Version A

I. Multiple choice

(1)a. (2)c. (3)d. (4)b. (5)d. (6)c. (7)d. (8)b. (9)a. (10)c.
(11)a. (12)b. (13)a. (14)a. (15)d. (16)b. (17)d. (18)a. (19)c. (20)g.
(21)b. (22)a.

II. Problems

(1) [Economic capital: 6 pts] Economic capital includes factories, buildings, machinery, equipment, vehicles, computers, and software: goods that help produce more goods. Note that economic capital is NOT the same as financial capital.

1. Yes.
2. No.
3. No.
4. Yes.
5. Yes.
6. Yes.

(2) [Comparative advantage, gains from grade: 17 pts]

1. 1/2 car.
2. 1 car.
3. 2 motorcycles.
4. 1 motorcycle.
5. Country X (because it has the lower opportunity cost of producing motorcycles).
6. Country Y (because it has the lower opportunity cost of producing cars).
7. ... if Country Y produces and exports three cars to Country X, which produces and exports 4 (or 5) motorcycles in return.
8. Trade must be plotted on graph. Must show production before trade (on PP curve) and consumption after trade (outside PP curve) for each country.

(3) [Shifts in demand and supply: 15 pts] Full credit requires graphs showing new demand or supply curve(s).

1. Demand shifts right, supply unchanged, equilibrium price increases, equilibrium quantity increases.
2. Demand unchanged, supply shifts left, equilibrium price increases, equilibrium quantity decreases.
3. Demand shifts left, supply shifts left, equilibrium price cannot be determined, equilibrium quantity decreases.

(4) [Spending approach: 12 pts]

1. $14.2 trillion = consumption of durable goods + consumption of nondurable goods + consumption of services.
2. $3.9 trillion = business fixed investment + residential investment + change in inventories.
3. $1.5 trillion = gross investment - depreciation.
4. $4.0 trillion = national defence purchases + federal nondefense purchases + state and local purchases.
5. trade deficit, because exports < imports.
6. $-0.7 trillion = exports - imports.

(5) [GDP and real GDP: 8 pts]

	Food		Clothing		Calculations
Year	Price	Quantity	Price	Quantity	2024 prices	2025 prices
2024	$3	100	$4	50	$500	$800
2025	$6	100	$4	60	$540	$840

1. 68 percent, using diagonal entries above because nominal GDP is computed using prices and quantities from the same period.
2. 8 percent, using entries in the first column (2024 prices) above.
3. 5 percent, using entries in the second column (2025 prices) above.
4. 6.5 percent, the average of the growth rate using constant 2024 prices and the growth rate using constant 2025 prices.

(6) [Nominal GDP, real GDP, and inflation: 7 pts] Data for Chile

1. base year = 1995 (because nominal GDP = real GDP in that year).
2. GDP price index = nominal GDP / real GDP × = 98.4, 100.0, 102.6.
3. Rate of inflation = (new price index - old price index) / (old price index) = 1.6 percent, 2.6 percent.

(7) [Interest rate and GDP shares: 6 pts]

1. C/Y shifts.
2. C/Y shifts left.
3. NG/Y also shifts left.
4. interest rate decreases.
5. C/Y decreases.
6. I/Y increases.
7. X/Y increases.
8. Investment (I/Y) directly affects potential GDP in the long run because new capital raises the aggregate production function.
9. growth increases.

(8) [Measuring the labor force: 4 pts]

1. out of the labor force.
2. employed.
3. out of the labor force.
4. unemployed.

(9) [Technical change: 4 pts]

1. 1.2 percent (capital's contribution computed as 3.6 percent × 1/3).
2. 1.2 percent (technology's contribution computed as 2.4 percent minus capital's contribution).

(10) [Quantity equation: 2 pts] 4.3 percent (computed as as growth rate of money supply minus growth rate of real GDP).

(11) [Keynesian cross, Keynesian multipliers: 12 pts]

1. $30 trillion.
2. up.
3. $0.5 trillion.
4. increase.
5. $1.0 trillion. (Find this by drawing the new expenditure line carefully.)
6. 2. (ΔY/ΔG = 1/0.5)

(12) [How business cycles begin: 20 pts] Full credit requires correct graphs on page 6.

1. down, left, recession.
2. down, left, recession.
3. up, right, boom.
4. down, left, recession.

(13) [Inflation adjustment: 16 pts] Begin by drawing the "inflation adjustment line" at the current rate of inflation, 2 percent.

1. $30 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment* because GDP = potential GDP.
3. $31 trillion (an increase).
4. 2 percent, because inflation rate has momentum in short run.
5. less than the natural rate* because GDP > potential GDP.
6. $30 trillion, because eventually the inflation rate will rise until GDP once more equals potential GDP.
7. 6 percent, where aggregate demand curve 2 intersects potential GDP.
8. equal to natural rate of unemployment* because once again GDP = potential GDP.

1. Discretionary policy (because requires Act of Congress).
2. Automatic stabilizer (because changes without Congressional or Administration action), decreases in a boom (because fewer people are unemployed).
3. Automatic stabilizer (because changes without Congressional or Administration action), increases in a boom (because as income rises, people owe more in taxes).

1. boom, because actual GDP > potential GDP.
2. actual budget surplus.
3. $200 billion.
4. structural budget deficit.
5. $200 billion.

1. 3 percent.
2. above.
3. boom, because real GDP > potential GDP.
4. 4.5 percent, using the rule.

III. Critical thinking [4 pts]

(1) The model of Thomas Malthus predicts that output per worker will always return to the subsistence level due to these assumptions:

1. There is no capital in Malthus's model. This matters because if the population and labor force grow, then output grows but not as fast as population grows. There is no possibility of output growth staying ahead of population growth. So output per worker falls. This assumption turned out to be wrong after the Industrial Revolution as factories, railroads and steamships were built.
2. There is no technology in Malthus's model. This matters because, if the population and labor force grow, then output grows but not as fast as population grows. There is no possibility of output growth staying ahead of population growth. So output per worker falls. This assumption turned out to be wrong after the Industrial Revolution as new inventions appeared.
3. Malthus assumed that whenever output per worker is greater than the subsistence level, the population grows. This matters because, with diminishing returns to labor, population growth drives output per worker down to the subsistence level. This turned out to be wrong in the twentieth century, when fertility rates began to fall in high income countries. Now fertility rates are below replacement in much of the world.

(2) The quantity equation for money and inflation says that, assuming money velocity is constant, the inflation rate equals the growth rate of the money supply minus the growth rate of real GDP. We are given that, hypothetically, the money supply is increasing by $2 trillion from an initial value of $20 trillion, an increase of 10 percent, and that real GDP is growing at about 2 percent. Applying the quantity equation gives an inflation rate of 8 percent.

(3) Congress should enact a tax increase. A tax increase would decrease GDP (through the tax-cut multiplier) and push the aggregate demand curve back to the left, cutting off the boom and preventing inflation from rising. This is an example of countercyclical fiscal policy. A tax cut, by contrast, would shift the aggregate demand curve further to the right and cause inflation to rise further in the long run. (Graph should show aggregate demand shifting to the right, and then shifting back to the left with the tax increase.)

Version B

I. Multiple choice

(1)b. (2)a. (3)b. (4)a. (5)b. (6)a. (7)b. (8)b. (9)c. (10)b.
(11)c. (12)d. (13)c. (14)c. (15)b. (16)d. (17)b. (18)c. (19)b. (20)c.
(21)a. (22)c.

II. Problems

(1) [Economic capital: 6 pts] Economic capital includes factories, buildings, machinery, equipment, vehicles, computers, and software: goods that help produce more goods. Note that economic capital is NOT the same as financial capital.

1. Yes.
2. Yes.
3. Yes.
4. No.
5. Yes.
6. No.

(2) [Comparative advantage, gains from grade: 17 pts]

1. 1 unit of wheat.
2. 1/2 units of wheat.
3. 1 unit of corn.
4. 2 units of corn.
5. Farmer B (because it has the lower opportunity cost of producing corn).
6. Farmer A (because it has the lower opportunity cost of producing wheat).
7. ... if Farmer A sends two units of wheat to Farmer B, who sends 3 units of corn in return.
8. Trade must be plotted on graph. Must show production before trade (on PP curve) and consumption after trade (outside PP curve) for each farmer.

(3) [Shifts in demand and supply: 15 pts] Full credit requires graphs showing new demand or supply curve(s).

1. Demand unchanged, supply shifts left, equilibrium price increases, equilibrium quantity decreases.
2. Demand shifts left, supply unchanged, equilibrium price decreases, equilibrium quantity decreases.
3. Demand shifts left, supply shifts left, equilibrium price cannot be determined, equilibrium quantity decreases.

(4) [Spending approach: 12 pts]

1. $17.5 trillion = consumption of durable goods + consumption of nondurable goods + consumption of services.
2. $4.8 trillion = business fixed investment + residential investment + change in inventories.
3. $2.0 trillion = gross investment - depreciation.
4. $4.4 trillion = national defence purchases + federal nondefense purchases + state and local purchases.
5. trade deficit, because exports < imports.
6. $-1.0 trillion = exports - imports.

(5) [GDP and real GDP: 8 pts]

	Food		Clothing		Calculations
Year	Price	Quantity	Price	Quantity	2024 prices	2025 prices
2024	$5	10	$4	50	$250	$500
2025	$5	16	$9	50	$280	$530

1. 112 percent, using diagonal entries above because nominal GDP is computed using prices and quantities from the same period.
2. 12 percent, using entries in the first column (2024) above.
3. 6 percent, using entries in the second column (2025) above.
4. 9 percent, the average of the growth rate using constant 2024 prices and the growth rate using constant 2025 prices.

(6) [Nominal GDP, real GDP, and inflation: 7 pts] Data for Mexico

1. base year = 2018 (because nominal GDP = real GDP in that year).
2. GDP price index = nominal GDP / real GDP × 100 = 89.3, 94.9, 100.0.
3. Rate of inflation = (new price index - old price index) / (old price index) = 6.3 percent, 5.4 percent.

(7) [Interest rate and GDP shares: 6 pts]

1. C/Y curve.
2. shifts right.
3. NG/Y shifts right.
4. interest rate increases.
5. C/Y increases.
6. I/Y decreases.
7. X/Y decreases.
8. Investment (I/Y) directly affects potential GDP in the long run because new capital raises the aggregate production function.
9. growth decreases.

(8) [Measuring the labor force: 8 pts]

1. 6.9 million = labor force - employed.
2. 4.1 percent = unemployed / labor force.
3. 59.9 percent = employed / working-age population, where working-age population = labor force + not in labor force.
4. 62.5 percent = labor force / working-age population.

(9) [Technical change: 4 pts]

1. 1.1 percent (capital's contribution computed as 3.3 percent × 1/3).
2. 0.7 percent (technology's contribution computed as 1.8 percent minus capital's contribution).

(10) [Quantity equation: 2 pts] 4.1 percent (computed as as growth rate of money supply minus growth rate of real GDP).

(11) [Keynesian cross, Keynesian multipliers: 12 pts]

1. $30 trillion.
2. up.
3. $1 trillion.
4. increase.
5. $1.5 trillion. (Find this by drawing the new expenditure line carefully.)
6. 1.5 (ΔY/ΔG = 1.5/1)

(12) [How business cycles begin: 20 pts] Full credit requires correct graphs on page 6.

1. up, right, boom.
2. down, left, recession.
3. up, right, boom.
4. up, right, boom.

(13) [Inflation adjustment: 16 pts] Begin by drawing the "inflation adjustment line" at the current rate of inflation, 4 percent.

1. $30 trillion, where aggregate demand curve 1 intersects current inflation rate.
2. equal to natural rate of unemployment* because GDP = potential GDP.
3. $28.5 trillion (a decrease).
4. 4 percent, because inflation rate has momentum in short run.
5. greater than the natural rate* because GDP < potential GDP.
6. $30 trillion, because eventually the inflation rate will rise until GDP once more equals potential GDP.
7. 1 percent, where aggregate demand curve 2 intersects potential GDP.
8. equal to natural rate of unemployment,* because once again GDP = potential GDP.

1. Automatic stabilizer (because changes without Congressional or Administration action), decreases in a recession (because as income falls, people owe less in taxes).
2. Discretionary policy (because requires Act of Congress).
3. Automatic stabilizer (because changes without Congressional or Administration action), increases in a recession (because more people are unemployed).

1. recession, because actual GDP < potential GDP.
2. actual budget deficit.
3. $400 billion.
4. structural budget deficit.
5. $200 billion.

1. 3 percent.
2. below.
3. recession, because real GDP < potential GDP.
4. 1 percent, using the rule.

III. Critical thinking [4 pts]

Same as Version A.

[end of answer key]