Macroeconomics Exam #1 Review – Step-by-Step Study Guidance

Q1. Two countries (A and B) can each produce only two goods: widgets and gadgets. Country A can produce 1000 widgets or 1000 gadgets per day if it devotes all resources to one good. Country B can produce 200 widgets or 600 gadgets per day if it devotes all resources to one good.

Background

Topic: Production Possibilities Frontier (PPF), Opportunity Cost, Comparative and Absolute Advantage

This question tests your understanding of the PPF, how to calculate opportunity costs, and how to determine comparative and absolute advantage between two countries.

Key Terms and Formulas:

• Production Possibilities Frontier (PPF): A curve showing the maximum combinations of two goods that can be produced with available resources and technology.

• Opportunity Cost: The value of the next best alternative forgone when making a choice.

• Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer.

• Absolute Advantage: The ability to produce more of a good with the same resources than another producer.

Step-by-Step Guidance

1. Draw the PPF for each country: For Country A, plot the endpoints (1000 widgets, 0 gadgets) and (0 widgets, 1000 gadgets). For Country B, plot (200 widgets, 0 gadgets) and (0 widgets, 600 gadgets). Connect the points with a straight line for each country.

2. Calculate the opportunity cost of producing widgets for each country: For each country, determine how many gadgets must be given up to produce one more widget. Use the formula:

   $\text{Opportunity Cost of 1 Widget} = \frac{\text{Maximum Gadgets}}{\text{Maximum Widgets}}$

3. Calculate the opportunity cost of producing gadgets for each country: For each country, determine how many widgets must be given up to produce one more gadget. Use the formula:

   $\text{Opportunity Cost of 1 Gadget} = \frac{\text{Maximum Widgets}}{\text{Maximum Gadgets}}$

4. Determine comparative advantage: Compare the opportunity costs for each good between the two countries. The country with the lower opportunity cost for a good has the comparative advantage in that good.

5. Determine absolute advantage: Compare the maximum outputs for each good. The country that can produce more of a good with the same resources has the absolute advantage in that good.

Try solving on your own before revealing the answer!

Final Answers:

B. Country A forgoes 1 gadget per widget; Country B forgoes 3 gadgets per widget.

C. Country A forgoes 1 widget per gadget; Country B forgoes 1/3 of a widget per gadget.

D. Country B has the comparative advantage in gadget production (lower opportunity cost); Country A has the comparative advantage in widget production.

E. Country A has the absolute advantage in both widgets and gadgets, as it can produce more of both goods with the same resources.

Q2. Use the following table to answer the questions below:

Year	Price Spinach	Quantity Spinach	Price Gasoline	Quantity Gasoline
2020	$3	1,000	$2	900
2021	$4	1,100	$3	800
2022	$5	1,300	$4	500

• A. Calculate Nominal GDP for each year

• B. Calculate Real GDP for each year using 2020 as the base year

• C. Calculate the GDP deflator for each year using 2020 as the base year

• D. Using the GDP deflator, what is the change in the price level from 2020-2021?

Background

Topic: GDP Measurement, Price Indices, Inflation

This question tests your ability to calculate nominal and real GDP, GDP deflator, and interpret changes in the price level.

Key Terms and Formulas:

• 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 within a country in a given year, measured using base year prices.

• GDP Deflator: A measure of the price level, calculated as:

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

Step-by-Step Guidance

1. Calculate Nominal GDP for each year: For each year, multiply the price and quantity for each good, then sum the totals:

   $\text{Nominal GDP} = (\text{Price of Spinach} \times \text{Quantity of Spinach}) + (\text{Price of Gasoline} \times \text{Quantity of Gasoline})$

2. Calculate Real GDP for each year (using 2020 as the base year): For each year, use the base year prices but the current year quantities:

   $\text{Real GDP} = (\text{Base Year Price of Spinach} \times \text{Current Year Quantity of Spinach}) + (\text{Base Year Price of Gasoline} \times \text{Current Year Quantity of Gasoline})$

3. Calculate the GDP deflator for each year: Use the formula:

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

4. Calculate the percentage change in the price level from 2020 to 2021: Use the GDP deflator values for 2020 and 2021:

   $\text{Percentage Change} = \frac{\text{GDP Deflator}_{2021} - \text{GDP Deflator}_{2020}}{\text{GDP Deflator}_{2020}} \times 100$

Try solving on your own before revealing the answer!

Final Answers:

A. 2020 = $4800; 2021 = $6800; 2022 = $8500

B. 2020 = $4800; 2021 = $4900; 2022 = $4900

C. 2020 = 100; 2021 = 138.78; 2022 = 173.47

D. Price change from 2020-2021 = 38.78%

Multiple Choice Questions (Selected Examples)

Q1. Using table 1, what is the equilibrium price of soybean?

Background

Topic: Market Equilibrium

This question tests your ability to identify the equilibrium price where quantity demanded equals quantity supplied.

Key Terms and Formulas:

• Equilibrium Price: The price at which the quantity demanded equals the quantity supplied.

Step-by-Step Guidance

1. Look at Table 1 and find the price where the quantity demanded equals the quantity supplied.

2. Compare the values for each price level to see where the two quantities match.

Try solving on your own before revealing the answer!

Final Answer: $10 per bushel

At $10, quantity demanded and supplied are both 20,000 bushels.

Q2. Using table 1, what is the equilibrium quantity of soybean bushels?

Background

Topic: Market Equilibrium

This question tests your ability to identify the equilibrium quantity where the market clears.

Key Terms and Formulas:

• Equilibrium Quantity: The quantity bought and sold at the equilibrium price.

Step-by-Step Guidance

1. From Table 1, find the price where quantity demanded equals quantity supplied.

2. Read off the quantity at that price.

Try solving on your own before revealing the answer!

Final Answer: 20,000 bushels

At the equilibrium price, the equilibrium quantity is 20,000 bushels.

Q3. Using table 1, if the price in the marketplace was $4 what would you be observing in the marketplace?

Background

Topic: Surplus and Shortage

This question tests your understanding of market disequilibrium—specifically, what happens when price is below equilibrium.

Key Terms and Formulas:

• Shortage: Occurs when quantity demanded exceeds quantity supplied at a given price.

• Surplus: Occurs when quantity supplied exceeds quantity demanded at a given price.

Step-by-Step Guidance

1. At $4, compare the quantity demanded and quantity supplied from Table 1.

2. Determine if there is a surplus or shortage by seeing which is greater.

Try solving on your own before revealing the answer!

Final Answer: Shortage

At $4, quantity demanded is much greater than quantity supplied, indicating a shortage.