Macroeconomics Exam 1 Practice Questions: Demand, GDP, and Unemployment

Demand, Supply, and Equilibrium

Impact of External Shocks on Markets

Understanding how external events affect supply and demand is crucial in macroeconomics. The outbreak of hoof-and-mouth disease in Europe led to the destruction of millions of cattle, which impacts several related markets.

• Supply of Cattle Hides: The supply decreases due to the loss of cattle, shifting the supply curve to the left.

• Price of Leather Goods: With fewer hides available, the price of leather increases due to scarcity.

• Demand and Equilibrium: Higher prices may reduce the quantity demanded for leather goods, leading to a new equilibrium price and quantity.

• Diagram: A standard supply and demand diagram can illustrate the leftward shift in supply and the resulting increase in equilibrium price and decrease in equilibrium quantity.

Example: If the supply of hides falls, the price of leather shoes rises, and fewer shoes are sold.

Additional info: External shocks can have ripple effects across related industries, affecting employment, production, and consumer welfare.

GDP

Measuring GDP and Economic Well-being

Gross Domestic Product (GDP) is a key indicator of a country's economic activity. It can be measured in nominal terms (using current prices) or real terms (adjusted for inflation).

• Nominal GDP: The value of all final goods and services produced within a country in a given year, measured using current prices.

• Real GDP: The value of all final goods and services produced, adjusted for changes in price level (inflation or deflation).

• GDP Deflator: A measure of the price level, calculated as the ratio of nominal GDP to real GDP, multiplied by 100.

Formulas:

• Nominal GDP: $\text{Nominal GDP} = \sum (\text{Price}_t \times \text{Quantity}_t)$

• Real GDP (using base year prices): $\text{Real GDP} = \sum (\text{Price}_{\text{base year}} \times \text{Quantity}_t)$

• GDP Deflator: $\text{GDP Deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$

Example: Using the provided data for the land of milk and honey:

Year	Price of Milk	Quantity of Milk	Price of Honey	Quantity of Honey
2016	$1	100 quarts	$2	50 quarts
2017	$1	200 quarts	$2	100 quarts
2018	$2	200 quarts	$4	100 quarts

• To compute nominal GDP for each year, multiply price and quantity for each good and sum.

• To compute real GDP, use 2016 prices for all years.

• GDP Deflator shows how much prices have changed relative to the base year.

• Percentage change in GDP can be calculated as: $\frac{\text{GDP}_{t} - \text{GDP}_{t-1}}{\text{GDP}_{t-1}} \times 100$

Additional info: Economic well-being is better reflected by real GDP, as it accounts for changes in price level and purchasing power.

Unemployment

Understanding Unemployment and Labor Force Participation

Unemployment measures the share of the labor force that is without work but actively seeking employment. Changes in employment status affect the unemployment rate and labor force participation.

• Unemployment Rate: The percentage of the labor force that is unemployed.

• Labor Force: Includes all people who are either employed or actively seeking work.

• Not in Labor Force: People who are retired, students, or otherwise not seeking work.

Examples:

• If Tyrion loses his job but continues to look for work, the unemployment rate increases.

• If Jon finds a job after searching, the unemployment rate decreases.

• If Arya retires and stops looking for work, she leaves the labor force, which may decrease both the labor force and the unemployment rate.

• If Jaime starts looking for a job after becoming an adult, he enters the labor force, potentially increasing the unemployment rate if he does not find a job immediately.

• If Cersei dies in retirement, there is no effect on the unemployment rate or labor force.

Additional info: The unemployment rate does not capture discouraged workers who stop looking for work, nor does it reflect underemployment.