Country A?

b) What is Country A’s opportunity cost of the production of phones?
c) What trading terms would be acceptable for both countries for 1 phone?
(33) 33.[T] France and Italy are potential trading partners. They can produce sofas and tables as
illustrated in the following PPCs:

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Assuming that the terms of trade are one sofa for one table:
a) Which country will sell sofas based on these terms? Explain.
b) Which country would want to buy sofas based on these terms?
(34) 34. [T] Joanna can make a birthday cake in 40 minutes, and she can prepare a wedding cake
in 60 minutes. Salim needs 30 minutes to prepare a birthday cake and 50 minutes to prepare a
wedding cake. Based on this information, explain who should specialize in birthday cakes and
who should supply wedding cakes.
(35) 35. [T] The following PPCs show the output of cars and machines for Countries A and B

using a certain number of workers.

a) Explain which country will import cars.

b) Identify beneficial terms of trade if the two countries decide to trade cars.

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(36) 36.
[T] Alice and Roy make identical sandwiches and burgers. The
following table shows the time in minutes taken by each to make both goods.

a) Who has an absolute advantage in the production of each of the following?

i. Sandwiches
ii. Burgers
b) If a trade is to take place between Alice and Roy, who will export sandwiches?

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Chapter 2 - Demand, Supply, and Market Equilibrium

Section 1 Demand
(37) 1. Consider the following demand schedule:

a) Draw a demand graph to illustrate the demand schedule.

b) What can be concluded about the relationship between the price and quantity demanded?
c) Why does the demand curve slope downwards?
(38) 2. Which factors cause an increase or a shift to the right in the demand for a normal good?
(39) 3. [G] What does the law of demand state?
(40) 4. [G] Which factors cause an increase in the demand for a normal good?

Section 2 Supply
(41) 5. State whether each of the following events influences the demand or the supply of clothes
in the domestic market:
a) Improvements in technology result in lower costs of production.
b) Many consumers are shifting their purchases to cheaper imported textiles.
c) Many sellers reduce their prices when they expect a decrease in people’s incomes.
(42) 6. Which factors cause an increase in the supply of a good?
(43) 7. [G] What does the law of supply state?
(44) 8. [G] What factors are likely to change the supply of a product?
(45) 9. [T] Identify an example that would cause each of the following:

a) A decrease in the demand for pies

b) An increase in the demand for houses
c) A decrease in the supply of cars
d) An increase in the supply of couches

Section 3 The Equilibrium Price and Quantity

(46) 10. Draw a correctly labelled graph to show a market for potatoes in equilibrium. Show
on your graph how a snowstorm that destroys most of the crops will affect the equilibrium.
(47) 11. Consider the following graph that represents the labor market:

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a) Where should the government set the price if it is planning to achieve an effective
minimum wage?
b) At a minimum wage of $10:
i. how many workers would supply their labor?
ii. how many workers would be hired?
iii. how many workers would not be employed?
(48) 12. Explain the effect of each of the following on the demand, supply, and the equilibrium

price of the good/service in question:

a) A decrease in the price of gasoline results in higher sales of cars.
b) Global warming awareness increased the use of recycled paper due to lower costs.
c) A hotel offers free gym access to its guests, leaving nearby gyms with few members.
(49) 13. Determine how each of the following changes affect the equilibrium quantity and price of

a good.
a) An increase in supply and a decrease in demand
b) A decrease in supply and an increase in demand
c) An increase in both demand and supply
d) A decrease in both demand and supply
(50) 14. What will happen if the price of a product was set:

a) higher than the equilibrium price?

b) lower than the equilibrium price?
(51) 15. [G] How is the market equilibrium determined? Show your answer graphically.
(52) 16. [G] What is the definition of a market shortage and a market surplus?
(53) 17. [G] Consider the following graph that shows the market for jeans:

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a) What happens when the price is set at $60 for each pair of jeans?
b) What happens when the price is set at $20 for each pair of jeans?
(54) 18. [G] How does a change in demand and supply determinants affect the equilibrium?
(55) 19. [G] How does a change in demand determinants and supply determinants affect the
equilibrium?
(56) 20. [G] How does the market restore equilibrium when there are imbalances?
(57) 21. [T] The following graph illustrates the market for a soft drink:

a) What is the equilibrium quantity and what is the equilibrium price?

b) What would occur if the current price is set at P1? How should equilibrium be restored?
c) What happens when the market is at equilibrium?
d) If the current price is at P3, will there be a surplus or a shortage? By how much?
e) If the government decides to set a price floor, where would it set it in order for it to be
effective?

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Chapter 3 - The Circular Flow of Income and the GDP

Section 1 Calculation of the GDP Using the Circular Flow of Income Diagram
(58) 1. Draw a correctly labelled expanded circular flow diagram to show the following:
 The flow of funds between the markets for products and for resources
 The leakage of money out of the economy due to the presence of the international market
 Money injections by the government
(59) 2. [G] What does the circular flow of income represent?
(60) 3. [G] Which transactions must be recorded when calculating a country’s GDP and which

ones must be excluded?

Section 2 Measurement, Uses, and Limitations of the GDP
(61) 4. Calculate the GDP using the following data:

(62) 5. In Country X, 75 units were purchased as capital equipment. The total investment in
buildings was 60 units and a decrease in stocks of 5 units was recorded.
a) What is the total gross investment?
b) What is the value of net investment?
(63) 6. Suppose that personal income is $7,000, personal taxes are $2,000, and depreciation is

$1,500. Calculate the disposable income.

(64) 7. Define GDP and explain how it is calculated.
(65) 8. For each of the following transactions, state whether they would be included in the

calculation of the US GDP:

a) Social security payments
b) A tailor buying a new machine
c) The purchase of a home built five years ago
d) Contributions made to charity
e) A meal cooked by a housewife for her family
f) An American individual producing and selling clothes in another country
g) Foreign companies building a new factory in the US
(66) 9. When would net investment be positive?
(67) 10. A student buys a used car model (2015) in 2019 for $12,000. What is the contribution of

this transaction to the GDP of 2019?

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(68) 11. The population of a country grows at a higher rate than the growth in real GDP. What can
be concluded from this?
(69) 12. Indicate whether each of the following transactions should be counted in the US GDP for

the year 2018:

a) The value of secondhand play stations sold online in 2018
b) The rent paid in 2018 by the residents of an apartment built in 2017
c) Commissions earned in 2018 by salespeople
d) The value of garments produced in 2018 in China by a firm fully owned by American
citizens
e) The value of insurance bought from an American insurance company by Indian
tourists in 2018
(70) 13. [G] Where would the production of a foreign company operating in another country be

recorded?
(71) 14. [G] How is the nominal GDP calculated?
(72) 15. [G] What are the limitations to the nominal GDP?
(73) 16. [G] What does an increase in real GDP definitely mean?

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Chapter 4 - Unemployment and the Business Cycle

Section 1 The Unemployment Rate as an Economic Indicator
(74) 1. Consider the following table:

Calculate the unemployment rate.

(75) 2. Explain the impact of the ageing of baby boomers and their movement toward retirement

on each of the following:

a) The labor force participation rate
b) The unemployment rate
(76) 3. Assume that a country has the following data:

 Population aged between 16 and 65 years: 13 million

 Employed: 2 million
 Unemployed: 1 million
a) Determine the size of the labor force.
b) What is the labor force participation rate?
c) What is the unemployment rate?
(77) 4. An economy collected the following information:
 Working-age population = 50 million
 Number of employed individuals = 20 million
 Number of unemployed and job-seeking individuals = 5 million
Calculate the labor force participation rate.
(78) 5. How does an increase in the number of discouraged workers affect the unemployment rate

in an economy?

(79) 6. Identify whether each of the following is considered unemployed or not:

a) A gardener who stopped working during the winter season.
b) A full-time student at a high school who does not have time to work.
c) A lady who quit her job at the local bookstore and has since applied for a position at a
local coffee shop.
d) A housewife who decided to stay home to look after her newborn.

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e) A secretary who gave up looking for a job after searching for a long time.
f) A full-time volunteer at an orphanage who does not receive any payment.
(80) 7. [G] Who is considered as unemployed?
(81) 8. [G] What does the unemployment rate measure?
(82) 9. [G] What does the labor force participation rate represent?
(83) 10. [G] How is the labor force participation rate calculated?
(84) 11. [G] What does the labor force represent?
(85) 12. [G] How is the unemployment rate calculated?
(86) 13. [G] When do the unemployment rate and the labor force participation rate change?
(87) 14. [G] Why does the official unemployment rate understate the actual unemployment

situation in an economy?
(88) 15. [T] In a population of 300 million, 30 million are 16 years old or younger. The total

working age population is 250 million divided as follows:

 200 million working at least one hour per week
 10 million not working but seeking employment
 40 million not working and not seeking employment
a) What is the value of the labor force participation rate?
b) What is the value of the unemployment rate?

Section 2 The Types of Unemployment and Full Employment

(89) 16.

a) Identify three factors that can lead to an increase in the natural rate of unemployment.
b) Explain why output decreases as unemployment increases.
(90) 17. Explain the effect of each of the following on the natural rate of unemployment:

a) Most of the teenagers pursue their education and do not start searching for jobs until
they graduate from college.
b) Employers and employees can easily post and find jobs on the Internet.
c) Labor union membership decreases.
(91) 18. Identify the most appropriate type of unemployment for each of the following:

a) Sue lost her job after she was replaced by a new machine.
b) Joan was a part-time employee and now she is being interviewed for a new post that
offers a full-time job in a multinational company.
(92) 19. The unemployment rate serves as an indicator of the economic performance of a country.

Assume an economy is currently at full employment. The government decides to expand the

economy by increasing the level of spending.

a) How does the actual unemployment rate compare to the natural rate of unemployment?
b) Due to specific conditions, a significant number of employees’ contracts have been
involuntarily changed from full-time employment to part-time employment. How will
this change affect the unemployment rate?

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(93) 20. Assume that the government reduces the level of unemployment compensation. Explain
how this will affect the natural rate of unemployment.
(94) 21. Define and give an example of each of the following unemployment types:

a) Frictional unemployment
b) Structural unemployment
c) Cyclical unemployment
(95) 22. [G] What is cyclical unemployment and how can it be corrected?
(96) 23. [G] When does frictional unemployment occur?
(97) 24. [G] When does an economy reach the natural rate of unemployment?
(98) 25. [G] When does the natural rate of unemployment change?
(99) 26. [G] Why is unemployment an economic problem?
(100) 27. [T] The total working-age population of a country is 50 million. The number of people in

the labor force is 30 million. The number of the unemployed is 2 million.

a) Based on these numbers, calculate the value of each of the following:
i. The labor force participation rate
ii. The unemployment rate
b) What are the main costs of unemployment?
c) Which type of unemployment is considered the most serious? Why?

Section 3 The Business Cycle

(101) 28. Name each phase presented on the business cycle below.

(102) 29. [G] What are the stages and turning points of a typical business cycle?
(103) 30. [G] What are the characteristics of a recession?
(104) 31. [G] When is the full or potential output achieved?

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Chapter 5 - Equilibrium in the Aggregate Demand and Aggregate Supply Model

Section 1 Aggregate Demand
(105) 1.
a) How is aggregate demand calculated?
b) Which aggregate demand component is the most sensitive to changes in the interest
rate?
(106) 2. Determine how the aggregate demand changes as a result of each of the following:

a) A monetary policy that results in an increase in the interest rate

b) An increase in the aggregate price level that results in a decrease in the real value of
money in the economy
c) Expectations that the job market for the coming year will worsen
d) A fiscal government policy that results in a decrease in the tax rates
e) A decrease in the aggregate price level that results in a higher real value of assets
f) An increase in foreign incomes
(107) 3. Complete the following table to determine the component of AD affected and the resulting

change on the AD curve.

(108) 4. Explain how each of the following would affect aggregate demand:
a) A decrease in the price level makes people expect a further decrease in the price level.
b) Income is redistributed from the rich to the poor.
c) Exports increase.
d) Government spending decreases.
(109) 5. [G] Define the aggregate demand curve and represent it graphically.
(110) 6. [G] How is aggregate demand calculated?

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(111) 7. [G] Why does the aggregate demand curve slope downward?
(112) 8. [G] Consider the following graph:

Which changes to the elements of AD could cause a movement from point e to point d?
(113) 9. [T] The following graph shows three aggregate demand curves:

State one factor that would cause a movement from:

a) point B to point D.
b) point A to point B.
c) point E to point B.
d) point C to point B.

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Section 2 Short- and Long-run Aggregate Supply

(114) 10. Determine how the short-run aggregate supply changes due to the following:
a) An increase in the aggregate price level encourages producers to increase output.
b) A reduction in oil prices makes producers increase output.
c) An increase in retirement benefits mandated by law forces producers to reduce output.

(115) 11.

a) Assume that the price of an input increases by $1 without an increase in productivity.

Explain the impact on the aggregate supply curve, the equilibrium price, and equilibrium
output in the short run.
b) Now, assume that productivity increases by 10% instead of the increase in the price of
inputs. What effect would this have on the economy’s aggregate supply curve, real
output, and the price level?
(116) 12.

a) How does an increase in labor productivity affect the SRAS and the LRAS?
b) How does increased spending on research and development affect the SRAS, the
LRAS, and the PPC?
(117) 13. Explain how an increase in subsidies provided by the government to encourage firms to

increase their investment in research and development might affect each of the following:
a) Aggregate demand
b) Long-run aggregate supply
(118) 14. [G] Why does the short-run aggregate supply curve slope upwards?
(119) 15. [G] What does the short-run aggregate supply represent?
(120) 16. [G] What does a movement along the short-run aggregate supply represent?
(121) 17. [G] What are the factors that cause a shift to the short-run aggregate supply?
(122) 18. [G] What does the long-run aggregate supply represent?
(123) 19. [G] What is the relationship between the PPC and the long-run aggregate supply?
(124) 20. [T] The following graph shows three aggregate supply curves:

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a) Give two examples of factors that would cause a movement from point D to point E.
b) What is the movement from point D to point E described as?
c) What would cause a movement from point A to point B?
d) What is the movement from point E to point B described as?
e) What would cause a movement from point C to point B?

(125) 21.
[T] What is the effect of each of the following on the short- and long-run aggregate
supply curves?
a) Producers face a permanent increase in labor productivity.
b) The prices of essential manufacturing commodities decrease across the economy.
c) Energy prices increase across the economy.
d) Nominal wages decrease across the economy.

Section 3 The AS-AD Model and the Equilibrium Level

(126) 22. Using the AS-AD model, explain the effect of each of the following on the economy,
ceteris paribus:
a) Fear on the part of consumers of an increase in the interest rate on investment
b) A major increase in government spending on healthcare
c) A 50% decrease in oil prices
(127) 23. An economy is currently operating at its full employment level.

a) Draw an AS-AD model to illustrate the current equilibrium level.

b) Explain the effect of each of the following on the equilibrium output and price:
i. Aggregate demand increases following an increase in government spending.
ii. Aggregate supply decreases without a change in aggregate demand.
iii. Aggregate demand increases by more than the increase in aggregate supply.
iv. New technology that increases productivity will be implemented.
(128) 24. An economy’s current output is below the full employment level, with an upward-

sloping aggregate supply curve.

a) Use a fully labelled AS-AD graph to represent the current equilibrium output level
(Y0), the price level (PL0), and the full employment level (Yf).
b) Assume that the government’s expenditure on military goods increases. Explain the
effect of this on the aggregate demand curve and the output and price levels.
c) In addition to military goods, the economy produces consumer goods. Draw a
production possibilities curve for this economy and show the effect of the increase in
government’s expenditure on military goods.
(129) 25. Country M is currently in long-run equilibrium at the potential GDP.

a) Draw a fully labelled AS-AD graph to show the SRAS, LRAS, and AD curves as well
as the equilibrium output and price level.
b) Assuming that exports from Country M increase, explain the effect of the increase in
exports on your graph in part a).
c) Explain how an increase in exports influences the price level in the short run.

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d) Which aggregate demand component will change if the exporting industries increase
their expenditure on new containers and equipment?
e) Explain how the increased expenditure on containers and equipment would affect the
long-run aggregate supply.
(130) 26. a) Draw an AS-AD graph showing the aggregate demand, short-run aggregate supply,

and long-run aggregate supply curves.

b) Label the output and price level at potential GDP as YP.

c) On your graph, show and explain the effect of an increase in aggregate demand in the
short run and in the long run.
d) Suggest two factors that could result in the change identified in part c).
(131) 27. Explain the effect of each of the following on the equilibrium price level and output:

a) Imports increase.
b) Nominal wages increase.
(132) 28. Assume that aggregate demand decreases when the economy is operating in the long run.

Explain, using a graph, how the decrease in AD will affect real GDP and the price level.
(133) 29. An economy is operating in the short run, at an equilibrium output level below full

employment/potential output level. Assuming that there is no government intervention, how

would output and the price level change in the long run?
(134) 30. Assume that France is currently operating at full employment and that its major

trading partner, Germany, enters a recession. Explain the short-run effect of the German
recession on each of the following:
a) France’s aggregate demand
b) France’s real output
c) France’s price level
(135) 31. What is the effect of a negative supply shock?
(136) 32. [G] What is the difference between the short- and long-run equilibrium?
(137) 33. [G] What is the effect of a positive and negative supply shock on the real GDP,

employment, and the price level in the short run?

(138) 34. [G] What is the effect of a positive and negative demand shock on the real GDP,

employment, and the price level in the short run?

(139) 35. [G] What is the effect of supply shocks on output, employment, and the price level in the

long run?
(140) 36. [G] What is the effect of demand shocks on output, employment, and the price level in

the long run?

(141) 37. [T] Refer to the following graph:

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a) Which point represents the short-run macroeconomic equilibrium?

b) Assume that the economy experiences a decrease in the level of investment. What effect
would this have on the aggregate output and the price level?
c) Assume that the economy is currently operating at Y1. What kind of output gap would exist
and what would it be equal to?
d) What would cause a shift from AD1 to AD2?

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Chapter 6 - Inflation and Price Indices

Section 1 Meaning and Measurement of the Consumer Price Index and the Inflation Rate
(142) 1. The table below presents the consumer price index for three consecutive years.

Based on the given data, how much did it cost in 2016 to buy the same good that cost $10 in
2014? Show your calculation.
(143) 2. Suppose a nation produces apples and copybooks as follows:

a) What is the country’s nominal GDP in 2013?

b) What is the country’s real GDP in 2013, using 2012 as the base year?
c) By how much did the real GDP increase between 2012 and 2014?

(144) 3. Assume that 2010 is the base year. Between 2010 and 2016, prices doubled. At the same
time, Sara’s nominal income increased from $50,000 to $100,000.
a) What is the value of the price index in 2010?
b) What is the value of the price index in 2016?
c) What is the percentage increase in Sara’s nominal income between 2010 and 2016?
d) What has happened to Sara’s real income between 2010 and 2016?
(145) 4. The following table shows the output and prices of Country X’s basket of goods in 2017

and 2018.

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Calculate each of the following with relevance to the base year 2017.
a) The nominal GDP in 2018
b) The real GDP in 2018
c) The GDP deflator in 2018
d) Using 2017 quantities, calculate the consumer price index for 2018.
(146) 5. [G] What does the consumer price index (CPI) mean?
(147) 6. [G] What is the purpose of using CPI?
(148) 7. [G] What is meant by inflation?
(149) 8. [G] How are the CPI and the inflation rates calculated?
(150) 9. [G] What is “real income” and when is it likely to change?
(151) 10. [G] What is the difference between real GDP and nominal GDP?
(152) 11. [G] In a simplified economy, you are given the following:

Price of Price of
Apples Oranges
Year each unit of each unit of
(units) (units)
apples ($) oranges ($)
2015 10 20 15 2
2016 11 30 20 3

Assuming 2015 to be the base year, what are the values of nominal GDP, real GDP, and the GDP
deflator respectively in 2016?
(153) 12. [G] What is the difference between inflation, deflation, and disinflation? Give examples.
(154) 13. [G] What are the limitations of the CPI when calculating inflation?
(155) 14. [T] Suppose that in a nation, the CPI was 125 in 2011 and 133 in 2012.

a) What was the inflation rate over this time period?

b) Suppose that the prices and the nominal GDP both double during this period. What
would be the effect on real output?
c) Suppose that the nominal GDP is 7,700 and that the GDP deflator is 110. What is the
value of the real GDP?
(156) 15. [T] The table below shows the prices and output quantity of burgers, laptops, and TVs in

a country in three consecutive years.

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a) What is the percentage change in the production of burgers between 2007 and 2008?
b) What is the percentage change in the price of TVs between 2008 and 2009?
c) Calculate the nominal GDP in 2007.
d) Using 2007 as the base year, calculate the real GDP in:
i. 2007.
ii. 2009.
(157) 16. [T] The following table shows the data collected from two countries: Country M and N.

a) What is the percentage change in the nominal GDP between 2010 and 2015 for each
country?
b) What happened to the price level between 2010 and 2015 in each country?
c) Use 2010 as the base year to calculate the real GDP in each country in 2015.
d) What is the percentage increase in the real GDP between 2010 and 2015 for each
country?
e) Use year 2010 as the base year to compare the two countries’ real GDP per capita in
2015.
(158) 17. [T] Consider the following:

a) Assuming 2010 as the base year, calculate the change in real GDP for the two given
countries.
b) Comment on countries L and M’s real GDP per capita.
c) What is not measured by the real GDP?

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(159) 18. [T]

a) What improves when the real GDP per capita increases?
b) What is an increase in national income at constant prices also known as?
c) The population of a country grows at a higher rate than the growth in the real GDP.
What can be concluded from this?
(160) 19. [T] The nominal GDP is $350 billion in the base year. After three years, it becomes $490

billion and the GDP price index becomes 130. Calculate the change in the real GDP over the
three years.
(161) 20. [T] The following data relates to Country X in 2019:

a) Calculate each of the following:

i. Nominal GDP
ii. Real GDP
iii. Real GDP per capita
iv. The unemployment rate
b) The GDP deflator for country X in 2018 was 110. Was this country experiencing
inflation or deflation in 2019? Explain.

Section 2 Causes and Costs of Inflation

(162) 21. Nabil borrowed $2,000 for one year at 5% interest in order to refurbish his kitchen.
He did not anticipate any inflation. However, an unexpected inflation of 5% occurred over the
life of the loan.
a) Calculate the real interest rate on the loan.
b) Who is the main loser and winner as a result of the unexpected inflation in the given
scenario? Explain.
(163) 22. [G] What does the quantity theory of money demonstrate and how is it determined?
(164) 23. [G] What are the possible long-run effects of increasing money supply?
(165) 24. [G] How is the quantity theory of money inflationary?
(166) 25. [G] What are the drawbacks of unanticipated inflation?

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Section 3 The Phillips Curve

(167) 26.
Assume an economy is in the long-run equilibrium with an expected inflation rate of 7%
and an unemployment rate of 6%. The nominal interest rate is 9%.
a) Using the given numbers, show the long-run equilibrium on a fully labelled Phillips
curve graph. Label the current long-run equilibrium as point M.
b) What is the value of the real interest rate?
c) For real incomes to remain the same, what should a 5% increase in the inflation rate be
matched with?
(168) 27.
a) Explain how each of the following might cause cost-push inflation:
i. A 10% increase in the wage level
ii. A 20% increase in the oil price
b) Explain the impact of cost-push inflation on the short-run Phillips curve.
(169) 28. Explain the effect of each of the following on the Phillips curve:

a) People expect higher inflation and start demanding higher wages. Consequently, firms
decrease production.
b) The price of imported oil increases significantly.
c) Money supply increases and causes unexpected inflation.
d) The government decides to lower its spending level.
e) The minimum wage decreases and results in a lower NRU.

(170) 29. A country’s economy is currently at the long-run equilibrium, with a natural rate of
unemployment equal to 5% and an inflation rate of 2%.
a) Draw a correctly labelled short-run Phillips curve graph, and label the curve as
“SRPC.” Indicate the corresponding current unemployment and inflation rates, labelled
as “R” point on the SRPC.
b) In part a) on the same graph, draw the long-run Phillips curve and label it as “LRPC.”
c) Assume that the country’s government increases its spending on infrastructure. What is
the impact of this increase in spending on the unemployment and inflation rates in the
short run? Explain.
d) In part a) on the same graph, label the new point “S” on the SRPC corresponding to
the results you stated in part c).
e) Following the increase in government spending, workers demand and receive higher
wages. Explain the effect of the hike in wages on the SRPC.
(171) 30. [G] What is the difference between the long run and short run Phillips curves?
(172) 31. [G] What is the relationship between inflation and unemployment in the short and long

run?
(173) 32. [G] What are the factors that would cause a shift in the SRPC?
(174) 33. [G] What are the factors that cause the LRPC to shift?
(175) 34. [G] What is the response of unemployment and inflation to changes in AD and AS in the

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short and long run?

(176) 35. [G] How does the Phillips curve represent an output gap?
(177) 36. [T] The unemployment rate in the US is 5%, and the natural rate of unemployment is 3%.

a) Using a correctly labelled AS-AD graph, show the current equilibrium real GDP,
labelled YC, and the price level, labelled PLC.
b) The US government is receiving economic advice from two advisors, Mr. Jack and
Mr. Tom, on how to reduce unemployment. Mr. Jack’s advice to the government is to
decrease income taxes.
i. How would the decrease in income taxes affect the aggregate demand? Explain.
ii. Draw a fully labelled short-run Phillips curve graph to show the effect of the
tax reduction. Label the initial equilibrium from part a) as point A, and the new
equilibrium following the tax reduction as point B.
c) Mr. Tom’s advice for the government is to not take any action.
i. Explain the impact of this advice on the SRAS curve in the long run.
ii. Using a new labelled graph of the short-run and long-run Phillips curves, show
the effect of the change in the short-run aggregate supply you identified in part
(c)(i). Label the initial equilibrium from part (a) as point A, and the new
equilibrium as point B.
iii. In the long run, what will happen to the natural rate of unemployment?

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Chapter 7 - Fiscal Policy and Automatic Stabilizers

Section 1 Fiscal Policy as a Stabilization Policy
(178) 1. An economy is currently operating on the upward-sloping part of the aggregate supply
curve. Assume that the government increases its spending.
a) Explain the effect of the increase in government spending on each of the following:
i. Aggregate demand in the short run
ii. Short-run aggregate supply
b) Show the effect of the increase in government spending on the real output and price
level using the AS-AD model graph.
(179) 2. An economy is currently operating in the long-run equilibrium. Assume that the

government increases its spending on national defense without increasing taxes.

a) Draw a correctly labelled AS-AD graph to show the current equilibrium output and
price level.
b) Show graphically the effect of the increase in government spending on the aggregate
demand.
c) What is the effect of the change on the output and price level?
(180) 3.

a) Identify a fiscal policy to address each of the following:

i. A recession
ii. Inflation
b) What are the drawbacks of the fiscal policy?
(181) 4. An economy is operating with an inflationary gap.

a) Which fiscal policy can be used to reduce this gap?

b) Using the AS-AD model, show the effect of the policy you selected in part a) on
output, the price level, and employment.
(182) 5. Suppose the government increases its purchases in an economy facing a

recessionary gap. How would this fiscal policy affect each of the following?
a) The investment level
b) Net exports
c) The real GDP
d) The price level
(183) 6. [G] What is meant by fiscal policy?
(184) 7. [G] Which fiscal policy needs to be used to remedy a recession? An inflation?
(185) 8. [G] What is the effect of a change in income taxes on real GDP?
(186) 9. [G] How does a discretionary fiscal policy affect the economy in the short run?
(187) 10. [G] What are the lags to fiscal policy?
(188) 11. [T] Assume that an economy has an unemployment rate of 8%, a natural rate of

unemployment of 6% and an inflation rate of 4%.

a) Identify a fiscal policy action to lower the unemployment rate in the short run.

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b) Draw a fully labelled AS-AD graph to show how the policy identified in part a)
impacts the output and price level at equilibrium.
(189) 12. [T] An economy faces a sudden and large decrease in private investment spending.

a) Use a fully labelled AS-AD graph to show the impact of this decrease on the output
and price levels.
b) Explain the effect of this decrease on the unemployment rate.
c) Identify a fiscal policy to offset the impact on the economy of the decrease in
investment.
d) Explain how the fiscal policy you identified in part a) impacts each of the following in
the short run:
i. Aggregate demand
ii. Real GDP
iii. The price level
iv. The real interest rate

Section 2 Budget Deficit and the National Debt

(190) 13.

a) Explain the difference between government spending and government revenues.

b) How does each variable affect the GDP?
(191) 14. [G] What is the difference between government budget deficit and surplus and the

national debt?
(192) 15. [G] What are the issues involved with the burden of the national debt?
(193) 16. [G] How does fiscal policy result in crowding out?
(194) 17. [G] What does the crowding effect mean?
(195) 18. [G] What are the automatic stabilizers?
(196) 19. [G] What are the characteristics of automatic stabilizers?

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Chapter 8 - The Expenditure Model and the Multipliers

Section 1 Disposable Income, Consumption, and Saving
(197) 1. Consider the following data:

a) Complete the table by filling the aggregate saving column.

b) Calculate the MPC and MPS values.
c) Determine the saving function.
d) Determine the consumption function.
(198) 2. Write the consumption function based on the data presented below:

(199) 3. If autonomous consumption = $400 and MPC = 0.8, calculate the increase in consumption
spending if disposable income increases by $1,500.
(200) 4. Consider the following data:

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a) What is the value of the MPC?

b) What is the value of APC when national income is $6,000 billion?
c) What is the level of autonomous consumption?
(201) 5. [G] What is the meaning of MPC and MPS?
(202) 6. [G] How are MPC and MPS calculated?
(203) 7. [G] What is the relationship between the interest rate and the level of planned investment?
(204) 8. [G] What are the factors that cause a shift in the investment curve?

Section 2 The Multipliers

(205) 9. Dana got a bonus in two years as follows:

a) What is the MPS?

b) What is the value of the expenditure multiplier?
(206) 10.

a) When do businesses increase their investment spending?

b) What is the impact of an increase in investment on the production function?
(207) 11. A nation has no income taxes, no international trade, and an MPC equal to 0.75.

a) What is the change in equilibrium expenditure if investment increases by $20 billion?

b) Explain the effect of the change in investment on aggregate demand.
c) Assume that the MPC was valued at 0.9 instead.
i. What will be the change in output?
ii. What will be the change in aggregate demand?
(208) 12. The current equilibrium output equals $2.5 million and potential output equals $2.7

million. What would an economist recommend about this economy if the MPC is equal to 0.75?
(209) 13. An economy is in recession. Assume that the government increases its spending and

taxes by equal amounts following a balanced-budget policy. How would aggregate demand
change?

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(210) 14. Consider the following AS-AD graph:

a) The government increases its spending by $100. What is the value of the expenditure
multiplier following a shift from AD1 to AD2?
b) The government wants to decrease income tax to achieve the same shift in AD
following the $100 increase in government spending. Should the decrease in taxes be
larger, smaller, or equal to $100? Explain your answer.
c) Will the spending multiplier increase, decrease, or remain the same following a
decrease in MPS?
d) Assume instead that the AS curve is upward sloping. Would the change in RGDP
resulting from the $100 increase in government spending be greater than, less than, or
equal to the change illustrated in the graph above?
e) Assume that wages and prices are perfectly flexible. As a result of the $100 increase in
government spending, will RGDP increase, decrease, or remain unchanged? Explain your
answer.
(211) 15. [G] Define the simple expenditure multiplier and state how it is calculated.
(212) 16. [G] If the change in investment and the MPC values are given, what will the change in
real GDP be equal to?
(213) 17. [G] What is the effect of an increase in government spending by $50 billion on the

economy in the short run, if the MPC is 0.8?

(214) 18. [G] What does the tax multiplier represent and how is it calculated?
(215) 19. [G] How is economic growth measured?
(216) 20. [T] An economy is operating below full employment.

a) Using a fully labelled AS-AD graph, draw the LRAS, AD, and SRAS curves and show
the current and full employment output levels.
b) Assume that policy-makers decide to implement fiscal policy to correct the
equilibrium level. If MPS is 0.2, and the recessionary gap is $300 billion, what is the
minimum change in government spending needed to eliminate the gap, without changing
the tax rates?

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c) Instead of changing government spending, the policy-makers decide to change taxes to

eliminate the gap. Should they introduce changes to the taxes greater than, smaller than,
or equal to the changes in government spending? Explain your answer.
d) Now assume that the government decides to reduce the income tax rates to correct the
recessionary gap. How will this action impact each of the following? Explain your
answers.
i. Aggregate demand
ii. Long-run aggregate supply
(217) 21. [T] An economy is currently facing a recessionary output gap with an MPC of 0.8, an

equilibrium real output at $500 billion, and a full employment output at $540 billion.
a) Draw a fully labelled AS-AD graph to represent the current and full employment
output and price levels at equilibrium.
b) Calculate the amount and the direction of change in government spending needed to
restore the recessionary gap.
c) Calculate the amount and the direction of change in the tax rates needed to restore the
recessionary gap.
(218) 22. [T] An economy is currently operating above the full employment level.

a) Draw a fully labelled AS-AD graph to show the current and full employment output
levels and the price level.
b) If the government decides not to implement any policy to correct this output gap,
explain on the graph how the economy will automatically adjust in the long run.
c) What is the cause of the adjustment you identified in part b)?
d) Now assume that the government uses fiscal policy to correct the output gap.
i. Identify an appropriate fiscal action to achieve the government objective.
ii. How will the unemployment rate and the natural rate of unemployment change
following the fiscal policy identified in part i.?
e) Explain whether the automatic adjustment identified in part b) changes the price by
less, more, or the same amount as the fiscal policy you identified in d) i.
(219) 23. [T] If the economy is at potential output with MPC = 0.8 and government spending is

increased by $100 billion, by how much taxes should be increased to offset the expansionary
effect of government spending? Show your work.

Section 3 Economic Growth and the Aggregate Production Function

(220) 24.

a) Draw a graph to illustrate the long-run aggregate supply curve (LRAS). Label the
potential output and illustrate an increase in LRAS.
b) List three possible causes of the shift in part a).
(221) 25. [G] How is the economic growth measured?
(222) 26. [G] How could LRAS increase to achieve economic growth and what are the likely

effects on real GDP and price level?

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(223) 27. [G] What are the supply-side policies?

(224) 28. [G] How do supply-side policies affect an economy?
(225) 29. [G] How is economic growth illustrated using the PPC and AS-AD model?
(226) 30. [G] What does the aggregate production function represent?

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Chapter 9 - Financial Assets and Interest Rates

Section 1 Money and Other Financial Assets
(227) 1. For each of the following, state the function that money fulfills:
a) Danny keeps $20 aside for next week’s allowance.
b) Sami earns $5 for each cake he prepares.
c) Tamer uses his $30 commission to buy a new headset.
(228) 2. Classify each of the following under M1 or M2:

a) A $100 bill hidden under the pillow

b) A $3,000 limit on a Visa card
c) A $4,000 balance in a checking account
d) $900 in a savings account
e) Small time cash deposits
(229) 3. Identify the money characteristic referred to in each of the following:

a) Money withstands being used several times.

b) Money is available in small units of value.
(230) 4. Explain the difference between each of the following:

a) Fiat and commodity money

b) Stocks and bonds
c) M1 and M2
(231) 5. [G] What does money mean?
(232) 6. [G] Give examples to explain each function of money.
(233) 7. [G] What does the monetary base mean?
(234) 8. [G] What is the difference between M1 and M2?
(235) 9. [G] What are the financial assets?
(236) 10. [G] What is liquidity and how is it possible to benefit from holding financial assets?
(237) 11. [T] Elias owns a bond with a 6% return. In the market, newly issued bonds have a 4%

return.
a) How will Elias’ bond price change based on the market?
b) What will happen to the current return on Elias’ bond following the change you identified in
part a)?

Section 2 The Money Market and Interest Rates

(238) 12. Use a correctly labelled money market graph to show the effect on the nominal interest
rate of selling government bonds.
(239) 13. a) Assume banks make loans with a flexible interest rate of 7%, expecting inflation to be

2%. If inflation ends up being 5%. Calculate each of the following.

i) The new nominal interest rate.
ii) The new real interest rate
b) Assume banks make loans with a fixed interest rate of 7% with no expected inflation. If
inflation is now expected to be 2%, calculate each of the following.
i) The new nominal interest rate.

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ii) The new nominal interest rate.

(240) 14.

a) The national saving level in Italy increases. What is the effect on the real interest rate?
b) Assume that personal savings in Italy increase. Use a correctly labelled loanable funds
market graph to show the impact of the increase on the real interest rate.
c) Based on your answer in part b), explain how expenditures on interest-sensitive
products will change.
d) Based on your answer in part c), explain the effect on the economic growth rate.
(241) 15.

a) How does an increase in inflationary expectations affect the nominal interest rate and
bond prices? Explain.
b) What happens to bond prices following an increase in money demand?
(242) 16. What will be the impact of an increase in total production (real GDP) on money demand

and the interest rate? Draw a graph to illustrate your answer.

(243) 17. [G] How are decisions regarding the purchase of previously issued bonds made

compared to savings?
(244) 18. [G] What is relationship between the nominal interest rate and the demand and supply for

money?
(245) 19. [G] What are the factors that cause the demand and supply of money to increase?
(246) 20. [G] What does a money market graph show?
(247) 21. [G] What are the factors that cause a change in the equilibrium nominal interest rate?
(248) 22. [G] How does the nominal interest rate equilibrium adjust to restore equilibrium in the

money market?
(249) 23. [G] What is the difference between the nominal and real interest rates?
(250) 24. [G] How are the interest rates calculated?
(251) 25. [G] What does the loanable funds market represent?
(252) 26. [G] What is the relationship between the nominal interest rate, the real interest rate, and

the inflation rate?

(253) 27. [G] What is the relationship between the real interest rate, the demand for loans and the

supply of loans?
(254) 28. [G] What are the factors that cause the demand for loans and the supply of loans to

increase in the loanable funds market?

(255) 29. [G] When does the equilibrium real interest rate change?
(256) 30. [G] What is the effect of national savings in a closed and open economy on the real

interest rate?
(257) 31. [T] Use a fully labelled money market graph to show the effect of each of the following:

a) Inflation caused by an increase in the general price level

b) Lower output caused by a decrease in the real GDP
c) Widespread adoption of online banking

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(258) 32.
[T] An economy is currently operating at full-employment output with a balanced
budget. Assume that the economy enters a recession due to a decrease in consumption following
an increase in consumers’ pessimism about the future.
a) Draw a fully labelled AS–AD graph to show each of the following:
i. The LRAS curve
ii. The current equilibrium output labelled as YE and the price level labelled as
PLE before the increase in consumers’ pessimism
iii. The short-run impact of the change in consumers’ confidence. Label the new
equilibrium price level and output Y1 and PL1, respectively.
b) Show the effect of the increase in consumers’ pessimism on a correctly labelled short-
run Phillips curve graph. Label the initial position A and the new position B.
c) What is the impact of the recession on the federal budget? Explain.
(259) 33. [T] Assume that the current real GDP falls below full employment output by $400

billion. The government decides to increase its spending to bring about full employment.
a) Using a fully labelled loanable funds market graph, show the effect of the increase in
government expenditure on the real interest rate.
b) Explain how the real interest rate change you identified in part a) will affect the growth
rate of the economy.
(260) 34. [T] Which money demand motive is most affected when interest rate changes?
(261) 35. [T] The money demanded for the purpose of purchasing goods and services is known as:
(262) 36. [T] Why is the money demand curve downward sloping?
(263) 37. [T] A drop in credit card fees causes people to use credit cards more often for

transactions and demand less money.

a) Show, using a correctly labeled graph of the money market, how the nominal interest
rate will be affected.
b) Given the interest rate change in part (a), what will happen to bond prices in the short
run?
c) Given the interest rate change in part (a), what will happen to the price level in the
short run? Explain.
d) Identify an open market operation the Federal Reserve could use to keep the nominal
interest rate constant at the level that existed before the drop in credit card fees. Explain.

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Chapter 10 - The Banking System and Money Supply

Section 1 Financial and Depository Institutions
(264) 1. [G] What does the banking system refer to?

Section 2 Money Creation in a Fractional Reserve Banking System

(265) 2. The table below represents a balance sheet for FNB Bank.

a) Calculate the required reserve ratio.

b) Suppose Anna withdraws $5,000 in cash from her checking account at FNB bank.
i. By how much will FNB bank’s reserves change following Anna’s withdrawal?
ii. What is the initial effect of the withdrawal on the M1 measure of money
supply? Explain.
iii. As a result of the withdrawal, what is the new value of excess reserves on the
balance sheet of FNB bank based on the reserve requirement from part a)?
c) Suppose that the next day Melissa withdraws an amount from FNB Bank that exceeds
the bank’s excess reserves. Assuming that no loans are called in, how can FNB bank
cover its required reserves?
(266) 3. Suppose that an individual deposits $5,000 in cash into his checking (demand deposit)

account. What is the immediate effect of the cash deposit on the M1 measure of the money
supply? Explain.
(267) 4. China’s central bank decided to reduce the reserve ratio from 19.5% to 18.5% in 2015.

a) What is the new deposit expansion multiplier?

b) What effect will this change have on the number of loans that will be available?
c) If 30,000 yuan were deposited, what will be the total worth of deposits under the
fractional reserve banking system?
(268) 5. What happens to the money multiplier and the money supply if the central bank raises the

reserve ratio?
(269) 6.
a) Assume that banks hold no excess reserves. A person deposits $1,000 in a bank.
Calculate the total reserves, the money multiplier, and the change in the money supply
with a reserve ratio of 20%.
b) Calculate the total reserves, the money multiplier, and the change in the money supply
with a reserve ratio of 10%.
c) What can be concluded?

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(270) 7. Consider the following balance sheet of a bank:

a) What is the effect on the bank’s excess reserves of increasing the reserve ratio by 5%?
b) What is the effect on the excess reserves of withdrawing $5,000 in cash from the
bank?
(271) 8. [G] The required reserve is 15% and a bank receives a demand deposit of $50 million. If
the banking system does not initially have excess reserves, what will be the excess reserves
created by this deposit?
(272) 9. [G] What is the effect of a change in assets or liabilities on banks?
(273) 10. [G] How do banks calculate the maximum deposits and loans?
(274) 11. [G] How is the deposit expansion multiplier calculated?
(275) 12. [G] How do banks create money and increase the money supply?

(276) 13. [T]

Assets Liabilities
Reserves $10,000 Demand deposits $40,000
Loans $25,000
Government securities $15,000
Equity $10,000
Total assets $50,000 Total liabilities and equities $50,000

Assume that the reserve requirement is 10 percent.

a) Calculate the reserves that the bank is required to hold.

b) Calculate the maximum amount of additional loans that the bank can make without
selling its holdings of government securities.
c) Now assume that this bank and all other banks lend out all excess reserves, calculate
the maximum possible change in each of the following.
i. Demand deposits throughout the banking system.
ii. Total reserves throughout the banking system.
(277) 14. [T] Primebank has the following balance sheet.

Assets Liabilities
Reserves $15,000 Demand Deposits $50,000
Loans $20,000
Property $25,000 Equity $10,000

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Assume that the reserve requirement ratio is 20 percent.

a) Calculate the reserves that Primebank is required to hold.
b) Given the current reserves, calculate the maximum value of additional loans that
Primebank can make.
c) Assume that Sam raises $1,000 from selling his car and deposits the cash in his
checking account at Primebank, by how much will the M1 money supply immediately
change as a result of Sam’s deposit? Explain.
d) Calculate the maximum change in demand deposits for the whole banking system as a
result of Sam’s deposit.
e) If Primebank is not currently meeting its reserve requirement, what action should it
take to meet the required reserve without calling in loans or selling property?
(278) 15. [T]

a) Assume that Donald deposits $9,000 in cash at his local bank. What is the immediate
effect of this transaction on the money supply? Explain.
b) Suppose that the reserve requirement is 10% and banks keep an additional 10% in
reserves by choice. Calculate each of the following.
i. The maximum amount by which this bank will increase its loans from the
transaction in part (a).
ii. The maximum increase in the money supply that will be created from the
transaction in part (a)
(279) 16. [T] Suppose that Adam deposits $5,000 of his cash holdings in his checking account at

Moody Bank. The reserve requirement is 20% and the bank holds no excess reserves.
a) What is the immediate effect of his deposit on the money supply? Explain.
b) What is the maximum amount of money Moody bank can initially lend out? Show
your work.
c) What is the maximum amount of money the entire banking system can create? Show
your work.
(280) 17.
[T] The simplified T-account (Balance sheet) for XYZ Bank in the economy of
Summerland is shown below. Assume the reserve requirement in Summerland is 20 percent.

Assets Liabilities
Reserves $80 Deposits $200 million
million
Loans $160 Net worth $40 million
million (owners’ equity)

a) Calculate the maximum amount by which XYZ bank can increase its loans.
b) Based on your answer in part (a), calculate the maximum possible increase in
Summerland’s money supply.

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c) Identify two reasons that Summerland’s money supply may expand by a smaller amount
than the amount you identified in part (b).

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Chapter 11 - The Monetary Policy

Section 1 Meaning and Tools of Monetary Policy
(281) 1.
Roy owns many bonds. By conducting open-market operations, the Fed offers Roy $500
for the bonds he owns. Roy sells the bonds to the Fed, and deposits the $500 into his bank
account at LL Bank.
a) Assuming the reserve ratio is 20%, complete the transactions in the following balance sheet:

b) By how much will the LL Bank’s reserves change due to the Fed’s action?
c) What is the maximum amount of loans created by the entire banking system?
d) What is the total change in money supply caused by the Fed’s action?
(282) 2. [G] What is a monetary policy?
(283) 3. [G] How does the central bank control the lending and borrowing of commercial banks?
(284) 4. [G] How does a change in monetary policy affect commercial banks and the amount of

money?
(285) 5. [G] Assume that the reserve requirement is 20% and that banks do not hold excess

reserves. The Fed buys $5 million in government bonds as an open market operation. What is the
maximum increase in the money supply in the banking system?
(286) 6. [G] How does a change in reserves or deposits change the quantity of money?
(287) 7. [T] The current money supply is $353. The Fed decides to decrease the money supply to

$303 using open-market operations.

a) Which open-market operation should the Fed use?
b) Assuming the money multiplier is 10, what is the worth of the bonds needed to reduce the
money supply to $303?
(288) 8. [T] Complete the following table to show the effect of each of the Fed’s monetary policies

on reserves, money supply, and federal funds rate (write increase or decrease).

(289) 9.
[T] If Adam deposits $5,000 of his cash holdings in his checking account at Moody Bank.
The reserve requirement is 20 percent and the bank holds no excess reserves.
a) What is the immediate effect of his deposit on the money supply? Explain why.

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b) What is the maximum amount of money Moody bank can initially lend out? Sow your
work.
c) What is the maximum amount of money the entire banking system can create?
Show your work.
The Central bank buys $2,000 in bonds from Moody bank.
d) As a result of the central bank’s action, what is the change in the money supply if the
required reserve ratio is 100 percent?
e) If the required reserve ratio is reduced to 10 percent, what is the maximum increase in
the total money supply from the Federal Reserve’s purchase of bonds? Show your
work.
f) If banks keep some of the deposit as excess reserves, how will this influence the
change in the money supply that was determined in part e)? Explain.
(290) 10. [T] XYZ Bank has the simplified balance sheet below.

Assets Liabilities
Required reserves $15,000 Demand deposits $60,000
Excess reserves $0 Owner’s equity $10,000
Customer loans $45,000
Government securities (bonds) $7,000
Building and fixtures $3,000
a) Based on XYZ Bank’s balance sheet, calculate the required reserve ratio.
b) Suppose that the Federal Reserve purchases $3,000 worth of bonds from XYZ Bank.
What will be the change in the dollar value of each of the following immediately after
the purchase?
i. Excess reserves.
ii. Demand deposit.
c) Calculate the maximum amount that the money supply can change as a result of the
$3,000 purchase of bonds by the Federal Reserve.
d) When the Federal Reserve purchases bonds, what will happen to the price of bonds in
the open market? Explain.
e) Suppose that instead of the purchase of bonds by the Federal Reserve, an individual
deposits $3,000 in cash into her checking (demand deposit) account. What is the
immediate effect of the cash deposit on the M1 measure of the money supply?
(291) 11. [T] Suppose that the reserve requirement is 20% and banks hold no excess reserves.
a) Suppose that John deposits $100 of cash from his pocket into his checking account.
Calculate each of the following.
i. The maximum dollar amount the commercial bank can initially lend.

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ii. The maximum total change in demand deposits in the banking system.
iii. The maximum change in the money supply.
b) Suppose that the Federal Reserve buys $5 million in government bonds on the open
market. As a result of the open market purchase, calculate the maximum increase in the
money supply in the banking system.
c) Given the increase in the money supply in part (b), what happens to real wages in the
short run? Explain.

Additional question:
a. Country X’s economy is in a short run equilibrium and the actual unemployment rate is lower
than the natural rate of unemployment.
Assuming that the country’s banking system has ample reserves, what monetary policy action
should the central bank use to move the economy toward its long-run equilibrium. Draw a
reserve market graph to show how the central bank’s action will affect the policy rate in the short
run.
b. Country Y’s economy is in a short run equilibrium and the actual unemployment rate is higher
than the natural rate of unemployment.
Assuming that the country’s banking system has ample reserves, what monetary policy action
should the central bank use to move the economy toward its long-run equilibrium. Draw a
reserve market graph to show how the central bank’s action will affect the policy rate in the short
run.

Section 2 Impact of Monetary Policy on the Economy

(292) 12. The Fed wants to increase the supply of reserves. Thus, it purchases $1 million worth of
bonds from the public. Explain the effect of this open-market operation and present it
graphically.
(293) 13. A country’s central bank conducts an open-market sale of government bonds.

a) Use a correctly labelled graph of the money market to show how the open-market sale of
bonds will affect each of the following:
i. The money supply
ii. The interest rate
b) Is the interest rate identified in part a) real or nominal?
c) What condition will make the nominal and the real interest rates equal?
(294) 14. Assume that the Fed purchases bonds through open-market operations.

a) Use a correctly labelled graph to show the effect of this purchase on the interest rate.
b) Explain how the change in interest rate will affect output and the price level in the short run.
(295) 15. The federal funds rate is used as a monetary policy tool.

a) Define the term “federal funds rate”.

b) What open-market operation helps reduce the federal funds rate?
c) What is the effect of the operation that you identified in part b) on the nominal interest rate?
d) Define the real interest rate.
e) Assume that the Fed’s action results in inflation. What would be the impact of the open-

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market operation that you identified in part b) on the real interest rate?
Explain
(296) 16. Assume that the reserve requirement is 10%, and banks hold no excess reserves.
Suppose that the Fed buys $5 million in government bonds on the open market.
a) Calculate each of the following:
i. The change in the monetary base of the country
ii. The maximum increase in money supply in the entire banking system. Show your work.
b) Given the increase in the money supply identified in part a), what happens to real wages in the
short run? Explain.
(297) 17. [G] How is monetary policy used to correct an output gap?
(298) 18. [G] What is the impact of monetary policy on the economy in the short run?
(299) 19. [G] What are the lags of monetary policy?
(300) 20. [T] In a given country, it is easy for people to get approval for credit cards, which

encourages them to make more transactions, thus reducing the demand for money.
a) Using a money market graph, show how this affects the nominal interest rate.
b) What will happen to bond prices in the short run following the change in the nominal
interest rate you identified in part a)?
c) Given the interest rate change identified in part a), what will happen to the price level
in the short run? Explain.
d) Identify an open-market operation that the Fed could use to keep the nominal interest
rate constant at the level that existed before the increase in the use of credit cards
assuming that the reserve requirement is 10%.

(301) 21. [T] Consider the following graph for an economy operating at Y:

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a) Should the central bank use an expansionary or tight monetary policy to
move the equilibrium at Yf instead of Y? Explain.
b) Suggest an open-market operation to restore full employment at Yf.
c) How would the policy identified in part b) affect the nominal interest rate in the short run?
d) What happens to real output in the short run following the central bank’s action?
e) What happens to the price level in the short run following the central bank’s action?

Section 3 Macroeconomic Policy Mix

(302) 22. What monetary policy action should the central bank take to maintain a stable interest
rate when the government is implementing an expansionary fiscal policy? Explain.
(303) 23. How will an increase in government deficit spending affect interest rates and bond

prices? Explain.
(304) 24. [G] When is it best to use a policy mix and what is the impact on the economy?

Chapter 12 - The Balance of Payments and the Exchange Rates

Section 1 The Balance of Payments

(305) 1. a) Real incomes in the US decreased significantly. Explain the effect of this decrease in
real incomes on the US current account.
b) Assume that the US requires high spending on an infrastructure program that it will finance by
borrowing. How will this program affect its balance of payments? Explain.
(306) 2. For each of the following transactions, identify the accounts affected on the US balance of

payments:
a) China purchases a new airplane from Boeing, a company based in the US.
b) Chinese businessmen purchase stocks in Boeing from American investors.
c) A Chinese company purchases a used airplane from an American airline company and ships it
to China.
(307) 3. Classify each of the following transactions according to where they appear on the US

balance of payments:
a) US residents purchase cars from Germany.
b) A US businessman purchases a factory in India.
c) The US government gives a long-term loan to a developing country.
d) The US government spends a large amount on maintaining its embassies in foreign countries.
(308) 4. Consider the following balance of payments:

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a) Calculate each of the following:

i. The current account balance
ii. The capital and financial account balance
b) Does the country have a deficit or surplus on the current account? Explain.
(309) 5. a) What could cause a surplus on the current account?

b) How can a government reduce the trade deficit using each of the following?
i. Tariffs
ii. Quotas

(310) 6. [G] What does a balance of payments show?

(311) 7. [G] What are the items included on a balance of payments?
(312) 8. [G] What does the current account and capital and financial record on the balance of

payments?
(313) 9. [G]

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Calculate the current account and the capital and financial account balances.
(314) 10. [G] How does a change in the current account affect the BOP?
(315) 11. [G] How does a change in the current account affect the BOP?
(316) 12. [T] An economy is running a budget deficit. Consequently, the government increases its

borrowings in the loanable funds market.

a) Draw a fully labelled loanable funds graph to show the effect of the increase in government
spending on the interest rate.
b) Assuming that the current and capital and financial accounts were balanced, what will be the
effect of the change in the interest rate identified in part a) on the current and capital and
financial accounts?
(317) 13. [T] A country recorded the following:

 Exports of goods = $29 million

 Imports of goods = $15 million
 Exports of services = $23 million
 Imports of services = $39 million
a) Calculate the balance on the current account.
b) Based on your answer in part a), suggest how the current account can be corrected to improve
the balance of payments.

Section 2 Exchange Rates

(318) 14. What will be the effect of an increase in a government’s budget deficit due to an increase
in government spending on the value of the country’s currency and its trade deficit? Explain.
(319) 15. The exchange rate is 1.2 euros per US dollar. If a shirt costs 30 euros in France, what is

its dollar cost to a US tourist?

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(320) 16.[G] How is the exchange rate calculated?
(321) 17. [G] What is the difference between currency appreciation and depreciation?

Chapter 13 - The Foreign Exchange Market

Section 1 Currency Markets in the Floating Exchange Rate System
(322) 1.
Explain the effect of each of the following on the exchange rate between the UK pound
sterling and the US dollar:

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a) The price level in the UK increases relative to other countries.
b) The US, a trading partner of the UK, reduces tariffs.
c) The UK economy faces a recession for the second consecutive year.
d) The interest rate in the US increases.
e) Average incomes in Germany, a trading partner of the UK, increase.
(323) 2. Assume that the real interest rates in Canada and India are 5%. Now, assume that the real

interest rate in India increases to 8%.

a) Draw a graph of the Canadian dollar ($C) market to show the effect of the higher real
interest rate in India on each of the following:
i. The supply of the Canadian dollar
ii. The value of the Canadian dollar
b) Draw a loanable funds market graph for Canada to show how the increase in the real
interest rate in India affects the real interest rate in Canada.
(324) 3.
a) Suppose that the real interest rate of the euro zone becomes higher than the real interest
rate of the US. Draw a correctly labelled graph of the foreign exchange market for the
euro and show the effect of the higher real interest rate in the euro zone on each of the
following:
i. The demand for the euro
ii. The value of the euro in terms of the US dollar
b) Assume that the US has a zero current account balance. Based on the change in the
value of the euro identified above, how will the US current account balance be affected?
c) Suppose that the European central bank decides to offset the change in the value of the
euro identified in part a).
i. Would the European central bank buy or sell euros?
ii. Would the European central bank buy or sell dollars?
(325) 4. The graph below shows the exchange rate between the pound sterling (£) and the US

dollar ($).

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a) What does P2 represent?
b) What is the effect of setting a price at P3 on the amount of dollars? How can this be corrected?
c) What does a movement from point e to a represent?
d) What does a movement from point e to c represent?
(326) 5. The graph below illustrates the exchange rate between the US (dollar) and Japan (yen).

Point e represents the exchange rate before an increase in the demand for Japanese goods from
US citizens, and point e’ shows the new exchange rate after the increase in demand.

a) If the exchange rate was free-floating prior to the change in demand for Japanese goods, what
was its likely value?
b) How much does each dollar buy in terms of yen after the increase in demand?

(327) 6. Explain whether each of the following will result in the appreciation or deprecation of the
US dollar:
a) A Chinese company purchases several Airbus planes assembled in the US.
b) An American telecommunication firm decides to build a training center in India.
c) A French manufacturer ships machinery on an American ship.
d) The US economy grows more slowly than the Chinese economy.
(328) 7. [G] When does the demand for a currency increase?
(329) 8. [G] What are the factors that increase/decrease the supply of the US dollar?
(330) 9. [G] How is the equilibrium exchange rate determined?
(331) 10. [G] What causes an increase in the exchange rate?

Section 2 The Effect of Exchange Rates on the Economy

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(332) 11. What is the effect on the US GDP of a decrease in the value of the
US dollar?
(333) 12. The US and Mexico are trading partners with floating exchange rates.

a) Assume that Mexico is currently in a recession. What fiscal policy action could the Mexican
government implement to eliminate the recession?
b) What would be the effect of the fiscal policy you identified in part a) on the real interest rates
in Mexico?
c) Draw a correctly labelled graph of the foreign exchange market for the US dollar. Show on
your graph the impact of the change in interest rates identified in part b) on each of the
following:
i. The supply of the US dollar
ii. The equilibrium exchange rate of the US dollar
d) What would be the effect of the change in the exchange rate identified in part c), ii. on
American exports?
e) What would be the effect of the change in American exports identified in part d) on the
unemployment rate?
(334) 13. Assume that Country A is running a budget deficit due to an increase in public spending

by the government.
a) Draw a loanable funds market graph and show the effect of the increase in Country A’s budget
deficit on the real interest rate.
b) Given your answer in part a), how will business investment be affected in Country A?
c) Country A (dollar) and Country B (peso) have flexible exchange rates. Using a correctly
labelled graph of the foreign exchange market for Country A’s dollar, show how the interest rate
change you identified in part a) affects the international value of Country A’s dollar.
d) Given your answer to part c), will Country A’s goods become relatively more or less
competitive than Country B’s goods?

(335) 14. Assume that French investors start purchasing assets in the US.
a) Draw an exchange rate market graph and an AS-AD graph to show the effect of this purchase
on each of the following for the US:
i. The exchange rate of the dollar
ii. The price level
iii. The real GDP
b) How will the purchase affect France’s real GDP and price level?
(336) 15. A country is currently in the recession phase. As a result, the central bank conducts an

expansionary monetary policy.

a) What is the effect of the open-market operation on the real interest rate and the real GDP,

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assuming that the price level does not change?
b) Now, suppose that the country has a current account deficit. What is the effect of the change
in the real GDP on the current account deficit?
c) What is the effect of the change in the real GDP on the country’s currency value in the
international exchange market?
(337) 16. Assume that the exchange rate between the euro and the dollar was €1 = $1.2. Now,

assume that the exchange rate is at €1 = $1.6. Explain the effect of the change in the exchange
rate on each of the following in the US in the short run:
a) Aggregate demand
b) The employment rate
(338) 17. [G] Explain the causes and effects of an increase in net exports on aggregate demand and

real output.
(339) 18. [G] What is the effect of an increase in the interest rate on the loanable funds market and

the exchange rate?

(340) 19. [T] Assume that the UK economy is operating at long-run equilibrium.

a) Using a correctly labelled AS-AD graph, show the short-run equilibrium price level, labelled
PL1, and output level, labelled Y1.
b) Assume that uncertainty has reduced business orders for machinery and tools. Explain the
impact of this reduction in orders on each of the following in the short run:
i. Aggregate demand
ii. Employment
c) Explain what will happen to the long-run economic growth rate following the reduction in
orders.
d) Using a correctly labelled graph of the loanable funds market, show the effect of the change in
business orders on the real interest rate in the short run.
e) Given the effect on the real interest rate identified in part d), explain what will happen to each
of the following:
i. The supply of the country’s currency in the foreign exchange market
ii. The international value of the country’s currency
(341) 20. [T] France and the US are trading partners. The US economy is operating at full

employment with a current account balance equal to zero.

a) Assume that the exchange rate between the French euro and the US dollar changes from €1 =
$2 to €1 = $1.5. Did the dollar appreciate or depreciate against the euro?
b) Given your answer in part a), will each of the following increase, decrease, or remain the
same?
i. The price of American goods in euros
ii. US net exports
c) Given your answer in part b) ii., will each of the following be in deficit, surplus, or equal to
zero for the US economy?
i. Current account balance
ii. Financial and capital account balance

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(342) 21. [T] Canada ($C) and Australia ($A) are trading partners with a
floating exchange rate.
a) Draw a correctly labelled foreign exchange market graph for the Canadian dollar to show the
equilibrium.
b) Assume the Canadian central bank implements an expansionary monetary policy. Explain the
effect of the policy on each of the following:
i. The Canadian interest rate
ii. The international capital flow
c) Illustrate graphically the effect of the monetary policy identified in part b) on each of the
following:
i. The demand for the Canadian dollar
ii. The supply of the Canadian dollar
iii. The equilibrium exchange rate
d) Explain the effect of the monetary policy identified in part b) on the level of aggregate
demand in Canada.
(343) 22. [T] Suppose that as a result of increased economic uncertainty, investors move their
funds out of country “Funland”.
a) How will this decision by investors affect the international value of Funland’s currency on the
foreign exchange market? Explain.
b) Show, using a correctly labeled graph of the loanable funds market in Funland, the impact of
this decision by investors on the real interest rate in Funland
c) Given your answer in part (b), what will happen to Funland’s rate of economic growth?
Explain.
(344) 23. [T] The United States and South Korea are trading partners, and the United States has a

zero current account balance. Suppose that the inflation rate in the United States decreases
relative to the inflation rate in South Korea.
a) Based on the decrease in the inflation rate in the United States, will United States exports to
South Korea increase or decrease?
b) Based on the change in United States exports in part (a), answer each of the following:

i. Will the United States current account balance remain at zero, be in surplus, or be in
deficit?
ii. What will happen to real gross domestic product in the United States in the short run?
Explain.
c. The South Korean currency is the won. Draw a correctly labeled graph of the foreign exchange
market for the United States dollar. Show the effect of the lower inflation rate in the United
States on the won price per United States dollar.
(345) 24. [T] Suppose that the US economy is operating at full employment.

a) Using a correctly labeled graph of the long-run aggregate supply, short-run aggregate supply,
and aggregate demand, show each of the following:
i. Current price level, labeled PL1.

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ii. Current output level, labeled Y1.
b) Suppose that personal savings in the United States increase.
Show, using a correctly labeled graph of the loanable funds market, the impact of the increase in
personal savings on the real interest rate.
c) Based on the real interest rate change identified in part (b):
i. Will interest-sensitive expenditures increase, decrease, or remain unchanged?
ii. What will happen to the rate of economic growth? Explain.
d) Suppose that the real interest rate of the euro zone increases relative to the real interest rate of
the United States. Draw a correctly labeled graph of the foreign exchange market for the euro
and show the impact of the change in the real interest rate in the euro zone on each of the
following:
i. Demand for the euro. Explain.
ii. Value of the euro relative to the United States dollar.
e) Suppose that the United States current account balance is zero. Based on the change in the
value of the euro identified in part (d)(ii), will the United States current account balance now be
in surplus, be in deficit, or remain at zero?
(346) 25. [T] Suppose that the country of Hartland is currently in recession.

a) Suppose that Hartland produces only food and clothing. Draw a correctly labeled production
possibilities curve for Hartland. Show a point that could represent the current output combination
and label it A.
b) Suppose that the Central Bank of Hartland pursues an expansionary monetary policy.
i. Identify the open market operation that the Central Bank would use.
ii. Draw a correctly labeled money market graph and show the short-run effect of the
expansionary monetary policy on the nominal interest rate.
iii. Assuming no change to the price level, what happens to the real interest rate as a
result of the expansionary monetary policy? Explain.
iv. Given your answer to part (b)(iii) regarding the real interest rate, what happens to the
real gross domestic product (GDP) in the short run? Explain.
c) Suppose that Hartland has a current account deficit. Hartland’s currency is called the terra.
i. What will initially happen to the current account deficit in Hartland solely due to the
change in the real GDP from part (b)(iv)? Explain.
ii. What will happen to the international value of the terra solely due to the change in the
real GDP from part (b)(iv)? Explain.

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