AP macroeconomics HW review guide for UNIT 2:

1. There are three scenarios when it comes to the relationship between expected and
actual inflation rate
What Happens When Actual Inflation Rate

a) Higher Than Expected

● Borrowers benefit: They pay back loans with money that is worth less than expected.
● Lenders lose: They get back money worth less than they thought it would be.

b) Same as Expected

● No big surprise: Both borrowers and lenders get what they planned for. No one wins
or loses unexpectedly.

c) Lower Than Expected

● Lenders benefit: They get back money worth more than expected.
● Borrowers lose: They have to pay back loans with money worth more than they
thought it would be.

Therefore, if the actual inflation rate is higher than the expected one, borrowers of
fixed interest rate loans will be better off

2. Nominal VS Real GDP:

Nominal GDP: income/output/spending of one year

Therefore if we have these values

Year Nominal GDP GDP deflator Real GDP

1980 $14,000 70 $200

1990 $18,000 100 $180

2000 $22,000 220 $100

2010 $50,000 200 $250

2015 $60,000 300 $200

1
At first glance, if we guide ourselves only by the nominal GDP, it would look like 2015 has
turned the highest GDP. However, after we adjusted for inflation and calculated the real
GDP, it is evident that 2010 had the largest GDP of all these years.

Extra information: if this was the US GDP for 2010, it would have been the opposite. 2010
was the second year after the 2008 crisis, and they had a negative GDP. The next big hit in
their GDP was in 2020, the year after Covid pandemic started. Look at this chart below.

3. Unemployment rate: general and real

Remember from class:

2
General population: everyone who lives in a country
Working-age population: everyone who could legally work in this country, but a part of
them will pursue other options (college, raising family, etc)
Labor force, also called workforce: the part of the working-age population that is
employed or looking for a job

Let us calculate the total unemployment rate based on the data in the chart above:

IMPORTANT: cyclical unemployment, which results from a recession in the business cycle,
is included in the calculations for total unemployment, but not in the calculation of the
natural unemployment rate. Mind this for the following question.

4. Calculating the natural unemployment rate:

3
We use the same formula as above, but we leave out the 4 million people who have lost
their jobs due to cyclical unemployment. So, we have (3+2)/ (91+9) x 100= 5/100 x 100= 5%

5. Inflation rate calculation:

Inflation Rate=Nominal GDP Growth Rate−Real GDP Growth Rate

If in a specified year nominal gross domestic product grew by 11 percent and real gross
the domestic product grew by 4 percent, inflation for this year would be

Let us calculate:

● Nominal GDP growth rate = 11%

Inflation Rate=11%−4%=7%

Is this a good or bad inflation rate:

High but Manageable: While 7% is higher than ideal, it's not hyperinflation (extremely high,
typically above 50%), which would be much more damaging.
Potentially Concerning: If persistent, it can have negative effects on the economy, but if it's
temporary and managed properly, it might not be disastrous. In most contexts, a 7% inflation
rate would be a cause for concern and likely lead to efforts by policymakers to bring it down

6. Failures of GDP as a tool of economic growth:

GDP has many shortcomings as a tool: including measuring only legal and documented
transactions (does not account for shadow economies), but does not also account for the
distribution of income. There is an attempt to rectify this by calculating the GDP per capita
(by dividing the real GDP by the number of population), but that measure also is far from the
realistic situation.

7. Wages and inflation:

Remember the conversation from class: inflation is a big problem only if the wages do not
grow at the same rate or a higher rate. Let us see a problem that will explore this concept:

4
If a worker’s nominal wage rate increases from $10 to $12 per hour and at the same
time the general price level increases by 10 percent, the worker’s real wage has

● Initial nominal wage: $10 per hour

Step 1: Calculate the percentage of increase of nominal wage (which will then be adjusted
for inflation; similar to we use the GDP deflector)

Percentage increase in nominal wage= (New wage- old wage)/ old wage X 100= (12-10)/10
x 100= 20% increase

Step 2: Calculate the real wage increase considering the inflation rate

Real wage: Percentage in change of nominal wage- percentage change of inflation= 20%-
10%= 10%

In this case, we have a 10% increase in real wages even though we have an increase of
inflation. Since the wages have gone up by 20%, the 10% increase in inflation does
not have much of a negative effect. The best-case scenario for workers would have been
for wages to go up and inflation to stay constant.

8. GDP and domestic labour

5
Remember from class: GDP counts only transactions where we have used resources to
create a new good or service and we have sold it for profit. Domestic labour, as does not
result in profitable transactions, is not counted towards the GDP, even though it saves
household money that can go towards the HHs disposable income

Example: a stay-at-home mother saves the family monthly $3000 by providing childcare,
cooking, and cleaning services. Since this is unpaid labour, gross domestic product
underestimates a country's production of goods and services when there is an
increase in household production.

What does this mean? If there are more people in a household to take over unpaid labour, it
frees up more time for the income earners to pick up a second job or overtime work.
Therefore, more labour=more production=higher GDP.

Remember the discussion also from class that the 40-hour work week was designed with the
idea that there will always be an unpaid-labour provider in the household to pick up all the
domestic chores.

9. Circular flow model and the flipped roles in finished product/factor markets

Households: demanders (buyers) in product market and sellers in factor markets

Remember from class, to be included in the GDP, an action has to result from a good or
service being created using new resources AND sold in a documented transaction. If
an action does not meet these two conditions, it is not counted towards the GDP.

○ Matt gives his secondhand bicycle to his brother (NOT included: there is NO
transaction and NO use of new factors of production to create a good or
service; an already existing product is given as a gift)

6
○ Sal paints his own bicycle (NOT included: the bike already exists, it is not a
new product that has been recently purchased. What may be included is the
price of paints, but we do not know if he already had the paint or bought it just
for this project)
○ Mike buys a share of stock in a bicycle firm (NOT included even though we
have a transaction here; the stocks already exist, they have not been
created anew using resources: this is similar to Mike buying a second-hand
bike)
○ Daniel bikes to school every day (NOT included: here we have a use of an
already existing good. What Daniel does here is create positive externalities:
he saves money on bus tickets, preserves the environment by not creating
additional pollution, and saves money on the healthcare system by keeping in
good health). We shall discuss externalities in some other class, even though
this is a microeconomic topic.
○ Ali buys a new bicycle (INCLUDED: new product has been made using
resources + a transaction happened)