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Macroeconomics practice questions with answers

Ten exam-style macroeconomics problems with complete worked solutions — the expenditure approach to GDP, real versus nominal growth, CPI inflation, the unemployment and participation rates, spending and tax multipliers, aggregate demand and supply shocks, the money multiplier, monetary policy transmission, real interest rates, and exchange rates. These are the calculations and chains of reasoning that AP Macro, IB and first-year university exams return to every year. Free to use, no signup.

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Problem 1

An economy reports the following (in billions): consumption 600, gross investment 150, government purchases 200, exports 120, imports 170, and transfer payments 90. Calculate GDP using the expenditure approach and explain why transfer payments are excluded.
Show worked solution
GDP=C+I+G+(X−M)=600+150+200+(120−170)=900GDP = C + I + G + (X - M) = 600 + 150 + 200 + (120 - 170) = 900 billion. Net exports are −50-50 (a trade deficit). Transfer payments such as pensions and unemployment benefits are excluded because they do not purchase newly produced goods or services — they move income from one group to another. Counting them would double-count the consumption they later finance.

Problem 2

Nominal GDP is 2,200 billion and the GDP deflator is 110 (base year = 100). Last year real GDP was 1,900 billion. Calculate this year's real GDP and the real growth rate.
Show worked solution
Real GDP =Nominal GDPDeflator×100=2,200110×100=2,000= \frac{\text{Nominal GDP}}{\text{Deflator}} \times 100 = \frac{2{,}200}{110} \times 100 = 2{,}000 billion. Real growth =2,000−1,9001,900≈5.3%= \frac{2{,}000 - 1{,}900}{1{,}900} \approx 5.3\%. Nominal GDP grew faster than that because part of the rise was price increases (the deflator shows prices are 10 percent above the base year); real GDP strips those out.

Problem 3

The consumer price index rises from 250 to 262.5 over a year. Calculate the inflation rate. A worker's nominal wage rose 3 percent over the same year — what happened to their real wage?
Show worked solution
Inflation =262.5−250250=5%= \frac{262.5 - 250}{250} = 5\%. The real wage changed by approximately 3%−5%=−2%3\% - 5\% = -2\%: purchasing power fell even though the pay cheque grew. Exactly: 1.031.05−1≈−1.9%\frac{1.03}{1.05} - 1 \approx -1.9\%. Nominal gains must be compared with inflation before calling them raises.

Problem 4

A country has an adult population of 240 million, of whom 141 million are employed and 9 million are unemployed (actively seeking work). Calculate the labour force, the unemployment rate, and the labour-force participation rate. How would 2 million discouraged workers who stopped searching affect the unemployment rate?
Show worked solution
Labour force =141+9=150= 141 + 9 = 150 million. Unemployment rate =9150=6%= \frac{9}{150} = 6\%. Participation rate =150240=62.5%= \frac{150}{240} = 62.5\%. Discouraged workers are not counted as unemployed because they are not searching; if 2 million of the unemployed stop searching, the labour force falls to 148 million and the unemployment rate falls to 7148≈4.7%\frac{7}{148} \approx 4.7\% — an apparent improvement with no new jobs, which is why the headline rate can understate labour-market weakness.

Problem 5

The marginal propensity to consume is 0.8. Calculate the spending multiplier and the tax multiplier. If government purchases rise by 40 billion, by how much does equilibrium GDP change? What if instead taxes are cut by 40 billion?
Show worked solution
Spending multiplier =11−MPC=10.2=5= \frac{1}{1 - MPC} = \frac{1}{0.2} = 5. Tax multiplier =−MPC1−MPC=−0.80.2=−4= -\frac{MPC}{1 - MPC} = -\frac{0.8}{0.2} = -4. A 40 billion rise in government purchases raises GDP by 5×40=2005 \times 40 = 200 billion. A 40 billion tax cut raises GDP by 4×40=1604 \times 40 = 160 billion — less, because households save 20 percent of the first round of the tax cut instead of spending it. (Real-world multipliers are smaller once imports, taxes and crowding out are included.)

Problem 6

A sharp rise in the world price of oil hits an economy that was at full employment. Using the AD–AS model, explain what happens to the price level, real output and unemployment in the short run, and why policymakers face a dilemma.
Show worked solution
Oil is an input for most producers, so the short-run aggregate supply curve shifts left. At the new short-run equilibrium the price level is higher and real output is below potential — stagflation: inflation and unemployment rise together. The dilemma: expansionary policy (shifting AD right) restores output but pushes prices even higher, while contractionary policy tames inflation at the cost of a deeper recession. In the long run, if wages adjust downward, SRAS shifts back and output returns to potential at a higher price level.

Problem 7

Banks hold reserves equal to 10 percent of deposits and lend out the rest. The central bank buys 500 million of government bonds from a commercial bank. Calculate the maximum possible increase in the money supply and explain why the actual increase is usually smaller.
Show worked solution
Money multiplier =1rr=10.10=10= \frac{1}{rr} = \frac{1}{0.10} = 10. The maximum increase in the money supply is 10×500=5,00010 \times 500 = 5{,}000 million. The actual increase is smaller if banks hold excess reserves (especially when loan demand is weak or interest rates are near zero) or if the public holds some of the new money as cash rather than redepositing it — both leak reserves out of the lending chain.

Problem 8

Describe the transmission mechanism when a central bank conducts an open-market purchase of bonds during a recession. Trace the effect through to aggregate demand, output and the price level.
Show worked solution
The central bank pays for the bonds with newly created reserves, so bank reserves and the money supply rise. With more funds to lend, the interest rate falls (money-market equilibrium). Lower interest rates raise interest-sensitive spending — business investment, housing, consumer durables — and depreciate the currency, raising net exports. Aggregate demand shifts right, so real output rises and unemployment falls; the price level rises somewhat, more so the closer the economy is to full employment. The effect works with lags of several quarters.

Problem 9

A savings account pays a nominal interest rate of 6 percent while inflation is 4 percent. Calculate the real interest rate. If inflation unexpectedly rises to 7 percent while the nominal rate is fixed, who gains and who loses?
Show worked solution
Real interest rate ≈\approx nominal rate −- inflation =6%−4%=2%= 6\% - 4\% = 2\% (exactly 1.061.04−1≈1.9%\frac{1.06}{1.04} - 1 \approx 1.9\%). If inflation unexpectedly rises to 7 percent, the real rate becomes 6%−7%=−1%6\% - 7\% = -1\%: lenders and savers lose purchasing power, while borrowers gain because they repay in money worth less than expected. Unexpected inflation redistributes wealth from lenders to borrowers; the Fisher effect says nominal rates eventually rise to compensate.

Problem 10

The US dollar appreciates by 10 percent against the euro. Explain the effect on US exports, imports and net exports, and how this feeds into aggregate demand. Which US groups gain from the appreciation?
Show worked solution
A stronger dollar means each euro buys fewer dollars, so US goods cost more in Europe (exports fall) while European goods cost fewer dollars in the US (imports rise). Net exports fall, shifting aggregate demand left and reducing output — a drag on growth and a disinflationary force. Gainers include US consumers and firms that buy imported goods and inputs, and Americans travelling abroad. Losers include exporters, import-competing industries and their workers. Trade effects build over time as contracts are renegotiated (the J-curve).

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