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Week 16 · Final study guide

Final Exam — Study Guide

Principles of Macroeconomics Free sample edition

Coverage — what the final covers

The final is cumulative: its questions reach all eight course objectives, across the fifteen teaching weeks. It is given in Week 16, the finals week, which has no new material. The exam has 40 questions, and every question counts the same. Thirty-four are multiple choice with one best answer, three ask you to select every choice that fits, and three are true-or-false statements. There is no time limit, and you get one attempt. It opens in Week 16, in Canvas, when your instructor sets it to open.

The questions were drawn from the course's question bank, and every objective appears at least once. The draw leans hard on the second half of the term. Here is what this form actually contains:

The final's 40 questions by source week, with the objectives each week's questions assess
Week Topic Questions Objectives assessed
1 The macro perspective 1 Objective 1 (1)
2 Measuring output: GDP 1 Objective 2 (1)
4 Growth and productivity 1 Objective 4 (1)
9 Money and banking 6 Objective 7 (5), Objective 6 (1)
10 The central bank and monetary policy 7 Objective 7 (5), Objective 3 (2)
11 Monetary policy and aggregate demand 4 Objective 7 (4)
12 Inflation, the Phillips curve, and expectations 5 Objective 8 (4), Objective 3 (1)
13 Trade and comparative advantage 2 Objective 8 (2)
14 Exchange rates and the balance of payments 6 Objective 8 (5), Objective 5 (1)
15 Schools of thought and policy debates 7 Objective 8 (5), Objective 6 (2)
The eight course objectives with their teaching weeks and their share of the final's 40 questions
Objective What you do Weeks Questions on this exam
Objective 1 Use scarcity, opportunity cost, the frontier, and the circular flow; tell positive from normative 1 1
Objective 2 Measure GDP by spending, decide what counts, and separate real from nominal 2 1
Objective 3 Read the CPI, price inflation, and the labor-market rates, and classify unemployment 3 3
Objective 4 Compute growth rates, doubling times, and per-capita growth 4 1
Objective 5 Name the AD–AS curve that shifts, its direction, and the new price level and output 5, 6 1
Objective 6 Apply fiscal policy and the two fiscal multipliers, and tell the deficit from the debt 7 3
Objective 7 Explain money, banking, the central bank's tools, the money market, and transmission 9, 10, 11 14
Objective 8 Use the Phillips curve, the quantity equation, and the open-economy tools, and weigh the schools 12, 13, 14, 15 16

That is 37 of 40 questions from Weeks 9–15, and one each from Weeks 1, 2, and 4. Money, banking, and monetary policy (14 questions) and the Phillips curve, the open economy, and the debates (16) carry 30 of the 40 between them, so put most of your review there. The Week 1–7 ideas still earn their place: ten questions assess Objective 1 through Objective 6, seven of them inside a later week's material, and real against nominal runs through nearly everything.

Topic-by-topic review

Each unit gives the idea in plain words first, then the course's exact definitions, then the mistakes students make most often and the cure for each. The "deeper review" line tells you where to look in that week's materials. Units 6–12 carry the weight of the exam, so they get the most space. Every number here is illustrative, constructed for this course, and not real data.

Unit 1 — The macro toolkit (Week 1, with Week 8's flow-vs-stock habit)

  • Key idea. Macroeconomics looks at the whole economy at once, and every choice in it gives something up.
  • The study itself. Macroeconomics is the study of the economy as a whole: total output, the overall price level, unemployment, and growth. Microeconomics studies individual markets and the choices of single households and firms. An economic model is a simplified picture that leaves out detail on purpose so it can answer one question.
  • Scarcity and its price. Scarcity means wants outrun the resources available. The opportunity cost of a choice is the value of the best alternative given up, measured in money or in units of another good.
  • The frontier. The production possibilities frontier shows the largest combinations of two goods an economy can make with all its resources and current technology. Its slope is the opportunity cost. A point on it is efficient; a point inside it is attainable but leaves resources idle, the macro reading of unemployment; a point outside it is unattainable. Real frontiers bow outward because of the law of increasing opportunity cost.
  • The circular flow. Households and firms meet in product markets and factor markets. A leakage (saving, taxes, imports) leaves the loop; an injection (investment, government purchases, exports) enters 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 it ought to be, which rests on values.
  • The flow-vs-stock habit (Week 8). A flow needs a period to make sense (a year's deficit, a year's investment, a year's inflation). A stock is measured at a moment (the debt, the capital stock, the price level).
  • Predictable mistakes → cures. "Positive means good": positive means testable. Calling an inside point unattainable: it is attainable and wasteful; only outside points are out of reach. Treating a straight frontier as the general case: real ones bow outward.
  • Deeper review: the Week 1 chapter and slides, and the Week 8 flow-vs-stock slides.

Unit 2 — Measuring the economy: GDP, prices, and jobs (Weeks 2 and 3)

  • Key idea. Count only new final output, strip out price changes before you compare years, and say whether a number is a level or a rate.
  • GDP. Gross domestic product is the market value of all final goods and services produced within a country during a given period. By the expenditure approach, GDP = C + I + G + NX, with net exports NX = X − IM. Imports are written IM, never M, which is the money supply. Investment means new capital goods, new homes, and inventories, not buying stocks. A transfer payment buys nothing and is left out of G and out of GDP. The pinned account gives GDP = 700 + 200 + 250 − 50 = 1,100 billion dollars.
  • Real and nominal. Nominal GDP values output at that period's prices; real GDP values it at a base year's prices. The GDP deflator = (nominal GDP ÷ real GDP) × 100, which is 100 in the base year; the pinned account's deflator is (1,100 ÷ 1,000) × 100 = 110. A rise in nominal GDP is not a rise in output.
  • The CPI and inflation. The Consumer Price Index compares the cost of a fixed market basket with its base-year cost, times 100. The inflation rate is the percentage change in a price index, (new − old) ÷ old × 100. A plain difference between two index readings is index points, not a rate. A real wage change is about the nominal raise minus the inflation rate.
  • The labor market. The labor force is the employed plus the unemployed. The unemployment rate = unemployed ÷ labor force × 100, and the labor-force participation rate = labor force ÷ adult population × 100. A discouraged worker has stopped looking and sits outside the labor force. Joblessness is frictional (the ordinary search), structural (a lasting skills or location mismatch), or cyclical (the extra joblessness of a recession).
  • Predictable mistakes → cures. Counting flour and bread both: count the final good or the value added. Adding a trade deficit: a negative NX subtracts. Reading a CPI of 108 as "8% this year": that is a level against the base year. Writing the year-3 rate as 113.4 − 108 = 5.4: divide by the old level, 5.4 ÷ 108 × 100 = 5%. Dividing the unemployed by all adults: divide by the labor force.
  • Deeper review: the Week 2 and Week 3 chapters, the market-basket table, and the labor-market slides.

Unit 3 — Long-run growth (Week 4)

  • Key idea. Small growth rates compound into huge gaps, and only output per person tracks living standards.
  • Growth. Economic growth is a sustained rise in real GDP, an outward shift of the whole frontier. A growth rate is (new − old) ÷ old × 100, always divided by the starting value. Potential output is what the economy produces with labor, capital, and technology in normal, full use.
  • Doubling. The rule of 70 estimates doubling time as about 70 ÷ the growth rate in percent; it is an approximation, since 70 rounds 100 × ln 2 ≈ 69.3. The course's check is 1.02³⁵ ≈ 2.0 at 2% growth.
  • Per person. Per-capita growth is about total growth minus population growth. Productivity is output per worker or per hour, built from physical capital, human capital, and technology.
  • Predictable mistakes → cures. Dividing by the new value: 40 ÷ 840 understates the pinned 40 ÷ 800 = 5%. Multiplying 70 by the rate: divide. Reading strong total growth as rising living standards: subtract population growth first.
  • Deeper review: the Week 4 chapter and the rule-of-70 table.

Unit 4 — Aggregate demand, aggregate supply, and the cycle (Weeks 5 and 6)

  • Key idea. Name the curve, name the direction, then read the new price level and output, and say where the economy sits against potential.
  • The diagram. The AD–AS model puts real output on the horizontal axis and the price level on the vertical. Aggregate demand slopes down for three macro reasons: the wealth effect, the interest-rate effect, and the exchange-rate effect. Short-run aggregate supply slopes up because some prices and wages are sticky; long-run aggregate supply is vertical at potential output.
  • Along or shift. A change in the price level is a movement along a curve. A change in anything else, such as spending or input costs, is a shift of a curve. An AD shift moves P and Y together; an SRAS shift moves them apart, and an SRAS shift to the left is stagflation. The pinned pair moves from (800, 12) to (900, 13) when AD shifts right.
  • The cycle and gaps. The business cycle runs expansion, peak, recession, trough. A recessionary gap is potential output minus actual output; an inflationary gap is actual output minus potential. Report every gap in units and as a percentage of potential. A recession is a significant decline in activity, spread across the economy and lasting more than a few months; two negative quarters is a popular rule of thumb, not the official test.
  • Predictable mistakes → cures. Explaining AD's slope with the micro substitution story: when every price falls, there is no "something else" to switch to. Drawing a price-level change as a shift: it is a movement along. Moving P and Y apart after an AD shift: they move together. Reporting a gap with no percentage, or with its sign flipped.
  • Deeper review: the Week 5 and Week 6 chapters, the linear AD–AS pair, and the gap slides.

Unit 5 — Fiscal policy (Week 7)

  • Key idea. The legislature's spending and taxes shift aggregate demand, and the multiplier sizes the shift.
  • The tools. Fiscal policy is the government's use of spending and taxes, set by the legislature, not the central bank. Expansionary fiscal policy shifts AD right; contractionary fiscal policy shifts it left. Automatic stabilizers are taxes and transfers that move with the cycle without a new law.
  • The multipliers. The marginal propensity to consume (MPC) is the share of an extra dollar of income that is spent. The spending multiplier is 1 ÷ (1 − MPC); at the pinned MPC of 0.8 it is 5. The tax multiplier is −MPC ÷ (1 − MPC), which is −4 at that MPC, so a tax cut is a little weaker dollar for dollar. Neither is the money multiplier.
  • Flow and stock. The budget deficit is spending minus revenue in one year, a flow. The national debt is the total owed at a point in time, a stock, and each year's deficit adds to it. Crowding out is the worry that government borrowing raises interest rates and squeezes private investment.
  • Predictable mistakes → cures. Using 1 ÷ RR on a fiscal question: that is banking. Writing the multiplier as 1 ÷ MPC: subtract from 1 first. Using deficit and debt as synonyms: one is per year, one is a total. "The central bank cut spending": spending is fiscal.
  • Deeper review: the Week 7 chapter and the multiplier table.

Unit 6 — Money and banking (Week 9)

  • Key idea. Banks create money by lending their excess reserves, and the chain of loans has a ceiling.
  • What money is. Money is any asset people generally accept in payment, and it does three jobs: a medium of exchange, a store of value, and a unit of account. Wealth is everything owned minus everything owed; a house is wealth but not money. Income is a flow; the money you hold is a stock.
  • Measuring it. The money supply (M) is measured as M1, currency plus the deposits people can spend most directly, and M2, M1 plus near-money such as small time deposits. The monetary base is currency plus bank reserves, the narrower total the central bank controls directly.
  • Fractional-reserve banking. A bank keeps the required reserves, the required reserve ratio RR times the deposit, and lends its excess reserves. The loan becomes someone else's deposit. In the pinned chain, a 1,000-dollar deposit at RR = 0.10 lends 900, then 810, then 729.
  • The ceiling. The money multiplier is 1 ÷ RR, the most one dollar of new reserves can become in deposits. With the pinned base of 105 and RR = 0.10, M = 10 × 105 = 1,050 dollars. It is an upper bound, not a forecast: excess reserves that banks keep, cash held outside banks, and the ample-reserves system now in use make real expansion far smaller than this classroom model.
  • Predictable mistakes → cures. Lending the required reserves: the bank keeps those and lends the excess. Putting the spending multiplier where 1 ÷ RR belongs. Reading 1 ÷ RR as a prediction: it is a ceiling. Treating money and wealth as one thing, or the monetary base and the money supply as one thing.
  • Deeper review: the Week 9 chapter, the deposit-chain table, and the bank-ledger slides.

Unit 7 — The central bank and the money market (Week 10)

  • Key idea. The central bank moves the money supply, and the money market turns that into an interest rate.
  • Who and why. A central bank runs a country's monetary policy; the Federal Reserve, or the Fed, is the United States' central bank. Its dual mandate is maximum employment and stable prices, watched through the unemployment rate and the inflation rate from Week 3. Monetary policy is set by the central bank, not the legislature.
  • The tools and their directions. Open-market operations: buying bonds adds reserves and raises the money supply; selling drains them and lowers it. A lower discount rate makes reserves cheaper to borrow and tends to raise the money supply. A higher reserve requirement shrinks the money multiplier and lowers the money supply. Raising interest on reserve balances makes holding reserves more attractive than lending and pushes rates up.
  • The money market. Money demand (M_d) slopes down in the interest rate; the money supply (M_s) is a vertical line at the quantity the central bank sets. They cross at the equilibrium interest rate. In the pinned market, 1,200 − 25r = 1,050 gives r = 6%. A change in the interest rate is a movement along money demand; only income or the price level shifts it.
  • Predictable mistakes → cures. "Buying bonds is spending, so it is fiscal": the central bank trades bonds for reserves, which is monetary. Reading "buying" as tightening: buying raises the money supply and lowers the rate. Reading a higher reserve requirement as letting banks lend more. Drawing a rate change as a shift of money demand.
  • Deeper review: the Week 10 chapter, the tools-and-effects table, and the money-market slides.

Unit 8 — Monetary policy reaches aggregate demand (Week 11)

  • Key idea. Five links, said in order, carry a central-bank move to output and prices.
  • The transmission mechanism. The money supply moves the interest rate, which moves interest-sensitive spending such as investment, which the spending multiplier scales into a shift of aggregate demand, which moves P and Y together. The pinned chain: the rate falls from 6% to 4%, investment rises 2 × 20 = 40, and output rises 5 × 40 = 200 billion dollars at the old price level.
  • Both directions. Expansionary monetary policy buys bonds: money supply up, rate down, investment up, AD right, P and Y up. Contractionary monetary policy is the same chain with every arrow reversed.
  • Real-world complications. The inside lag is the time to recognize a problem and decide; the outside lag is the time for a decision to reach spending and output. Expectations matter too: firms that expect weak sales may not borrow even at a lower rate.
  • The debate, both sides at full strength. The Keynesian case for fine-tuning: idle workers and machines in a gap are a real loss, and a central bank that leans against the gap can shorten it. The monetarist case: policy works with long and variable lags, so a move made now can land after the economy has turned, and a predictable policy rule steadies expectations. Which risk weighs more is a normative judgment; the course gives no verdict.
  • Predictable mistakes → cures. Flipping only the last arrow for the contractionary case: every link reverses. Skipping the investment link ("rates fell, so GDP rose"). Using the money multiplier where the spending multiplier belongs. "The central bank sets the market rate by decree": it sets the quantity of reserves and what it pays banks to hold them, and the market rate follows.
  • Deeper review: the Week 11 chapter and the transmission-chain slides.

Unit 9 — Inflation, the Phillips curve, and the quantity equation (Week 12)

  • Key idea. There is a short-run trade-off between inflation and unemployment, but it fades once people expect the inflation.
  • The short run. The short-run Phillips curve slopes down, with unemployment on the horizontal axis and inflation on the vertical. Along one curve, lower unemployment comes with higher inflation. The pinned points are (u = 4%, π = 6%) and (u = 6%, π = 2%).
  • The long run. The natural rate of unemployment (u*) is the frictional plus structural rate, with no cyclical unemployment; the pinned value is 5%. The long-run Phillips curve is vertical at u*. A rise in expected inflation shifts the short-run curve up, so holding unemployment below u* buys higher inflation and, once expectations catch up, the same unemployment.
  • Money and prices. The quantity equation is M × V = P × Q, with velocity V the number of times a dollar is spent on final output in a year. With V and Q fixed, a given percentage rise in M is the same percentage rise in P: the pinned 500 → 550 raises P from 2 to 2.2. That is long-run neutrality of money. Inflation is approximately money growth minus output growth, an approximation that holds when velocity is stable.
  • Predictable mistakes → cures. Treating the short-run trade-off as a permanent menu. Giving the long-run curve a slope: it is vertical. "MV = PQ says money does not matter": it says money is neutral for real output in the long run. Stating the trade-off backwards: lower unemployment pairs with higher inflation.
  • Deeper review: the Week 12 chapter, the Phillips-curve slides, and the quantity-equation table.

Unit 10 — Trade and comparative advantage (Week 13)

  • Key idea. Each side should make what it gives up least to make, even when one side is better at everything.
  • Two advantages. Absolute advantage is producing more of a good from the same resources, such as more per worker-day. Comparative advantage is producing a good at a lower opportunity cost, measured in the other good given up. Opportunity cost of good A = units of good B given up ÷ units of good A gained.
  • The terms of trade. The terms of trade must sit in the mutually beneficial range, between the two partners' opportunity costs. The pinned case runs from 2 to 3 wheat per cloth, at 2.5. With specialization and trade inside that range, both partners can end with more of both goods, the gains from trade.
  • The trade balance. The trade balance is exports minus imports, the same as NX. A trade deficit says imports exceeded exports; by itself it is not a loss of national income.
  • Both sides on trade policy. A tariff is a tax on imports. The case for freer trade: specialization raises total output, lowers prices, and widens choice. The case for protection: the gains are spread thin while the losses land hard on particular industries, regions, and workers, and some argue for protection on strategic grounds. That specialization raises total output is positive; how to weigh who bears the losses is normative.
  • Predictable mistakes → cures. Giving comparative advantage to whoever has the absolute advantage. Inverting a ratio: cloth in wheat is not wheat in cloth. Accepting terms outside the range as a gain. Reading a trade deficit as lost income.
  • Deeper review: the Week 13 chapter and the before-and-after trade table.

Unit 11 — Exchange rates and the balance of payments (Week 14)

  • Key idea. A stronger dollar makes exports dearer abroad and imports cheaper at home, and the two halves of the balance of payments mirror each other.
  • Exchange rates. The exchange rate is written as the foreign currency one dollar buys, so 1 dollar = 120 yen. Appreciation means a dollar buys more foreign currency; depreciation means it buys less. The pinned chain: from 100 to 120 yen, a 25,000-dollar car goes from 2,500,000 to 3,000,000 yen abroad, and a 1,200,000-yen machine goes from 12,000 to 10,000 dollars at home.
  • The price chain. After an appreciation, exports tend to fall, imports tend to rise, and net exports fall, shifting AD left. A depreciation reverses every arrow. Under a floating exchange rate the market sets the rate; a fixed exchange rate is held by a government or central bank buying or selling currency.
  • The foreign-exchange market. Buyers of a country's exports and assets demand its currency; its buyers of imports and foreign assets supply it.
  • The balance of payments. The current account records trade in goods and services plus income and transfer flows; the financial account records cross-border purchases of assets. At the principles level CA + FA = 0, an accounting identity that records what happened and passes no judgment. The pinned case: CA = −50 is matched by FA = +50.
  • Predictable mistakes → cures. "The dollar went from 100 to 120 yen, so it weakened": it buys more yen, so it appreciated. Calling appreciation good for exporters. Assuming a government sets a floating rate by decree. Reading a current-account deficit as money that disappears: it returns as financial-account inflows.
  • Deeper review: the Week 14 chapter and the exchange-rate chain slides.

Unit 12 — Schools of thought and the debates (Week 15)

  • Key idea. Two traditions read one shared toolkit differently, and they agree on more than the headlines suggest.
  • The Keynesian tradition, at full strength. It stresses sticky prices and wages and aggregate demand as the driver of short-run swings. An economy can stay stuck in a gap for a long time, so activist policy can help close it, and its preferred lever in a deep slump is fiscal policy. The risk it names is a prolonged gap: idle workers, lost output, and skills that fade.
  • The classical and monetarist tradition, at full strength. It stresses flexible prices and wages in the long run, with potential output as the anchor, so a gap tends to correct itself. Monetary policy works with long and variable lags, so it favors steady, predictable rules. The risks it names are lags and crowding out, and it worries that a rising debt leaves a larger burden for future taxpayers.
  • The agreed ground, stated plainly. The long-run Phillips curve is vertical. Sustained inflation is in the long run a monetary matter. The short run and the long run behave differently. These are positive results, not a debate.
  • Shared arithmetic. The deficit-to-GDP ratio is one year's deficit ÷ GDP × 100; the debt-to-GDP ratio is the debt at a point in time ÷ GDP × 100. The pinned budget gives 50 ÷ 1,250 × 100 = 4% and 1,000 ÷ 1,250 × 100 = 80%. Under inflation targeting, a central bank announces a numerical goal for inflation and sets its tools to stay near it.
  • Predictable mistakes → cures. Declaring one school right and the other outdated. Treating sticky against flexible prices as a political stance: it is an empirical question evidence can test. Confusing rules against discretion with fiscal against monetary: both kinds of policy can follow a rule. Putting the debt where the deficit belongs in a ratio.
  • Deeper review: the Week 15 chapter and the two-column schools table.

Representative practice

These are fresh variants, not the exam's questions. Every dataset here is illustrative, constructed for this guide. Work each one, then check it.

Worked example 1 — an island's frontier and a free afternoon (Unit 1)

An illustrative island has 60 million labor-hours a year. One unit of consumer goods (x) takes 5 hours, and one unit of capital goods (y) takes 15 hours.

  1. Endpoints: 60 ÷ 5 = 12, the point (12, 0); 60 ÷ 15 = 4, the point (0, 4). The frontier is 5x + 15y = 60.
  2. Opportunity cost: giving up 12 consumer goods buys 4 capital goods, so one capital good costs 12 ÷ 4 = 3 consumer goods.
  3. On the frontier: (6, 2) needs 5 × 6 + 15 × 2 = 30 + 30 = 60 hours, all of them, so it is efficient.
  4. Inside: (3, 2) needs 5 × 3 + 15 × 2 = 15 + 30 = 45 hours, so 60 − 45 = 15 million labor-hours sit idle.
  5. Outside: (9, 3) needs 5 × 9 + 15 × 3 = 45 + 45 = 90 hours, which is 90 − 60 = 30 million more than the island has.
  6. At personal scale: a student skips a 3-hour shift paying 20 dollars an hour to join a free community clean-up, so the opportunity cost is 3 × 20 = 60 dollars of pay given up.

Why it matters: the slope of the frontier and the cost of an afternoon are the same idea, the best alternative given up.

Worked example 2 — measuring an illustrative economy (Unit 2)

  1. GDP: an account shows C = 480, I = 130, G = 190, X = 70, and IM = 100, in billions of dollars. NX = 70 − 100 = −30, so GDP = 480 + 130 + 190 − 30 = 770 billion dollars.
  2. Deflator: the same output at base-year prices is 700, so (770 ÷ 700) × 100 = 110. Prices sit 10 percent above the base year.
  3. A grocery basket: a family's basket costs 50 dollars in the base year, 55 in year 2, and 57.75 in year 3. The CPI is (55 ÷ 50) × 100 = 110 in year 2 and (57.75 ÷ 50) × 100 = 115.5 in year 3.
  4. The rate, not the gap: from year 2 to year 3, (115.5 − 110) ÷ 110 × 100 = 5.5 ÷ 110 × 100 = 5%. The 5.5 is index points, not the inflation rate.
  5. A paycheck: a 6% raise in year 3 against that 5% inflation is a real wage change of about 6% − 5% = 1%.
  6. A mountain town's jobs: 8,000 adults, 5,700 employed, and 300 unemployed. The labor force is 5,700 + 300 = 6,000, so the unemployment rate is 300 ÷ 6,000 × 100 = 5% and the participation rate is 6,000 ÷ 8,000 × 100 = 75%. The other 8,000 − 6,000 = 2,000 adults sit outside the labor force.

Why it matters: the deflator strips prices out of output, and the inflation rate divides by the old level, never the base.

Worked example 3 — a coastal city grows (Unit 3)

  1. Growth rate: real output rises from 1,200 to 1,242 billion dollars. The change is 1,242 − 1,200 = 42, and 42 ÷ 1,200 × 100 = 3.5%.
  2. Wrong base: 42 ÷ 1,242 × 100 ≈ 3.38% divides by the new value and understates growth.
  3. Doubling: by the rule of 70, 70 ÷ 3.5 = 20 years for output to double, an approximation.
  4. Per person: the population grows 1.5% a year, so per-capita growth is about 3.5% − 1.5% = 2%, and output per person doubles in about 70 ÷ 2 = 35 years.
  5. Productivity: a food truck's 4 workers make 360 meals a day, 360 ÷ 4 = 90 each. A new grill lifts output to 396 meals, 396 ÷ 4 = 99 each, a rise of (99 − 90) ÷ 90 × 100 = 10%.

Why it matters: living standards follow output per person, and the denominator is always the starting value.

Worked example 4 — a slump, the gap, and the fiscal lever (Units 4 and 5)

In an illustrative economy, the aggregate demand line is P = 35 − Y⁄100 and the short-run aggregate supply line is P = 5 + Y⁄100, with Y in billions of dollars of real output. Potential output is 1,500.

  1. Starting crossing: 35 − Y⁄100 = 5 + Y⁄100, so 30 = 2Y⁄100 and Y = 30 × 100 ÷ 2 = 1,500. P = 35 − 15 = 20, checked on SRAS as 5 + 15 = 20.
  2. A movement along: on the starting AD line at P = 21, buyers want (35 − 21) × 100 = 1,400. Only the price level changed, so the curve did not move.
  3. Households grow pessimistic: AD shifts left to P = 32 − Y⁄100. Then 27 = 2Y⁄100, so Y = 1,350, and P = 32 − 13.5 = 18.5. Both fell, together.
  4. The gap: 1,500 − 1,350 = 150 billion dollars, a recessionary gap, and 150 ÷ 1,500 × 100 = 10% of potential.
  5. The lever: with an MPC of 0.6, the spending multiplier is 1 ÷ (1 − 0.6) = 1 ÷ 0.4 = 2.5, so closing the gap takes 150 ÷ 2.5 = 60 billion dollars of new spending in the simple model.
  6. The tax route: the tax multiplier is −0.6 ÷ 0.4 = −1.5, so the same gap needs a tax cut of 150 ÷ 1.5 = 100 billion dollars.
  7. The wrong multiplier: a money multiplier of 10 would claim 150 ÷ 10 = 15, a banking number on a fiscal question.
  8. A separate budget: in a different illustrative economy, not the one above, a government collects 300 and spends 330, so the deficit is 330 − 300 = 30 for the year. A debt of 900 becomes 900 + 30 = 930. On that economy's GDP of 1,500, the deficit ratio is 30 ÷ 1,500 × 100 = 2%, and the debt ratio rises from 900 ÷ 1,500 × 100 = 60% to 930 ÷ 1,500 × 100 = 62%.

Why it matters: an AD shift moves P and Y together, and the fiscal multiplier, never the money multiplier, sizes the lever.

Worked example 5 — a credit union's chain (Unit 6)

A credit union faces an illustrative required reserve ratio of 0.25. A member deposits 2,000 dollars.

  1. First round: required reserves 0.25 × 2,000 = 500; the loan is 2,000 − 500 = 1,500.
  2. Second round: the 1,500 is deposited elsewhere, which keeps 0.25 × 1,500 = 375 and lends 1,500 − 375 = 1,125.
  3. So far: deposits total 2,000 + 1,500 + 1,125 = 4,625, and the chain keeps going.
  4. The ceiling: 1 ÷ 0.25 = 4, so the whole chain reaches at most 2,000 × 4 = 8,000 dollars of deposits.
  5. The system: a monetary base of 250 supports at most 4 × 250 = 1,000 dollars of money.
  6. Wrong multiplier: a spending multiplier of 5 would claim 5 × 2,000 = 10,000, more than the ceiling of 8,000.
  7. Banks hold extra: if banks keep another 0.25 as excess reserves, 0.25 + 0.25 = 0.5, the multiplier falls to 1 ÷ 0.5 = 2, and the base supports at most 2 × 250 = 500.

Why it matters: banks lend the excess, and 1 ÷ RR is a ceiling, reached only if every bank lends every excess dollar.

Worked example 6 — the same banks in a money market (Unit 7)

Money demand is M_d = 2,000 − 60r, with r in percent, and RR stays at 0.25.

  1. Start: a monetary base of 425 gives M_s = 4 × 425 = 1,700. Set 2,000 − 60r = 1,700, so 60r = 300 and r = 5%.
  2. Open-market purchase: the base rises to 455, so M_s = 4 × 455 = 1,820. Then 60r = 2,000 − 1,820 = 180, and r = 3%. Buying bonds lowered the rate.
  3. Open-market sale: the base falls to 395, so M_s = 4 × 395 = 1,580. Then 60r = 420, and r = 7%.
  4. A shift of demand: if the price level rises, people need more money for the same shopping, so money demand shifts right and the rate rises with the supply line unchanged.

Why it matters: the central bank moves the vertical line; the price level and income move the demand curve.

Worked example 7 — carrying the move to output (Unit 8)

Continue Worked example 6. Take the illustrative rule that investment rises 30 billion dollars for each whole percent the interest rate falls, and let the MPC be 0.8.

  1. The rate: the purchase moved r from 5% to 3%, a fall of 5 − 3 = 2.
  2. Investment: ΔI = 30 × 2 = 60 billion dollars.
  3. The multiplier: 1 ÷ (1 − 0.8) = 5, so ΔY = 5 × 60 = 300 billion dollars at the old price level. AD shifts right, and P and Y both rise.
  4. The wrong multiplier: the money multiplier of 4 would give 4 × 60 = 240, a banking number on a spending question.
  5. The mirror: the sale moved r from 5% to 7%, so ΔI = −30 × 2 = −60 and ΔY = 5 × (−60) = −300. AD shifts left, and P and Y both fall. Every arrow flipped.

Why it matters: every link is said in order, and each multiplier stays in its own lane.

Worked example 8 — a trade-off that fades, and money that shows up in prices (Unit 9)

  1. A pair of readings on one curve: on an illustrative short-run Phillips curve, unemployment of 3% comes with inflation of 9%, and unemployment of 7% comes with inflation of 1%. As unemployment falls from 7% to 3%, inflation rises from 1% to 9%.
  2. Slope: (1 − 9) ÷ (7 − 3) = −8 ÷ 4 = −2, so inflation rises by 2 for each 1 that unemployment falls along this curve.
  3. The natural rate: this economy's u* is set midway, (3 + 7) ÷ 2 = 5%.
  4. Expectations catch up: policy holds unemployment at 3% with 9% inflation. Once 9% is expected, the short-run curve shifts up and the economy settles at (u = 5%, π = 9%): back at the natural rate with the higher inflation.
  5. The quantity equation: M = 250, V = 6, and Q = 500, so P = (250 × 6) ÷ 500 = 1,500 ÷ 500 = 3.
  6. More money: M rises 10% to 250 × 1.10 = 275. With V and Q fixed, P = (275 × 6) ÷ 500 = 1,650 ÷ 500 = 3.3, a rise of (3.3 − 3) ÷ 3 × 100 = 10%, and real output is still 500.
  7. The growth form: money growth of 6% and output growth of 4% give inflation of about 6% − 4% = 2%, an approximation that holds when velocity is stable.

Why it matters: the short-run trade-off is real, and the long run returns unemployment to u* whatever the inflation rate.

Worked example 9 — two regions trade rugs and fruit (Unit 10)

Per worker-day, illustrative Upland makes 12 crates of fruit or 4 rugs, and illustrative Lowland makes 10 crates or 2 rugs. Each has 10 worker-days.

  1. Absolute advantage: 12 is more than 10 crates and 4 is more than 2 rugs, so Upland leads in both goods; the absolute advantage in each is Upland's.
  2. Cost of a rug: Upland gives up 12 ÷ 4 = 3 crates; Lowland gives up 10 ÷ 2 = 5 crates. Upland has the comparative advantage in rugs.
  3. Cost of a crate: Upland gives up 4 ÷ 12 = 1⁄3 of a rug; Lowland gives up 2 ÷ 10 = 1⁄5 of a rug. Lowland has the comparative advantage in fruit.
  4. The range: terms of trade between 3 and 5 crates per rug help both; take 4 crates per rug.
  5. Before trade: Upland spends 2 days on fruit and 8 on rugs, 2 × 12 = 24 crates and 8 × 4 = 32 rugs. Lowland spends 7 and 3, 7 × 10 = 70 crates and 3 × 2 = 6 rugs.
  6. Specialize and trade: Upland makes 10 × 4 = 40 rugs; Lowland makes 10 × 10 = 100 crates. Upland sends 7 rugs for 7 × 4 = 28 crates.
  7. After trade: Upland has 28 crates and 40 − 7 = 33 rugs, up from 24 and 32. Lowland has 100 − 28 = 72 crates and 7 rugs, up from 70 and 6. World output rises from 24 + 70 = 94 crates and 32 + 6 = 38 rugs to 100 crates and 40 rugs.
  8. A trade balance: a country that exports 140 and imports 125, in billions of dollars, has NX = 140 − 125 = 15, a trade surplus.

Why it matters: the side that is better at everything still gains by making what it gives up least to make.

Worked example 10 — a stronger dollar, a boat, and a machine (Unit 11)

  1. The move: the dollar goes from 1 dollar = 80 yen to 1 dollar = 100 yen. It buys more yen, so it appreciated by (100 − 80) ÷ 80 × 100 = 25%.
  2. An export: a 20,000-dollar boat costs 20,000 × 80 = 1,600,000 yen before and 20,000 × 100 = 2,000,000 yen after, so it is dearer abroad and exports tend to fall.
  3. An import: a 900,000-yen machine costs 900,000 ÷ 80 = 11,250 dollars before and 900,000 ÷ 100 = 9,000 dollars after, so it is cheaper at home and imports tend to rise.
  4. The chain: exports down and imports up, so NX falls, and all else equal AD shifts left.
  5. The books: if the trade surplus from Worked example 9 is the whole current account, it is a current-account balance of CA = +15, matched by FA = −15, so CA + FA = 15 − 15 = 0.

Why it matters: multiply a dollar price by the yen per dollar, divide a yen price by it, and the two accounts always mirror.

Worked example 11 — one policy question, both columns (Unit 12)

A legislature in an illustrative economy debates borrowing to close a recessionary gap of 150 billion dollars, like the one in Worked example 4. Label each claim before you weigh it.

  1. "In the simple model, 60 billion dollars of new spending, scaled by 2.5, adds 150 billion dollars of output." Positive: 2.5 × 60 = 150 can be checked.
  2. "In the separate budget from Worked example 4, a deficit of 30 lifts the debt from 60% to 62% of GDP." Positive: it is arithmetic both schools accept.
  3. "A recovery that reaches every region matters more than a lower debt." Normative: it weighs one goal against another.
  4. "Spending cuts are the fairer way to balance the books." Normative: it rests on a value judgment about fairness.
  5. The Keynesian reading: prices and wages are sticky, the gap could last, and a deficit in a slump is a tool whose ratio can fall again as output recovers.
  6. The classical and monetarist reading: prices and wages catch up in time, lags may land the stimulus late, and borrowing can crowd out private investment.

Why it matters: the arithmetic is shared; the disagreement is about how fast prices move and how to weigh the risks.

Self-check questions

  1. A council member says, "Bus fares ought to be free." Positive or normative? Self-check: normative. Why: it says what ought to be, so evidence alone cannot settle it.
  2. A new house is built this year and sold to a family. Which GDP component is it? Self-check: investment. Why: new residential construction counts in I, not in C.
  3. Your pay rises 3% in a year when inflation is 3%. What happened to your real wage? Self-check: about no change. Why: the real change is about 3% − 3% = 0%.
  4. Why does 70 ÷ the growth rate only approximate the doubling time? Self-check: 70 is a rounded constant. Why: it stands in for 100 × ln 2 ≈ 69.3, close for the small rates economies usually grow at.
  5. Households' savings jump in value, and they spend more at every price level. Which curve shifts, and what happens? Self-check: aggregate demand shifts right, and P and Y both rise. Why: something other than the price level changed, so the whole curve moves.
  6. Why is a gap reported as a percentage of potential? Self-check: so the size means something. Why: a gap of 50 is large for a small economy and small for a big one.
  7. A headline says the debt fell this year because the deficit shrank. What is wrong? Self-check: a smaller deficit still adds to the debt. Why: the debt is a stock that every year's deficit, a flow, adds to; only a surplus lowers it.
  8. A bank lends out its required reserves. What is wrong? Self-check: it has the split backwards. Why: a bank keeps the required reserves and lends the excess.
  9. On the money-market diagram, which line is vertical, and why? Self-check: the money supply. Why: the central bank's tools set its quantity, whatever the interest rate.
  10. Why can a rate cut do less than the engineered rule predicts? Self-check: expectations and lags. Why: firms that expect weak sales may not borrow, and the outside lag delays the effect.
  11. Can policy hold unemployment below the natural rate forever? Self-check: no. Why: once people expect the higher inflation, unemployment returns to u*, and the long-run curve is vertical.
  12. Is "a deficit adds to the debt" a Keynesian claim or a classical one? Self-check: neither. Why: it is arithmetic that both schools accept; they differ on how much the rising ratio should worry you.

Check yourself — choose one. (a) Which unit in this guide felt least familiar, and which worked example would you redo first? (b) Pick one early habit, such as real against nominal or a movement along against a shift, and explain in two sentences how it changes the way you read one Weeks 9–15 topic. Either choice is a good use of ten minutes.

Study plan

A short countdown. Count backward from the day the final opens in Week 16.

  • Two weeks out: review Units 1–5 in one sitting and redo Worked examples 1 through 4 from scratch. These ideas return inside later questions.
  • Ten days out: review Units 6, 7, and 8. Redo Worked examples 5, 6, and 7 until each step comes with its reason. Money, banking, and monetary policy carry 14 of the 40 questions.
  • One week out: review Units 9 and 12. Redo Worked examples 8 and 11 without looking, labelling every claim positive or normative.
  • Five days out: take the paired practice exam once, closed-book and under exam-like conditions, then sort every miss by week. Remember that it leans on Weeks 1–7 far more than the final does.
  • Four days out: review Units 10 and 11 and redo Worked examples 9 and 10. Weeks 14 and 15 carry 13 questions between them.
  • Three days out: run the paired exam-prep tutorial (the copy-and-paste chatbot tutor, or its no-AI route) on the two units that felt weakest, with at least one from Units 6–12.
  • Two days out: answer the twelve self-check questions cold, then retake the practice exam.
  • The day before: skim the "Predictable mistakes → cures" lines in every unit and watch one video from the list below. Sleep.

Use the exam-prep tutorial and the practice exam for active recall; this guide is for review, and those two are where you rehearse. Rereading alone does less for you than retrieval practice does.

Watch before the exam

These videos come from the course's own weekly readings. Use them to retrieve what you already learned and to connect weeks, not for new material.

Exam format and scoring

The final is scored automatically, and all 40 questions count the same. The questions appear one at a time, and you cannot go back to an earlier question once you move on. You have one attempt and no time limit. AI tools are not permitted on the final.

Test-taking strategies for this material:

  • For any curve, decide first whether the price level or the interest rate moved (a movement along) or something else did (a shift). Then name the curve, the direction, and where P and Y, or r, land.
  • Before you use a multiplier, name the one the question needs: 1 ÷ RR scales reserves into money; 1 ÷ (1 − MPC) scales spending into output.
  • For any rate, divide by the starting value: growth, inflation, and appreciation all use the old number.
  • For a chain, say every link in order, and for the contractionary case reverse every arrow, not only the last one.
  • For an exchange-rate price, multiply a dollar price by the yen per dollar, and divide a yen price by it.
  • For a ratio, check whether the top is a flow or a stock: the deficit ratio uses one year's deficit, and the debt ratio uses the debt.
  • For a policy claim, label it positive or normative before you judge it.
  • Since you cannot go back, settle each question before you move on.

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