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Week 8 · Midterm study guide

Midterm Exam — Study Guide

Principles of Macroeconomics Free sample edition

Coverage — what the midterm covers

The midterm is cumulative over Weeks 1–7. It opens in the Week 8 module and closes at the due time your instructor sets. There is no time limit, and you get one attempt. The questions appear one at a time, and you cannot go back once you move on.

Format: 25 questions, and every question counts the same. Sixteen ask you to pick one option, five ask you to judge a statement as true or false, and four ask you to pick every option that applies. Any graph a question needs is described in words in the question, every figure it uses is printed there, and the arithmetic is short enough for scratch paper.

What is in scope, with the number of midterm questions on each course objective:

Midterm coverage by course objective: the weeks the drawn questions come from, the main skills, and the number of questions out of 25
Course objective Weeks the questions come from Main skills Questions
1. The tools of macroeconomic modeling 1 and 4 Macro versus micro; opportunity cost; the frontier, its slope, and points on, inside, and outside it; the bowed-out frontier; the circular flow; positive versus normative 5
2. Measuring output with GDP 2 and 3 GDP = C + I + G + NX; what counts and what does not; real versus nominal GDP; the GDP deflator and how it differs from the CPI 3
3. The price level and the labor market 3 and 6 The CPI as a level and the inflation rate as a rate; real wages; the unemployment and participation rates; frictional, structural, and cyclical unemployment 5
4. Long-run growth 4 A growth rate divided by the starting value; the rule of 70 as an approximation; per-capita growth; productivity and its three sources 2
5. The AD–AS model and the business cycle 5 and 6 Why each curve slopes the way it does; movement along versus shift; name the curve, the direction, the new P and Y; the four phases; gaps in units and percent; official recession dating; self-correction 7
6. Fiscal policy 7 Expansionary versus contractionary; the spending and tax multipliers; automatic stabilizers; the deficit as a flow and the debt as a stock; the case for and against acting 3

By week, the questions come out as 4 from Week 1, 2 from Week 2, 5 from Week 3, 3 from Week 4, 4 from Week 5, 4 from Week 6, and 3 from Week 7. The AD–AS model and the business cycle carry the most questions, 7 of the 25, so put the most review time on Weeks 5 and 6. The modeling tools and the price level and labor market come next with 5 each. Week 3 is the largest single week, with 5 questions. Week 8's flow-vs-stock habit is not scored on its own, and practicing it is still good review, because it is how you keep Week 7's deficit and debt apart.

Topic-by-topic review

Each topic gives the key idea in plain words, the course's own definitions, a course example, and the mistakes students make most often with the cure for each. Every number in a course example is illustrative, constructed for this course, not real data. The deeper review for every topic is that week's chapter, lecture page, slide deck, and readings.

Week 1 — The macro perspective

  • Key idea: every choice gives something up, and a simple model of a whole economy shows what it can make, where its resources sit idle, and what each extra unit costs.
  • Macro and micro: macroeconomics is the study of the economy as a whole: total output, the overall price level, unemployment, and growth. Microeconomics is the study of individual markets and of the choices made by single households and firms. An economic model is a simplified picture of how part of the economy works, which leaves out detail on purpose so that it can answer one question.
  • Scarcity and opportunity cost: scarcity is the condition in which people's wants outrun the resources available to meet them. Opportunity cost is the value of the best alternative given up when a choice is made, measured in money or in units of another good.
  • The frontier: a production possibilities frontier shows the largest combinations of two goods an economy can produce with all of its resources and its current technology. Consumer goods are used up by households; capital goods are made to help produce other goods in the future. A point on the frontier is an efficient point. A point inside is attainable but wasteful, with idle labor and capital, a first look at unemployment. A point outside is unattainable with the resources it has now. An outward shift of the whole frontier is a first look at growth.
  • Why a real frontier bows outward: the law of increasing opportunity cost says each extra unit of a good costs more of the other good than the last unit did, because resources are not equally suited to every task. A straight line is the constant-cost special case.
  • The circular flow: households and firms meet in product markets, where households buy the goods and services firms produce, and in factor markets, where households sell labor and other inputs to firms for income. Every dollar one side spends is a dollar of income to the other. Leakages (saving, taxes, imports) leave the loop; injections (investment, government purchases, exports) enter it.
  • Positive and normative: a positive statement is a claim about how the economy is, was, or will be, which evidence can confirm or refute. A normative statement is a claim about how the economy ought to be, which rests on values.
  • Course example (illustrative): a free evening of 5 hours that could earn 18 dollars an hour costs 5 × 18 = 90 dollars forgone. On the labor-hours frontier 3x + 6y = 24, the endpoints are 24 ÷ 3 = 8, the point (8, 0), and 24 ÷ 6 = 4, the point (0, 4), so one capital good costs 8 ÷ 4 = 2 consumer goods. The point (4, 2) uses 12 + 12 = 24 million labor-hours and is efficient. The point (2, 2) uses 6 + 12 = 18 and leaves 24 − 18 = 6 million labor-hours idle.
  • Predictable mistakes → cures: (1) "positive means good and normative means bad." Cure: positive means testable; normative means it rests on values. (2) an interior point called unattainable. Cure: inside is attainable and wasteful; only outside points are unattainable. (3) a straight-line frontier assumed to be the usual case. Cure: real frontiers bow outward. (4) opportunity cost counted as the money spent. Cure: it is the best alternative given up.

Week 2 — Measuring output: GDP

  • Key idea: add up the spending on new final output, sort it into four buckets, and keep prices apart from quantities.
  • GDP: gross domestic product is the market value of all final goods and services produced within a country during a given period. Final goods and services are bought by their last user. An intermediate good is used up in making another good for sale, so GDP leaves it out. Value added is the price of what a producer sells minus the cost of the intermediate goods it bought; value added at every stage sums to the price of the final good. Counting an intermediate good on its own and again inside the final price is double counting.
  • The expenditure approach: GDP = C + I + G + NX. Consumption (C) is household spending on new goods and services. Investment (I) is business spending on new capital goods, plus new residential construction and additions to inventories; it does not mean buying stocks or bonds. Government purchases (G) include the pay of public employees and leave out transfer payments, such as a Social Security check or unemployment benefits. Net exports NX = X − IM, exports minus imports, and they subtract from GDP when they are negative. Imports are written IM, never M.
  • Real and nominal: nominal GDP values output at the prices of that same period; real GDP values it at the fixed prices of a base year, so it changes only when the amount of output changes. In the base year, nominal GDP equals real GDP and a price index equals 100.
  • The GDP deflator: a price index for all of the goods and services counted in GDP, (nominal GDP ÷ real GDP) × 100. The check on any pair of growth rates is (1 + real growth) × (1 + inflation) = (1 + nominal growth). GDP measures output, not well-being.
  • Course example (illustrative): NX = 100 − 150 = −50, so GDP = 700 + 200 + 250 − 50 = 1,100 billion dollars. Real GDP is 1,000, so the deflator is (1,100 ÷ 1,000) × 100 = 110, and prices sit 10 percent above the base year. In the two-good economy, real growth is (330 − 300) ÷ 300 × 100 = 10%, nominal growth is (363 − 300) ÷ 300 × 100 = 21%, and 1.10 × 1.10 = 1.21 checks them. In the bread chain, value added is 1 + 1 + 3 = 5 dollars, the price of the loaf.
  • Predictable mistakes → cures: (1) a rise in nominal GDP read as a rise in output. Cure: only real GDP measures output. (2) the flour and the bread both counted. Cure: count final goods or value added. (3) a Social Security check counted in G. Cure: it is a transfer and buys nothing in return. (4) a trade deficit added to GDP. Cure: NX is negative, so it subtracts. (5) "investment" read as buying stocks. Cure: in GDP it means new capital goods and new housing.

Week 3 — Measuring inflation and unemployment

  • Key idea: a price index is a level, an inflation rate is a percentage change between two levels, and the labor market counts people three ways.
  • The CPI: the Consumer Price Index compares the cost of a fixed market basket in a year with its cost in the base year, times 100. It is a level, written with no percent sign.
  • The inflation rate: the percentage change in a price index from one period to the next, (new − old) ÷ old × 100, written with a percent sign. Index points are the plain gap between two readings, such as 113.4 − 108 = 5.4; that gap is not a rate. "CPI − 100" gives the rate only in the first year after the base year.
  • Real and nominal wages: a nominal wage is the dollars received; a real wage is what those dollars buy. A real wage change ≈ the nominal wage change − the inflation rate.
  • Counting people: a person is employed, unemployed (no job, available, and actively looking), or outside the labor force. Labor force = employed + unemployed. Unemployment rate = unemployed ÷ labor force × 100. Labor-force participation rate = labor force ÷ adult population × 100. A discouraged worker wants a job but has stopped looking, so the survey places that person outside the labor force, and the measured rate can fall with no one hired.
  • Three types: frictional unemployment is the ordinary time a search and a match take; structural unemployment is a lasting mismatch of skills or places; cyclical unemployment is the extra joblessness of a recession, which shrinks again in an expansion.
  • One sentence each: the CPI can overstate inflation when shoppers switch goods or quality improves, and the GDP deflator prices all of GDP while the CPI prices what households buy.
  • Course example (illustrative): the basket costs 200 dollars in the base year and 216 in year 2, so the CPI is (216 ÷ 200) × 100 = 108, and inflation from the base year is (108 − 100) ÷ 100 × 100 = 8%. In year 3 the CPI is 113.4, and inflation is 5.4 ÷ 108 × 100 = 5%. A 4% raise against 5% inflation is a real wage change of about 4% − 5% = −1%. In the labor market, 114 + 6 = 120 million in the labor force, 6 ÷ 120 × 100 = 5% unemployed, and 120 ÷ 200 × 100 = 60% participation.
  • Predictable mistakes → cures: (1) a CPI level of 108 read as "8% inflation this year." Cure: a level compares with the base year; a rate compares two periods. (2) 113.4 − 108 = 5.4 called the inflation rate. Cure: divide by the old level, 5.4 ÷ 108 × 100 = 5%. (3) a discouraged worker counted as unemployed. Cure: no search means outside the labor force. (4) the unemployment rate divided by all adults. Cure: divide by the labor force.

Week 4 — Economic growth and productivity

  • Key idea: growth is measured from where you started, small differences in rates compound into large gaps, and only output per person tracks living standards.
  • Growth: economic growth is a sustained rise over many years in real GDP; on the frontier it is an outward shift of the whole frontier. Potential output is the real output an economy can produce when its labor, capital, and technology are in normal, full use.
  • The growth rate: (new − old) ÷ old × 100, divided by the starting value.
  • The rule of 70: doubling time ≈ 70 ÷ the growth rate in percent. It is an approximation, close for the small rates economies usually grow at, and it is taught as one. Compound growth adds each year's increase to the base for the next year.
  • Per person: real GDP per capita = real GDP ÷ population. Per-capita growth ≈ total growth − population growth.
  • Productivity: output per worker, or per hour of work. Its three sources are physical capital (equipment, machines, tools, and buildings), human capital (education, skills, training, and health), and technology (ideas and methods for turning labor and capital into output). The Solow growth model organizes the three with an aggregate production function; the course names it and does not derive it.
  • Course example (illustrative): real GDP rising from 800 to 840 billion dollars is (840 − 800) ÷ 800 × 100 = 5%. At 7% growth, 70 ÷ 7 = 10 years to double. Grown at 7% a year for ten years, 100 billion dollars reaches about 196.72 billion, close to the 200 billion the rule predicts but not exactly 200, which is what an approximation means. A city whose output grows 3% while its population grows 1% raises output per person by about 3% − 1% = 2%.
  • Predictable mistakes → cures: (1) dividing the change by the new value, 40 ÷ 840 × 100 ≈ 4.76%. Cure: divide by the starting value. (2) multiplying 70 by the rate. Cure: divide 70 by the rate. (3) big total growth read as rising living standards. Cure: subtract population growth first. (4) the rule of 70 treated as exact. Cure: it is a shortcut, and compounding shows how close it lands.

Week 5 — Aggregate demand and aggregate supply

  • Key idea: one diagram splits the economy into a price level and a real output, and the most important habit of the term is telling a slide along a curve from a shift of the whole curve.
  • The diagram: in the AD–AS model, real output Y runs along the horizontal axis and the price level P, an index like the GDP deflator, runs up the vertical axis. A point is written (Y, P).
  • Aggregate demand is the total quantity of real output that households, firms, the government, and foreign buyers want to buy at each price level. It slopes down for three economy-wide reasons: the wealth effect (a lower price level raises what money holdings can buy), the interest-rate effect (less money is needed for everyday purchases, so interest rates fall and loan-financed spending rises), and the exchange-rate effect (exports get cheaper abroad and imports dearer at home, so net exports rise). The micro story of switching to something cheaper does not apply, because there is no "something else" when the price level of everything falls.
  • Short-run aggregate supply slopes up because of sticky prices and wages, which are slow to change because of contracts, menus, and agreements already in place. Long-run aggregate supply is a vertical line at potential output, the output the economy produces once every price and wage has fully caught up.
  • Movement versus shift: a change in the price level is a movement along a curve. Only a change in something other than P is a shift of a curve. Consumption, investment, government purchases, and net exports shift aggregate demand; input costs, productivity, and expected inflation shift short-run aggregate supply.
  • Comparative statics: name the curve that moves, name the direction, then read the new price level and real output. An aggregate demand shift moves P and Y together; a short-run aggregate supply shift moves them apart. A supply shock shifts short-run aggregate supply, and a leftward one brings stagflation: a higher price level with lower real output.
  • Course example (illustrative): aggregate demand P = 20 − Y⁄100 meets short-run aggregate supply P = 4 + Y⁄100 where 16 = 2Y⁄100, so Y = 800 and P = 12. At P = 13 on the same demand line, Y = 700, a slide along it. Government spending shifts aggregate demand right to P = 22 − Y⁄100, and the new crossing is (900, 13): output rose 900 − 800 = 100 billion dollars and the price level rose from 12 to 13, together.
  • Predictable mistakes → cures: (1) "aggregate demand slopes down because people switch to cheaper goods." Cure: use the wealth, interest-rate, and exchange-rate effects. (2) a change in P drawn as a shift of aggregate demand. Cure: a price-level change is a movement along. (3) a supply shock drawn as an aggregate demand shift. Cure: input costs move short-run aggregate supply. (4) P and Y moved in opposite directions after a demand shift. Cure: a demand shift moves them together.

Week 6 — Business cycles and short-run fluctuations

  • Key idea: a gap is where the economy sits against the vertical potential-output line, measured in units and as a percentage of potential, and that is a separate question from which curve put it there.
  • The cycle: the business cycle has four phases. In an expansion, real output, jobs, and incomes rise. The peak is the high point; a recession is a significant decline in economic activity, spread across the economy, that lasts more than a few months; the trough is the low point before the next expansion.
  • Gaps: actual output is where aggregate demand crosses short-run aggregate supply. A recessionary gap is potential output minus actual output; workers and machines sit idle, and cyclical unemployment is above zero. An inflationary gap is actual output minus potential output; resources are stretched past normal, full use, and price pressure builds. Every gap is reported in billions of dollars and as a percentage of potential.
  • Expectations: expected inflation is the rate of price increase that workers and firms build into the wages and prices they set, and a change in it shifts short-run aggregate supply. Because wages and prices are sticky, a gap can last for many months.
  • Self-correction and stabilization: self-correction is the process by which wages, prices, and expected inflation change over time and shift short-run aggregate supply until real output returns to potential, with no new policy. Stabilization policy is deliberate action by a government or a central bank to shrink a gap by shifting aggregate demand.
  • How recessions are dated: the Business Cycle Dating Committee, the official group that dates U.S. peaks and troughs, weighs depth, diffusion, and duration across several monthly indicators. The two-negative-quarters rule of thumb is a popular shortcut, not the official definition.
  • Both sides, at full strength: the Keynesian tradition stresses sticky wages and prices, so an economy can stay stuck in a gap for a long time and active stabilization can help. The classical and monetarist traditions stress flexible prices in the long run and potential output as the anchor, so the economy corrects itself and predictable rules beat discretion. Both read the same diagram; which risk weighs more is a judgment you argue, not a verdict the course hands down.
  • Course example (illustrative): with potential output at 1,000 and actual output at 950, the recessionary gap is 1,000 − 950 = 50 billion dollars, and 50 ÷ 1,000 × 100 = 5% of potential. With actual output at 1,040, the inflationary gap is 1,040 − 1,000 = 40 billion dollars, or 4% of potential.
  • Predictable mistakes → cures: (1) "two negative quarters" stated as the official definition. Cure: the committee judges depth, diffusion, and duration. (2) a gap's sign flipped, 950 − 1,000 = −50. Cure: subtract so the gap is a positive distance, and name its type in words. (3) a gap reported as a bare number. Cure: add the percentage of potential. (4) a recessionary gap read as "the economy cannot produce more." Cure: it can; the resources are idle.

Week 7 — Fiscal policy

  • Key idea: the legislature's spending and taxes shift aggregate demand, rounds of re-spending multiply the first push, and a yearly deficit piles up into the debt.
  • Fiscal policy is the government's use of its spending and taxes to influence the whole economy, set by the legislature and not by the central bank. Expansionary fiscal policy raises spending or cuts taxes and shifts aggregate demand right; contractionary fiscal policy cuts spending or raises taxes and shifts it left.
  • The multipliers: the marginal propensity to consume (MPC) is the fraction of an extra dollar of income a household spends rather than saves. The spending multiplier is 1 ÷ (1 − MPC). The tax multiplier is −MPC ÷ (1 − MPC); a tax cut is weaker dollar for dollar because part of it is saved first. The money multiplier, 1 ÷ RR, belongs to banking in Week 9 and never answers a fiscal question.
  • Automatic stabilizers are taxes and transfer programs already on the books, such as income taxes and unemployment insurance, that cushion spending in a downturn and restrain it in a boom with no new law. Discretionary fiscal policy is a deliberate new decision by the legislature.
  • Deficit and debt: the budget deficit is the amount by which spending exceeds revenue in one year, a flow. The national debt is the total the government owes at a point in time, a stock, and each year's deficit adds to it.
  • Both sides, at full strength: the Keynesian case says idle workers and machines can be put back to work, crowding out is small in a slump, and waiting leaves the gap open longer. The classical and monetarist case for caution says government borrowing can push up interest rates and crowd out private investment, policy lags (recognizing, deciding, taking effect) can make help land late, and every deficit adds to the debt. Label each claim positive or normative, and leave the verdict to the evidence and your own values.
  • Course example (illustrative): at an MPC of 0.8 the spending multiplier is 1 ÷ 0.2 = 5, so a 20 billion road project raises output by 5 × 20 = 100 billion dollars. The tax multiplier is −0.8 ÷ 0.2 = −4, so a tax cut of 25 also adds −4 × (−25) = 100. Revenue of 400 against spending of 450 is a deficit of 50 for the year, and the debt rises from 1,000 to 1,050.
  • Predictable mistakes → cures: (1) the multiplier computed as 1 ÷ MPC, 1 ÷ 0.8 = 1.25. Cure: divide by 1 − MPC. (2) the money multiplier used on a fiscal question. Cure: 1 ÷ RR is banking. (3) a tax cut and a spending rise of equal size treated as equal. Cure: the tax cut is smaller, because part of it is saved. (4) the deficit and the debt used interchangeably. Cure: a flow per year against a stock at a moment. (5) "the central bank cut spending." Cure: spending and taxes belong to the legislature.

Week 8's new habit (not scored on its own)

The flow-vs-stock habit is a one-question check run on any economic number: does it need a period, such as "per year," to make sense, which makes it a flow, or a moment, such as "at the end of the year," which makes it a stock? A year's GDP, a year's investment, a year's deficit, and a year's inflation rate are flows. The national debt, the capital stock (the machines, equipment, and buildings an economy has at a point in time), and the price level are stocks. A flow over a period raises or lowers a stock: a deficit fills the tub, and the debt is the water level.

Representative practice

These are fresh variants, not the midterm's questions. Work each worked example yourself first, then compare your steps. Every number below comes from the course's own illustrative datasets or from arithmetic on them, computed and checked in advance.

Worked example — the frontier's slope, a point out of reach, and a council debate (Week 1)

Read the slope a second way. On the course frontier 3x + 6y = 24 (illustrative), slide from the endpoint (8, 0) to the efficient point (4, 2).

  • Consumer goods fall from 8 to 4, so the economy gives up 8 − 4 = 4 consumer goods.
  • Capital goods rise from 0 to 2, so it gains 2 − 0 = 2 capital goods.
  • Each capital good cost 4 ÷ 2 = 2 consumer goods, the same opportunity cost the endpoints gave. On a straight frontier the cost is the same everywhere.

Test a point out of reach. The point (6, 3) needs 3 × 6 + 6 × 3 = 18 + 18 = 36 million labor-hours. Only 24 million exist, so it is unattainable, short by 36 − 24 = 12 million labor-hours. Only an outward shift of the whole frontier, which is growth, could bring it within reach.

Sort two claims from a city council meeting:

  • "If the city adds bus routes, more residents will ride the bus to work." Positive: it predicts what will happen, and ridership counts could confirm or refute it.
  • "The city should spend more on buses than on roads." Normative: it rests on a judgment about what matters more.

Why it matters: the slope is the opportunity cost wherever you read it, an outside point fails for lack of hours, and the test for "positive" is whether evidence could settle the claim, not whether it sounds pleasant.

Worked example — a missing minus sign and what counts (Week 2)

Catch the slip. A news summary of the course's illustrative account adds exports and forgets to subtract imports: 700 + 200 + 250 + 100 = 1,250 billion dollars.

  • The right first step is NX = X − IM = 100 − 150 = −50.
  • Then GDP = 700 + 200 + 250 − 50 = 1,100 billion dollars.
  • The summary overstated output by 1,250 − 1,100 = 150 billion dollars, exactly the imports it left in.

Sort a household's year:

  • A family buys a newly built condo: it counts, in investment, as new residential construction.
  • A neighborhood café buys coffee beans to brew: an intermediate good, already inside the price of the drinks it sells.
  • A retiree's Social Security check: a transfer payment, so it is in neither G nor GDP.

Split price from quantity. In the illustrative two-good economy, year 2's 44 pizzas are worth 44 × 5.50 = 242 dollars at year-2 prices but 44 × 5 = 220 dollars at base-year prices. So 242 − 220 = 22 dollars of the pizzas' nominal value is higher prices, not more pizza.

Why it matters: the sign of NX decides whether trade adds or subtracts, only new final output counts, and real GDP strips out the price part.

Worked example — a level, a rate, and a town's labor count (Week 3)

Get the year-3 rate from the basket costs. The illustrative basket costs 216 dollars in year 2 and 226.80 in year 3.

  • The change is 226.80 − 216 = 10.80 dollars.
  • Divide by the starting cost: 10.80 ÷ 216 × 100 = 5%.
  • The CPI route agrees: (113.4 − 108) ÷ 108 × 100 = 5%. Prices rose 5 percent that year.
  • The level 113.4 says something else: the basket costs 113.4 − 100 = 13.4 percent more than in the base year, over all the years since.

Recount a town (illustrative). A town's labor force is 4,800 people, and 240 are unemployed: 240 ÷ 4,800 × 100 = 5%. Then 50 discouraged job seekers stop looking.

  • They leave the labor force: 4,800 − 50 = 4,750.
  • They leave the unemployed count: 240 − 50 = 190.
  • The new rate is 190 ÷ 4,750 × 100 = 4%, and no one was hired.

Name the type:

  • A graphic designer who moved across the country for a partner's new job and is sending out a portfolio: frictional, the ordinary time a search takes.
  • A film-camera repair technician whose trade has vanished from the region: structural, a lasting skills mismatch.
  • A furniture-plant worker laid off when spending across the economy fell in a recession: cyclical.

Why it matters: a rate always divides by the old value, a level is not a rate, and a falling unemployment rate needs a second look at who left the count.

Worked example — another year of growth and a doubling date (Week 4)

One more year at the same rate. The illustrative economy grew from 800 to 840, a 5% rate. Suppose it grows 5% again.

  • The increase is 0.05 × 840 = 42 billion dollars, figured on the new starting value of 840.
  • Real GDP reaches 840 + 42 = 882 billion dollars.
  • The increase grew from 40 to 42 because each year's growth is figured on a bigger base: compound growth.

Estimate a doubling. At a steady 5%, the rule of 70 gives 70 ÷ 5 = 14 years. So the 800 billion economy would reach about 800 × 2 = 1,600 billion dollars in about 14 years. Call it "about," because the rule is an approximation.

Why it matters: every growth rate is figured on the year it starts from, and doubling times are estimates, not exact dates.

Worked example — why the crossing sits where it does (Week 5)

Test a price level that is too low. Use the course pair (illustrative): aggregate demand P = 20 − Y⁄100 and short-run aggregate supply P = 4 + Y⁄100. Try P = 11.

  • Demand side: 20 − Y⁄100 = 11, so Y⁄100 = 9 and buyers want Y = 900 billion dollars of output.
  • Supply side: 4 + Y⁄100 = 11, so Y⁄100 = 7 and firms supply Y = 700.
  • Buyers want 900 − 700 = 200 billion dollars more than firms supply, so the price level is pushed up, sliding along both lines, until it reaches 12, where both give 800.

Name the curve, the direction, and the result:

  • Firms across the country grow confident and order new equipment: investment rises, aggregate demand shifts right, and the price level and real output both rise.
  • Shipping and fuel costs jump for producers everywhere: input costs rise, short-run aggregate supply shifts left, the price level rises, and real output falls. That mix is stagflation.
  • The price level falls with nothing else changing: no curve shifts; the economy moves down the demand curve to a larger quantity of output demanded.

Why it matters: only a change in something other than P moves a whole curve, and the direction of P and Y together tells you which curve moved.

Worked example — size a gap, then close it (Weeks 6 and 7)

The recession case. With potential output at 1,000 and actual output at 950 (illustrative):

  • Gap: 1,000 − 950 = 50 billion dollars, a recessionary gap.
  • Share of potential: 50 ÷ 1,000 × 100 = 5%.
  • With the course multiplier of 5, new spending of 50 ÷ 5 = 10 billion dollars closes it in the simple model, since 5 × 10 = 50.

The boom case. With actual output at 1,040:

  • Gap: 1,040 − 1,000 = 40 billion dollars, an inflationary gap, or 40 ÷ 1,000 × 100 = 4% of potential.
  • In the simple model, a spending cut of 40 ÷ 5 = 8 billion dollars closes it, since 5 × 8 = 40.

Both readings of the same numbers. A Keynesian reading says the recession case should get the 10 billion now: idle workers and machines are output lost for good every month the gap stays open, and in a slump there is little private borrowing to crowd out. A classical or monetarist reading says wait, because lags can land the help after self-correction has done the work, and the borrowing can crowd out private investment. The arithmetic is the same on both sides; the disagreement is about how fast prices move and which risk weighs more.

Why it matters: a gap is a distance and a percentage, the multiplier turns it into a policy size, and the policy choice is a judgment you argue from both sides.

Worked example — a smaller multiplier and a second deficit (Week 7)

A lower MPC. At an MPC of 0.6 (a row of the course's multiplier table):

  • The multiplier is 1 ÷ (1 − 0.6) = 1 ÷ 0.4 = 2.5.
  • A 20 billion road project raises output by 2.5 × 20 = 50 billion dollars, half what it does at an MPC of 0.8.
  • The slip 1 ÷ 0.6 ≈ 1.67 divides by the MPC itself and badly understates the effect.

A second year of the same budget (illustrative). Revenue stays 400 and spending stays 450.

  • The deficit is again 450 − 400 = 50 billion dollars, a flow for the year.
  • The debt rises again, from 1,050 to 1,050 + 50 = 1,100 billion dollars, a stock at the year's end.

Why it matters: the closer the MPC is to 1, the bigger the multiplier, and an unchanged deficit still makes the debt grow every year it lasts.

Worked example — the flow-vs-stock habit on a city's books (Week 8)

A city's finance report lists six items. Ask "per year, or as of a moment?" of each.

  • The wages the city pays its workers this year: a flow.
  • The bonds the city still owes at the end of the year: a stock.
  • New buses the city bought this year: a flow, investment that adds to its fleet.
  • The city's whole fleet of buses right now: a stock, its share of the capital stock.
  • This year's rise in bus fares, as a percentage: a flow, a rate of change.
  • The fare a rider pays now: a level, the stock-like reading.

Why it matters: a flow over a period changes a stock, and keeping the two apart is the habit the money and debt weeks build on.

Self-check questions

Try each one, then read the check and the one-line why.

  1. On the course frontier, what does one consumer good cost? Check: half a capital good, 4 ÷ 8 = 0.5. Why: giving up 8 consumer goods buys 4 capital goods, so each consumer good costs 4 ÷ 8 of a capital good.
  2. A newly built house is sold this year. Does it count in GDP, and in which bucket? Check: yes, in investment. Why: new residential construction counts in I.
  3. A CPI reads 108 in year 2. Is that 8% inflation this year? Check: here it is, but only because the base year came right before year 2. Why: 108 is a level; the rate compares two levels, (108 − 100) ÷ 100 × 100 = 8%, and "CPI − 100" works only in that first year.
  4. A person wants work but stopped looking, sure that none is available. Is that person unemployed? Check: no. Why: a discouraged worker sits outside the labor force.
  5. For a growth rate, do you divide the change by the old value or the new one? Check: the old, starting value. Why: dividing by the new value is the wrong-base error.
  6. The price level falls and nothing else changes. Does aggregate demand shift? Check: no. Why: a price-level change is a movement along the curve.
  7. For a recessionary gap, which do you subtract from which? Check: actual output from potential output. Why: that keeps the gap a positive shortfall.
  8. A highway bill raises spending. Which multiplier sizes its effect on output? Check: the spending multiplier, 1 ÷ (1 − MPC). Why: 1 ÷ RR is the money multiplier, a banking idea.

Check yourself — choose one. Write two or three sentences to a friend.

  • (a) Explain why a CPI of 113.4 in year 3 does not mean prices rose 13.4 percent that year.
  • (b) Explain why a deficit that stays at 50 every year still makes the debt grow.

Either one rehearses an explain-why skill the midterm checks.

Watch before the exam

These eight videos come from the course's Readings & Resources pages for Weeks 1 to 8, and every one has captions. Use them to review and to connect weeks, not to learn anything new.

Study plan

A short countdown. Count back from the day you plan to sit the midterm.

  • Two weeks out: as you finish Week 6, start a one-page list of the course's swapped pairs: positive and normative, real and nominal, a level and a rate, unemployed and outside the labor force, and a movement along and a shift. Add the deficit and the debt when Week 7 arrives.
  • One week out: as you finish Week 7, reread the topic reviews above for Weeks 1 to 3, the weeks furthest back. Week 3 alone holds 5 of the 25 questions.
  • At the start of Week 8: take the practice exam once, cold and closed-note. Note which objectives cost you the most.
  • Three or four days before you sit it: reread the topic reviews for your two weakest objectives, and redo the matching worked examples from scratch without looking.
  • Two days before: run the paired exam-prep tutorial (the copy-and-paste chatbot tutor, or its no-AI route) for active recall. Tell it which areas the practice exam exposed.
  • The day before: retake the practice exam, explain every miss out loud, and work the self-check questions above.
  • Right before: say the one calculation and the one curve for each week aloud, skim the "predictable mistakes → cures" lines for all seven weeks, and then stop studying.

This guide is for review. The exam-prep tutorial and the practice exam are where you rehearse. Pulling ideas back out of memory, not rereading, is what makes them stick.

Exam format

Every one of the 25 questions counts the same, and the midterm checks your own understanding without AI. The questions come one at a time, and there is no going back, so settle each one before you move on.

Test-taking strategies for this material:

  • Name the pair before you choose. Most questions turn on two neighboring ideas, such as real and nominal, a level and a rate, or a movement along and a shift. Say which pair is in play first.
  • Name the curve, the direction, then P and Y. For any change, decide which curve moves before you read the options, and remember that a demand shift moves P and Y together.
  • Divide by the starting value. Growth rates and inflation rates both divide the change by where you began.
  • Write the formula on its own line first. NX = X − IM, a gap as potential minus actual, and the multiplier as 1 ÷ (1 − MPC) each go down before the numbers do.
  • Ask "per year, or as of a moment?" It keeps a deficit apart from the debt and an inflation rate apart from the price level.
  • For a "pick every option that applies" question, judge each statement on its own, as if it were a true-or-false question.

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