Economics & the History of Money · Units 4–6, 9–10 · Quick reference
MacroeconomicsPrinciples
Grades 9–12 · College8 pages
GDP · inflation and the CPI · unemployment · the business cycle and growth · aggregate demand and supply · money and banking · the Federal Reserve and monetary policy · fiscal policy and the multiplier · the Phillips curve · trade · exchange rates
1GDP2Inflation & CPI3Unemployment4Cycle & growth5AD/AS6Money timeline7Money & banking8Monetary policy9Fiscal policy10Phillips curve11Trade12Exchange rates13Policy history14Practice15Key formulas16Common errors17Key terms
1Measuring Output: GDP
| Spending (billions) | $ | Share |
|---|---|---|
| C Consumption (households) | 14,000 | 66% |
| I Investment (machines, buildings, new homes, inventories) | 3,500 | 16.5% |
| G Government purchases (not transfer payments) | 4,200 | 19.8% |
| X Exports | 2,300 | |
| − M Imports | (2,800) | |
| NX Net exports = X − M | (500) | -2.4% |
| GDP = C + I + G + NX | 21,200 | 100% |
| Two goods | 2020 | 2025 |
|---|---|---|
| Pizzas (qty × price) | 100 × $10 | 120 × $12 |
| Haircuts (qty × price) | 50 × $20 | 60 × $22 |
| Nominal GDP (that year’s prices) | 2,000 | 2,760 |
| Real GDP (2020 prices) | 2,000 | 2,400 |
| GDP deflator = nominal ÷ real × 100 | 100 | 115 |
Nominal grew 38%, but real output grew only 20%; the rest was higher prices.
What counts
- GDP
- market value of all final goods and services produced within a country in a year
- Final good
- bought by the last user; counting parts too would count them twice
- Not counted
- used goods, stocks and bonds, transfer payments (Social Security checks), unpaid home work, the underground economy
- GNP
- output of a country’s people and firms, wherever they are
| Income approach (billions) | $ |
|---|---|
| Compensation of employees | 12,800 |
| Rent | 700 |
| Interest | 1,100 |
| Proprietors’ income | 1,900 |
| Corporate profits | 2,600 |
| Indirect business taxes | 1,500 |
| Depreciation | 600 |
| Total = GDP | 21,200 |
Every dollar spent is a dollar earned, so both approaches give 21,200.
| Stage | Sale price | Value added |
|---|---|---|
| Farmer: wheat | $0.40 | $0.40 |
| Miller: flour | $0.90 | $0.50 |
| Baker: bread | $2.50 | $1.60 |
| Total | $2.50 |
The sum of value added equals the price of the final loaf. Adding every sale (3.80) would count the wheat three times.
Using GDP
- Real GDP per person
- real GDP ÷ population: the usual yardstick of living standards
- Limits
- leaves out leisure, home production, the quality of goods and how output is shared
Once, final, here, now
GDP counts each good once, only final goods, only what is made here, and only what is made this year. Simon Kuznets built the first U.S. national accounts in the 1930s.
2Inflation & the CPI
| Basket item | Qty | 2020 | 2024 | 2025 |
|---|---|---|---|---|
| Pizzas | 10 | $10 | $11.50 | $12 |
| Haircuts | 4 | $20 | $21.25 | $22 |
| Basket cost | 180 | 200 | 208 | |
| CPI = cost ÷ base cost × 100 | 100 | 111.11 | 115.56 |
Inflation 2024 → 2025 = (115.56 − 111.11) ÷ 111.11 = 4%.
Measuring prices
- CPI
- BLS index of a fixed basket bought by city consumers; base 1982–84 = 100
- CPI biases
- overstates the cost of living: substitution, new goods, better quality
- Other indexes
- GDP deflator (all goods made here), PCE price index (the Fed’s 2% goal)
Real wage and real interest Worked
Wage rose $18.00 → $20.80 while the CPI went 100 → 115.56
Real 2025 wage in 2020 dollars: 20.80 ÷ 1.1556 = $18no raise at all
Savings account pays 7%; inflation is 4%
Real interest rate ≈ 7% − 4% = 3%Fisher
Quantity equation: M × V = P × Y
2,000 × 5 = P × 8,000 → P = 1.25; with V and Y steady, 10% more money → 10% higher pricesMV = PY
Real = nominal with prices peeled off
Divide by the price index (as a decimal) to turn any dollar figure into base-year dollars.
Terms
- Inflation
- a rise in the general price level; deflation is a fall; disinflation, a slower rise
- Demand-pull
- spending grows faster than output (too much money chasing too few goods)
- Cost-push
- input costs jump (an oil shock) and push prices up
- Who loses
- savers and lenders at fixed rates, people on fixed incomes; who gains: borrowers at fixed rates
- Costs
- shoe-leather and menu costs, confusing price signals, taxes on inflated gains
“But thou shalt have a perfect and just weight, a perfect and just measure shalt thou have: that thy days may be lengthened in the land which the LORD thy God giveth thee.” (Deuteronomy 25:15, KJV)
3Unemployment
| Made-up economy (millions) | Number |
|---|---|
| Adults 16+, civilian, not in institutions | 250 |
| Employed | 156 |
| Unemployed (no job, looked in the last 4 weeks) | 9 |
| Labor force = employed + unemployed | 165 |
| Not in the labor force | 85 |
| Unemployment rate = 9 ÷ 165 | 5.45% |
| Participation rate = 165 ÷ 250 | 66% |
| Type | Cause | Example |
|---|---|---|
| Frictional | between jobs, searching | a graduate interviewing |
| Structural | skills or place no longer match jobs | a typesetter after computers |
| Cyclical | a recession cuts spending | factory layoffs in a downturn |
| Seasonal | time of year | a lifeguard in winter |
Terms
- Natural rate
- frictional + structural; the rate at full employment (roughly 4–5% in recent U.S. estimates)
- Full employment
- cyclical unemployment is zero, not unemployment
- Discouraged workers
- want work but stopped looking, so they are not counted; the rate can understate hardship
- Underemployed
- part-time but want full-time, or working below their skills
- U-3 / U-6
- the official rate / a broad rate that adds discouraged and part-time-for-economic-reasons workers
Looking counts
To be unemployed you must be looking. Stop looking and you leave the labor force; the rate can fall while no one finds a job.
| Report | Agency | How often |
|---|---|---|
| GDP | BEA | quarterly (first estimate about a month after the quarter) |
| Employment Situation (jobless rate, payrolls) | BLS | monthly, usually the first Friday |
| Consumer Price Index | BLS | monthly |
| PCE price index | BEA | monthly |
| Trade balance | Census and BEA | monthly |
| FOMC rate decision | Federal Reserve | 8 scheduled meetings a year |
Okun’s rule of thumb Worked
Each point of unemployment above the natural rate ≈ 2% of output lost
Unemployment 7%, natural rate 5%
Output gap ≈ −2 × (7 − 5) = -4% of potentialabout
On $20 trillion potential: about $0.8 trillion not produced
4The Business Cycle & Growth
| Growth rate | Rule of 70 | Exact doubling |
|---|---|---|
| 1% a year | 70 yrs | 69.7 yrs |
| 2% a year | 35 yrs | 35 yrs |
| 3.5% a year | 20 yrs | 20.1 yrs |
| 7% a year | 10 yrs | 10.2 yrs |
Doubling time ≈ 70 ÷ growth rate. A country growing 3.5% doubles living standards in 20 years; at 1% it takes 70.
Seven fat years
Joseph stored grain in the good years for the lean ones. Cycles come and go; growth is the trend underneath.
Phases and signals
- Expansion
- real GDP rising, unemployment falling
- Peak
- the top before a downturn
- Contraction
- real GDP falling; a recession is a significant, widespread decline lasting months (dated by the NBER)
- Trough
- the bottom
- Depression
- a severe, long contraction: 1929–33, real GDP fell about a quarter and unemployment reached about a quarter of workers
- Indicators
- leading (building permits, stock prices, new orders), coincident (payrolls, output), lagging (unemployment duration)
| Recent U.S. recessions (NBER) | Months |
|---|---|
| July 1981 – November 1982 | 16 |
| July 1990 – March 1991 | 8 |
| March 2001 – November 2001 | 8 |
| December 2007 – June 2009 | 18 |
| February 2020 – April 2020 | 2 |
The four complete expansions since 1982 each lasted about 6 to 11 years.
| $10,000 a person, 35 years | Ends at |
|---|---|
| 1% a year | $14,166 |
| 2% a year | $19,999 |
| 3% a year | $28,139 |
Two points of growth a year is the difference between $14,166 and $28,139 a generation later.
Long-run growth
- Sources of growth
- more and better physical capital, human capital (skills, health), technology, natural resources
- What lets them grow
- secure property rights, the rule of law, stable money, open trade, saving and investment, freedom to start a business
- Productivity
- output per hour of work: the long-run source of higher real wages
- Shown on graphs
- the PPF and the LRAS shift out
“And that food shall be for store to the land against the seven years of famine, which shall be in the land of Egypt; that the land perish not through the famine.” (Genesis 41:36, KJV)
5Aggregate Demand & Aggregate Supply
| Classical and monetarist | Keynesian | Supply-side | |
|---|---|---|---|
| Wages and prices | flexible; markets clear | sticky; slumps can last | respond to incentives |
| Recessions | correct themselves | may need a push | ease barriers to work and investment |
| Policy emphasis | steady money growth; rules | active spending and rate changes | lower tax rates on work, saving, investment |
| Names | Adam Smith, Milton Friedman | John Maynard Keynes | Robert Mundell, Arthur Laffer |
Each school stresses different parts of the same model; most economists borrow from more than one.
Terms
- AD slopes down
- the wealth, interest-rate and exchange-rate effects
- SRAS slopes up
- some input prices (wages) are sticky in the short run
- LRAS is vertical
- at potential output, set by resources and technology, not the price level
- Inflationary gap
- output above potential; wages and prices tend to rise
- Self-correction
- wages adjust and SRAS returns to potential; how fast is debated
W-I-X
Three reasons AD slopes down: Wealth, Interest rate, eXchange rate.
Reading the graph Worked
AD₁: P = 160 − 3Y; SRAS: P = 40 + 3Y
Start: Y = 20, P = 100 = potential (LRAS)E₁
AD₂: P = 148 − 3Y (households cut spending)
New: Y = 18, P = 94E₂
Gap = 20 − 18 = 2 trillion below potentialrecessionary
| AD shifts with | SRAS shifts with |
|---|---|
| consumer wealth and confidence | input prices (wages, oil) |
| business expectations and interest rates | productivity and technology |
| government spending and taxes | business taxes, subsidies, regulation |
| the money supply | supply shocks (drought, war) |
| foreign incomes and the exchange rate | expected inflation |
| Shock | Price level | Real GDP | Unemployment |
|---|---|---|---|
| AD ↑ | ↑ | ↑ | ↓ |
| AD ↓ | ↓ | ↓ | ↑ |
| SRAS ↑ | ↓ | ↑ | ↓ |
| SRAS ↓ (stagflation) | ↑ | ↓ | ↑ |
| LRAS ↑ (growth) | ↓ | ↑ | — |
6The Story of Money: A Timeline
| When | What happened | Lesson |
|---|---|---|
| 600s B.C. | Lydia (in today’s Turkey) strikes the first coins; Croesus later issues gold and silver ones | stamped weight builds trust |
| 200s A.D. | Rome cuts the silver in its coins again and again; prices soar | debasement is inflation |
| 1252 | Florence mints the gold florin, trusted across Europe | sound coin travels |
| 1545 on | Silver from Potosí (Bolivia) floods Spain and Europe; prices rise for a century | more money, higher prices |
| 1600s | London goldsmiths issue receipts and lend out stored gold | fractional reserves |
| 1694 | The Bank of England is founded; it later becomes lender of last resort | central banking |
| 1791 | Hamilton’s First Bank of the United States | a national bank |
| 1900–1913 | Gold Standard Act (1900); Panic of 1907; Federal Reserve Act (1913) | gold and a central bank |
| 1933–34 | Americans must turn in gold coin; gold is repriced at $35 an ounce | government sets the gold price |
| 1944 | Bretton Woods: currencies pegged to the dollar, the dollar to gold at $35 | fixed exchange rates |
| Aug 15, 1971 | The U.S. stops exchanging dollars for gold with foreign governments | fiat money |
| 1973 on | Major currencies float; central banks manage fiat money | floating rates |
7Money & Banking
Three functions of money
- Medium of exchange
- accepted in trade, ending barter’s “double coincidence of wants”
- Unit of account
- a common measure of value
- Store of value
- holds buying power over time (if inflation is low)
Banking history in brief
- Fractional reserve
- goldsmiths in London lent out gold left with them and found few depositors came at once
- Bank run
- depositors rush to withdraw; the FDIC (1933) now insures $250,000 per depositor, per bank, per ownership category
- Lender of last resort
- a central bank lends to sound banks in a panic (the Bank of England from the 1800s; the Fed since 1913)
| Kind | Meaning | Example |
|---|---|---|
| Commodity | valuable in itself | gold and silver coins (Lydia), salt |
| Representative | paper redeemable in a commodity | gold certificates |
| Fiat | money by government decree | U.S. dollar since 1971 |
| Round | Deposit | Reserve (10%) | Loan |
|---|---|---|---|
| 1 | 1,000 | 100 | 900 |
| 2 | 900 | 90 | 810 |
| 3 | 810 | 81 | 729 |
| 4 | 729 | 72.9 | 656.1 |
| Total | 10,000 | 1,000 | 9,000 |
Money multiplier = 1 ÷ reserve ratio = 1 ÷ 0.10 = 10. Maximum new deposits = 1,000 × 10 = 10,000. Cash held outside banks and extra reserves make the real multiplier smaller.
Measuring the money supply
- M1
- currency, checking deposits and other liquid deposits (including savings since 2020)
- M2
- M1 + small time deposits (CDs) + retail money market funds
- Not money
- credit cards (a loan), stocks, bonds
| First Bank | Assets | Liabilities |
|---|---|---|
| Reserves (required 10%) | 100 | |
| Loans | 900 | |
| Checking deposits | 1,000 | |
| Total | 1,000 | 1,000 |
Assets = liabilities + owners’ capital. Banks keep a fraction of deposits and lend the rest.
Swap, score, save
Money lets you swap (medium of exchange), score prices (unit of account) and save (store of value).
“The rich ruleth over the poor, and the borrower is servant to the lender.” (Proverbs 22:7, KJV)
8The Federal Reserve & Monetary Policy
The central bank
- Created
- 1913 (the Federal Reserve Act, planned at Jekyll Island in 1910)
- Structure
- a 7-member Board of Governors in Washington, 12 regional Federal Reserve Banks, and the FOMC (the 7 governors + 5 bank presidents), which sets policy
- Goals
- Congress’s dual mandate: maximum employment and stable prices (a 2% inflation goal since 2012)
- Independence
- governors serve 14-year terms, so policy is set apart from elections
| $50 million purchase | Assets | Liabilities |
|---|---|---|
| Fed: government bonds | +50 | |
| Fed: bank reserves (owed to banks) | +50 | |
| Banks: bonds | −50 | |
| Banks: reserves at the Fed | +50 |
The Fed pays by crediting reserves: new money in the banking system.
Buy builds, sell shrinks
When the Fed buys bonds, bank reserves build and money expands. When it sells, reserves shrink.
| Tool | To expand | To contract |
|---|---|---|
| Interest on reserve balances (main tool today) | lower it | raise it |
| Open market operations: buying or selling government bonds | buy bonds | sell bonds |
| Discount rate on Fed loans to banks | lower it | raise it |
| Reserve requirement (set to 0% in March 2020) | lower it | raise it |
The FOMC sets a target range for the federal funds rate (banks’ overnight lending rate to each other) and uses the tools to keep it there.
| Step | Expansionary | Contractionary |
|---|---|---|
| Fed action | buys bonds; lowers rates | sells bonds; raises rates |
| Interest rates | ↓ | ↑ |
| Borrowing, investment, home buying | ↑ | ↓ |
| Aggregate demand | ↑ (shifts right) | ↓ (shifts left) |
| Output and jobs | ↑ | ↓ |
| Price level | ↑ | ↓ |
| Dollar | tends to weaken | tends to strengthen |
Open market purchase Worked
The Fed buys $50 million of bonds from banks
Bank reserves rise $50 million
At a 10% reserve ratio, deposits can grow up to 50 × 10 = $500 millionmaximum
In practice
- Lags
- policy takes months to a couple of years to reach prices and jobs
- Limits
- near a zero interest rate the usual tool runs out; the Fed has then bought long-term bonds (quantitative easing)
- Debate
- economists differ on rules versus discretion and on how big and fast effects are
9Fiscal Policy & the Multiplier
Multipliers (MPC = marginal propensity to consume)
MPC 0.8: spending multiplier 5, tax multiplier -4. Raising spending and taxes by the same amount: multiplier 1.
spending multiplier = 11 − MPC = 1MPS
tax multiplier = −MPC1 − MPC
Terms
- Fiscal policy
- Congress and the President changing government spending and taxes
- Automatic stabilizers
- income taxes and unemployment benefits that rise and fall with the economy, no new law needed
- Deficit / surplus
- one year’s spending minus revenue; the national debt is the running total of past deficits
- Lags
- recognizing, passing and spending take time; help can arrive after the recession ends
- Views differ
- some economists stress multipliers, others crowding out, incentives and debt costs
| Round | New spending | Saved (20%) |
|---|---|---|
| 1 | 100 | 20 |
| 2 | 80 | 16 |
| 3 | 64 | 12.80 |
| 4 | 51.20 | 10.24 |
| All rounds | 500 | 100 |
Each round, people spend 80% of new income and save 20%: 100 × (1 + 0.8 + 0.8² + …) = 100 ÷ 0.2.
Closing a $1 trillion gap (simple model) Worked
Output is $1 trillion below potential; MPC = 0.8
Raise spending by 1 ÷ 5 = $0.2 trillionor
Cut taxes by 1 ÷ 4 = $0.25 trillion
Price changes and crowding out make the real effect smallercaution
| Made-up brackets | Rate | Tax on $60,000 |
|---|---|---|
| First $10,000 | 10% | 1,000 |
| $10,001–$40,000 | 20% | 6,000 |
| Above $40,000 | 30% | 6,000 |
| Total tax | 13,000 |
Marginal rate (on the next dollar) 30%; average rate 13,000 ÷ 60,000 = 21.67%. Moving into a higher bracket taxes only the dollars above the line.
Tax structures
- Proportional (flat)
- same average rate at every income
- Graduated
- the average rate rises with income (the U.S. income tax)
- Regressive
- the average rate falls as income rises (a sales tax as a share of income)
| Tax principle (Adam Smith, 1776) | Meaning |
|---|---|
| Ability to pay | in proportion to means |
| Certainty | clear amount and date |
| Convenience | collected when easy to pay |
| Economy | cheap to collect |
A dollar that echoes
New spending is someone’s income, and part of it is spent again. The smaller the share saved (MPS), the louder the echo: multiplier = 1 ÷ MPS.
10The Phillips Curve & the Policy Mix
Short trade, long wall
In the short run there is a trade-off. In the long run the Phillips curve is a wall at the natural rate.
| Point | Unemployment | Inflation |
|---|---|---|
| A (start, natural rate) | 4.5% | 2% |
| B (demand push, short run) | 3.5% | 3.5% |
| C (long run, expectations up) | 4.5% | 5% |
SRPC: inflation = 8.75 − 1.5 × unemployment. Pushing unemployment below the natural rate bought only a temporary gain.
| Goal | Fiscal tool | Monetary tool |
|---|---|---|
| Fight a recession | spend more or tax less | lower rates, buy bonds |
| Fight inflation | spend less or tax more | raise rates, sell bonds |
| Who decides | Congress and the President | the Fed (FOMC) |
| Speed to act | slow to pass | fast to decide, slow to work |
Terms
- Phillips curve
- A. W. Phillips (1958) found low unemployment years had faster wage growth
- Long run
- vertical at the natural rate: no lasting trade-off (Friedman and Phelps)
- 1970s
- high inflation and high unemployment broke the simple trade-off
11International Trade
| $1 tariff (Qd = 120 − 10P, Qs = 10P − 20) | Before ($4) | After ($5) |
|---|---|---|
| Quantity demanded | 80 | 70 |
| Home production | 20 | 30 |
| Imports | 60 | 40 |
| Tariff revenue 1 × 40 | 40 | |
| Deadweight loss ½ × 1 × 10 + ½ × 1 × 10 | 10 |
Home producers and the treasury gain; buyers pay more. The two triangles are lost to everyone.
Trade terms
- Comparative advantage
- nations gain by making what they give up least to make (Ricardo); see the micro sheet
- Tariff
- a tax on imports
- Quota
- a limit on import quantity; the price rises but no tariff revenue is collected
- Embargo
- a ban on trade with a country
- WTO
- the World Trade Organization (1995) sets trade rules among its members
- Arguments made for limits
- national security, infant industries, answering unfair practices, protecting particular jobs
- Arguments made against
- higher prices, retaliation, protected firms grow less efficient
| Balance of payments (billions) | $ |
|---|---|
| Goods exports − imports: 120 − 150 | (30) |
| Services, net | 12 |
| Income from abroad, net | 5 |
| Transfers, net | (7) |
| Current account | (20) |
| Financial account: net foreigners’ purchases of home assets | 20 |
| Sum (ignoring errors) | 0 |
A current-account deficit is matched by a financial-account surplus: dollars spent abroad come back to buy home assets.
Every dollar comes home
Dollars paid for imports end up buying U.S. goods, services or assets. The accounts always balance.
History
The Corn Laws taxed imported grain in Britain until 1846; the container ship (1956) cut shipping costs and helped world trade grow.
12Exchange Rates
| Floating | Fixed (pegged) | |
|---|---|---|
| Rate set by | supply and demand | the government or central bank |
| Shocks absorbed by | the exchange rate | reserves, interest rates, prices |
| Gives up | certainty for traders | independent monetary policy |
| Examples | dollar, euro, yen | gold standard; Hong Kong dollar to U.S. dollar |
Converting and comparing Worked
The rate goes from ¥150 to ¥160 per dollar
The dollar appreciated 6.67%; the yen depreciated
A ¥3,000 meal costs an American $20 → $18.75cheaper trips
A $30 U.S. book costs a Japanese buyer ¥4,500 → ¥4,800harder to export
PPP: a $6 sandwich costs ¥900 → PPP rate ¥150 per $purchasing power parity
At ¥160, the yen is undervalued by PPP
| Change | Effect on the dollar |
|---|---|
| Foreigners buy more U.S. goods or assets | demand ↑ → appreciates |
| U.S. interest rates rise relative to others | demand ↑ → appreciates |
| Americans buy more imports | supply of $ ↑ → depreciates |
| U.S. inflation is higher than abroad | depreciates |
| Speculators expect a rise | appreciates now |
| Incomes abroad rise | demand ↑ → appreciates |
Terms
- Exchange rate
- the price of one currency in another
- Appreciate
- buys more foreign currency: imports cheaper, exports harder
- Depreciate
- buys less: exports easier, imports dearer
- Floating
- set by the market (major currencies since 1973)
- Devaluation
- a government lowering a fixed rate on purpose
- Fixed / pegged
- a government holds the rate; the gold standard and Bretton Woods (1944–71) were fixed systems
- PPP
- in the long run a basket should cost the same everywhere once converted
Strong dollar, cheap trips
A strong (appreciated) dollar makes trips and imports cheap and makes U.S. exports hard to sell.
13Policy in History
| Episode | What happened (approximate figures) | Policy response | What economists took from it |
|---|---|---|---|
| German hyperinflation, 1923 | the government printed marks to pay its bills; by November a dollar cost over 4 trillion marks | a new currency (the Rentenmark) with strict limits on its supply | money printed to cover spending can destroy a currency |
| Great Depression, 1929–33 | real GDP fell about a quarter; unemployment near 25% by 1933; the money supply fell about a third; thousands of banks failed | little at first; then deposit insurance (FDIC, 1933), leaving gold coin, New Deal spending | Keynes stressed collapsing spending; Friedman and Schwartz stressed the shrinking money supply |
| Stagflation, 1970s | oil shocks in 1973 and 1979; inflation near 13.5% in 1980 alongside high unemployment | wage and price controls (1971), then tighter money | supply shocks and expectations matter; the simple Phillips trade-off failed |
| Disinflation, 1979–82 | Fed chair Paul Volcker let the federal funds rate climb near 20%; unemployment reached about 10.8% in 1982 | tight money held until inflation fell to about 3% by 1983 | credible central banks can end inflation, at a cost in jobs |
| Great Recession, 2007–09 | housing prices and mortgage lending collapsed; unemployment peaked at 10% in 2009 | rates cut to near zero; Fed bond buying (quantitative easing); bank rescues and stimulus spending | financial crises deepen recessions; debate over rescues and debt continues |
Economists still weigh these causes differently; the sheet reports the main views without choosing among them.
14Practice with Answers
| # | Problem | Answer (every number recomputed by the build) |
|---|---|---|
| 1 | C = 900, I = 300, G = 250, X = 120, M = 170. GDP? | 900 + 300 + 250 + (120 − 170) = 1,400 |
| 2 | The CPI rose from 240 to 252. Inflation? | (252 − 240) ÷ 240 = 5% |
| 3 | 190 million employed, 10 million unemployed. Unemployment rate? | 10 ÷ 200 = 5% |
| 4 | MPC = 0.75. Spending and tax multipliers? | 1 ÷ 0.25 = 4; −0.75 ÷ 0.25 = -3 |
| 5 | Reserve ratio 20%; a $500 deposit. Maximum new loans in the whole system? | 500 × 5 = 2,500 deposits; new loans $2,000 |
| 6 | Real GDP per person grows 2.5% a year. Years to double (rule of 70)? | 70 ÷ 2.5 = 28 years |
| 7 | Nominal rate 6%, expected inflation 2.5%. Real rate? | 6 − 2.5 = 3.5% |
| 8 | Nominal GDP 1,200 and the deflator is 120. Real GDP? | 1,200 ÷ 1.20 = 1,000 |
| 9 | A recession: which way should AD shift, and name one fiscal and one monetary tool. | Right: more spending or lower taxes; buy bonds or lower rates |
| 10 | €0.90 per dollar. What does a €45 jacket cost in dollars? | 45 ÷ 0.90 = $50 |
| 11 | Income $25,000 with the sheet’s made-up brackets. Tax and average rate? | 1,000 + 15,000 × 0.20 = $4,000; 16% |
| 12 | Real GDP grows from $20.0 to $20.6 trillion. Growth rate? | 0.6 ÷ 20 = 3% |
| 13 | M = 3,000, V = 4, real output Y = 10,000. Price level? | 3,000 × 4 ÷ 10,000 = 1.2 |
| 14 | The Fed sells $20 million of bonds; reserve ratio 10%. Largest change in deposits? | −20 × 10 = −$200 million |
| 15 | ¥160 per dollar. What does a $40 U.S. shirt cost in yen? | 40 × 160 = ¥6,400 |
| 16 | A $50,000 loan: rate goes from 6% to 9%. Extra interest a year? | 50,000 × 0.03 = $1,500 |
| 17 | Unemployment 8%, natural rate 5%. Output gap by Okun’s rule? | −2 × (8 − 5) = -6% of potential |
| The economy changes | What a small bakery feels | A sensible response |
|---|---|---|
| Interest rates rise from 6% to 9% | a $50,000 oven loan costs $1,500 more interest a year | borrow less, lock in a fixed rate, pay down debt |
| Inflation runs 4% | flour, butter and wages cost more each year | review prices; track profit in real terms |
| A recession arrives | fewer customers, and they shop on price | trim waste; keep a cash reserve for lean months |
| The dollar strengthens | imported vanilla gets cheaper; fewer foreign tourists | buy imported supplies ahead |
| A tariff on imported mixers | new equipment costs more | compare home suppliers or repair the old one |
| Unemployment is low | hiring is hard and wages rise | train and keep good workers |
| The local economy booms | more orders than one oven can bake | expand with care; plan for the next downturn |
Name the rule first
GDP: C + I + G + NX. Rates: part ÷ whole. Change: (new − old) ÷ old. Multipliers: 1 ÷ MPS and 1 ÷ reserve ratio.
“Wealth gotten by vanity shall be diminished: but he that gathereth by labour shall increase.” (Proverbs 13:11, KJV)
15Key Formulas
| Quantity | Formula | Example on this sheet |
|---|---|---|
| GDP (expenditure) | C + I + G + (X − M) | 14,000 + 3,500 + 4,200 − 500 = 21,200 |
| Real GDP | nominal ÷ (deflator ÷ 100) | 2,760 ÷ 1.15 = 2,400 |
| CPI | basket cost ÷ base-year cost × 100 | 208 ÷ 180 × 100 = 115.56 |
| Inflation rate | (new index − old) ÷ old × 100 | 4% |
| Real value | nominal ÷ (price index ÷ 100) | $20.80 ÷ 1.1556 = $18.00 |
| Real interest rate | nominal − expected inflation | 7% − 4% = 3% |
| Quantity equation | M × V = P × Y | 2,000 × 5 = 1.25 × 8,000 |
| Unemployment rate | unemployed ÷ labor force × 100 | 9 ÷ 165 = 5.45% |
| Participation rate | labor force ÷ adult population × 100 | 165 ÷ 250 = 66% |
| Growth rate | (Ynew − Yold) ÷ Yold × 100 | real GDP +20% |
| Rule of 70 | doubling years ≈ 70 ÷ growth % | 70 ÷ 3.5 = 20 years |
| Spending multiplier | 1 ÷ (1 − MPC) = 1 ÷ MPS | 1 ÷ 0.2 = 5 |
| Tax multiplier | −MPC ÷ (1 − MPC) | −0.8 ÷ 0.2 = −4 |
| Money multiplier | 1 ÷ reserve ratio | 1 ÷ 0.10 = 10 |
| Appreciation % | (new rate − old) ÷ old × 100 | ¥150 → ¥160 = 6.67% |
| PPP rate | price abroad ÷ price at home | 900 ÷ 6 = ¥150 per $ |
16Common Errors
| Slip | Right way |
|---|---|
| Counting intermediate goods or used goods in GDP | final, new goods only |
| Counting Social Security checks in G | transfers are not purchases |
| Calling stock purchases “investment” in GDP | I means new capital goods, new homes and inventories |
| Using nominal GDP to compare years | use real GDP |
| Counting discouraged workers as unemployed | they are out of the labor force |
| Thinking full employment means 0% unemployment | it means no cyclical unemployment |
| Saying the Fed sets the prime rate or taxes | the Fed targets the federal funds rate; Congress taxes and spends |
| Mixing up fiscal and monetary policy | fiscal = spending and taxes; monetary = money and interest rates |
| Treating the deficit and the debt as the same | deficit = one year; debt = the running total |
| A weaker dollar hurts exporters | it helps exporters and hurts importers |
Graph checklist
- AD/AS: label P and real GDP; draw LRAS at potential.
- Money market: money supply is vertical; demand slopes down.
- Phillips: inflation on the vertical axis; LRPC at the natural rate.
- Exchange rate: label the axis “foreign currency per dollar” and say which currency appreciated.
Two teams, two toolkits
Fiscal = Congress and the President: spending and taxes. Monetary = the Fed: money and interest rates.
17Key Terms
A–C
- Aggregate demand
- total spending on final goods at each price level
- Aggregate supply
- total output firms offer at each price level
- Appreciation
- a currency buying more foreign currency
- Balance of payments
- record of a nation’s transactions with the world
- Commodity money
- money with value of its own (gold, silver)
D–N
- Deflation
- a falling price level
- Disinflation
- inflation slowing but still positive
- Fiat money
- money by government decree, not backed by a commodity
- Hyperinflation
- extremely fast inflation (often above 50% a month)
- Liquidity
- how easily an asset becomes spendable money
- National debt
- the total the federal government owes
O–V
- Output gap
- actual minus potential real GDP
- Potential GDP
- output at the natural rate of unemployment
- Recession
- a broad fall in activity lasting months
- Stagflation
- inflation and stagnant output at once
- Velocity
- how many times a dollar is spent in a year