Free practice final
Macroeconomics practice final (free, with answers)
A typical intro macroeconomics final covers measuring GDP, inflation and unemployment, long-run growth, the aggregate demand and aggregate supply model, and fiscal and monetary policy. Work each question on your own before opening the answer, then use the explanation to see where your reasoning matched or went off track.
Topics
- GDP and National Accounts
- Inflation and Price Indexes
- Unemployment
- Economic Growth
- Aggregate Demand and Supply
- Fiscal Policy
- Money and Banking
- Monetary Policy
15 questions
Try each one before you open its answer.
1. Which of the following is counted in this year's US GDP?
- A A household buys $5,000 worth of shares of stock
- B The government sends a $1,500 Social Security payment to a retiree
- C A builder finishes a new house this year and sells it to a family
- D A bakery buys flour that it uses to make bread sold this year
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Answer: C. A builder finishes a new house this year and sells it to a family
GDP counts the market value of final goods and services produced this year, and a newly built home counts as residential investment. Buying stock is a financial transaction, Social Security is a transfer payment, and the flour is an intermediate good whose value is already included in the price of the bread.
2. An economy reports, in billions of dollars: consumption 800, investment 200, government purchases 300, exports 150, imports 200, and government transfer payments 120. What is GDP?
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Answer: $1,250 billion
Using GDP = C + I + G + (X − M): 800 + 200 + 300 + (150 − 200) = 1,250. Transfer payments are left out because they are not purchases of newly produced goods or services.
3. A bank makes a 5-year loan at a fixed 6% nominal interest rate, and both sides expect 2% inflation. Inflation turns out to average 5% a year instead. Who gains from the surprise?
- A The bank, because it is repaid in dollars worth more than it expected
- B The borrower, because the loan is repaid with dollars that buy less than expected
- C Neither, because a fixed nominal rate adjusts automatically for inflation
- D Both, because higher inflation raises everyone's nominal income
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Answer: B. The borrower, because the loan is repaid with dollars that buy less than expected
The real interest rate is roughly the nominal rate minus inflation. Both sides expected a real rate of about 6% − 2% = 4%, but the realized real rate is only about 6% − 5% = 1%, so unexpected inflation shifts wealth from the lender to the borrower.
4. A fixed basket of goods costs $250 in the base year, $270 in Year 2 and $283.50 in Year 3. Using a price index built from this basket, what is the inflation rate from Year 2 to Year 3?
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Answer: 5%
The index is 100 in the base year, 108 in Year 2 and 113.4 in Year 3, and inflation is the percent change in the index: (113.4 − 108) ÷ 108 = 0.05, or 5%. The index rose 5.4 points, but that is not a 5.4% rise, because the starting index is 108, not 100.
5. Which statement best describes the natural rate of unemployment?
- A The unemployment rate when cyclical unemployment is zero, made up of frictional and structural unemployment
- B An unemployment rate of zero, reached when every job seeker is working
- C The unemployment rate at the low point of a typical recession
- D The part of unemployment caused by falling output during recessions
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Answer: A. The unemployment rate when cyclical unemployment is zero, made up of frictional and structural unemployment
Even a healthy economy has frictional unemployment (people between jobs or searching) and structural unemployment (skills or locations that do not match the open jobs). The natural rate is the unemployment rate with only these two, when output is at potential and cyclical unemployment is zero.
6. A country's working-age population is 200 million. Of these people, 114 million are employed, 6 million are unemployed (without a job and actively looking), and the rest are not in the labor force. What are the unemployment rate and the labor-force participation rate?
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Answer: Unemployment rate 5%; labor-force participation rate 60%
The labor force is the employed plus the unemployed: 114 + 6 = 120 million. The unemployment rate is 6 ÷ 120 = 5%, and the participation rate is 120 ÷ 200 = 60%.
7. If real GDP per person grows at a steady 2% per year, about how many years does it take to double?
- A 14 years
- B 50 years
- C 70 years
- D 35 years
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Answer: D. 35 years
By the rule of 70, the doubling time is about 70 divided by the growth rate in percent: 70 ÷ 2 = 35 years. It takes less than 50 years because growth compounds: each year's 2% is applied to a larger base.
8. A sharp rise in world oil prices hits an economy that was at full employment. In the short run, what does the AD-AS model predict?
- A Aggregate demand shifts right, so the price level and real GDP both rise
- B Short-run aggregate supply shifts right, so the price level falls and real GDP rises
- C Short-run aggregate supply shifts left, so the price level rises and real GDP falls
- D Aggregate demand shifts left, so the price level and real GDP both fall
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Answer: C. Short-run aggregate supply shifts left, so the price level rises and real GDP falls
Oil is an input to production, so higher oil prices raise firms' costs and shift short-run aggregate supply to the left. The result is a higher price level together with lower output and higher unemployment, a combination called stagflation.
9. An economy is in a recession, with real GDP below potential output. If policymakers do nothing, how does the AD-AS model predict it will return to potential output in the long run?
- A Wages and other input prices gradually fall, shifting short-run aggregate supply right until output returns to potential at a lower price level
- B Wages rise, shifting short-run aggregate supply left until output returns to potential at a higher price level
- C Aggregate demand shifts right on its own, because unemployed households spend more
- D Long-run aggregate supply shifts left to match the lower output, so the recession never ends
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Answer: A. Wages and other input prices gradually fall, shifting short-run aggregate supply right until output returns to potential at a lower price level
With unemployment above its natural rate, wages and other input prices eventually fall. Lower costs shift short-run aggregate supply to the right, raising output back to potential and lowering the price level, though this self-correction can be slow.
10. In a simple model with no taxes, no imports and a fixed price level, the marginal propensity to consume (MPC) is 0.8. If government purchases rise by $50 billion, by how much does equilibrium GDP rise?
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Answer: $250 billion
The spending multiplier is 1 ÷ (1 − MPC) = 1 ÷ 0.2 = 5. Each round of spending becomes someone's income, 80% of which is spent again, so GDP rises by 5 × $50 billion = $250 billion in total.
11. In a simple model with no imports, a fixed price level, and taxes that do not depend on income, the marginal propensity to consume is 0.75. If the government cuts taxes by $40 billion, by how much does equilibrium GDP rise?
- A $30 billion
- B $40 billion
- C $160 billion
- D $120 billion
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Answer: D. $120 billion
The tax cut raises disposable income by $40 billion, but households spend only 75% of it, so first-round spending rises by $30 billion. Multiplying by the spending multiplier 1 ÷ (1 − 0.75) = 4 gives $120 billion, less than the $160 billion that $40 billion of extra government purchases would add.
12. A bank has $400,000 in checkable deposits and $60,000 in reserves. The required reserve ratio is 10%. How much does the bank hold in excess reserves?
- A $6,000
- B $20,000
- C $40,000
- D $340,000
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Answer: B. $20,000
Required reserves are 10% of deposits: 0.10 × $400,000 = $40,000. Excess reserves are total reserves minus required reserves, $60,000 − $40,000 = $20,000, which is the most this bank could safely lend out.
13. The required reserve ratio is 20%. The central bank buys $2 million of government bonds from commercial banks. If banks lend out all excess reserves and every loan is redeposited rather than held as cash, what is the maximum increase in the money supply?
- A $0.4 million
- B $2 million
- C $10 million
- D $12 million
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Answer: C. $10 million
The purchase gives banks $2 million of new excess reserves. With the simple money multiplier of 1 ÷ 0.20 = 5, rounds of lending and redepositing can create up to 5 × $2 million = $10 million of new deposits, which is the maximum increase in the money supply.
14. Using the quantity equation M × V = P × Y, suppose velocity is constant, the money supply grows 6% per year, and real GDP grows 2% per year. About what will the inflation rate be?
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Answer: About 4% per year
In growth-rate form, money growth plus velocity growth is approximately equal to inflation plus real GDP growth. With velocity constant, inflation ≈ 6% − 2% = 4%.
15. Unemployment is rising and inflation is low. Which central bank action would help fight the slowdown?
- A Buy government bonds, which lowers interest rates, encourages investment and borrowing, and shifts aggregate demand right
- B Sell government bonds, which raises interest rates and shifts aggregate demand right
- C Raise the required reserve ratio, so that banks have more money to lend
- D Raise income taxes, which lowers interest rates and increases spending
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Answer: A. Buy government bonds, which lowers interest rates, encourages investment and borrowing, and shifts aggregate demand right
Expansionary monetary policy pushes interest rates down, for example through open-market purchases of bonds. Cheaper borrowing raises investment and interest-sensitive consumer spending, shifting aggregate demand to the right. Changing taxes is fiscal policy, which the central bank does not control.