Free Principles of Macroeconomics CLEP Practice Test

The cost to produce the first 100,000 hamburgers is 1000 computers (move from point A to Point B)

The cost to produce the next 100,000 hamburgers is 2000 computers (move from point B to point C)

The cost to produce the next 100,000 hamburgers is 3000 computers (move from point C to point D)

The cost to produce the next 100,000 hamburgers is 4000 computers (move from point D to point E)

As we move down the curve, the cost of producing one more unit of product X results in a larger decrease in production of product Y. The reason this occurs is that not all resources are equally well adaptable to producing hamburgers and computers.

As society tries to increase hamburger production it becomes necessary for it to use some of its "computer” resources to do so. The resources used for making computers are not easily adapted to making hamburgers and thus as more hamburgers are produced the more resources intended for computer making need to be modified.

Almost every productive resource is better at producing some things than others. Some machines are good at digging holes and others are better at moving dirt, some land is good for farming and some is best for mining. This lack of perfect flexibility or interchangeability is what defines the law of increasing opportunity costs.

By final goods we mean goods and services purchased for final use and not for resale or for use in further manufacturing processes. Intermediate goods are those that are used to produce other goods that will eventually be sold. In making bread, flour is used as a basic input. When the baker buys the flour from the miller, we do not count this transaction as a sale of a final good. When we sell the bread to the customer who eats it, we count that transaction as the sale of a final good.

By using this law, the output an economy sacrifices to unemployment can be calculated. Example: if unemployment in 2000 is 10% and natural unemployment is 6%, then the excess unemployment is 4%. This 4% is then multiplied by Okun's figure of 2.5 and we get a GDP gap of 10%. If 2000's GDP was $450 billion, then the economy sacrificed $45 billion to cyclical unemployment.

Because both the price level and the money wage rate change, the real wage rate remains constant. The real wage rate remains at the level that achieves full employment of labor. Remember, real wage rate refers to buying power -- in other words, if the price of goods doubles, but your wage rate doubles as well, then your real wage rate is still the same.

The GDP level that the market economy dictates is well beyond the current capacity, this creates high pricing and competition for product. In this example the inflationary gap is $100 billion. There is a need for $100 billion more product and service than can be provided.

Change in Y ÷ Change in AE

(750 - 600 ) ÷ (700 - 600)

150 ÷ 100

Multiplier = 1.5

AE increases 100 billion and the multiplier is 1.5, therefore the change in Equilibrium GDP = 100 * 1.5 = 150.

Equilibrium GDP moves from 600 billion to 750 billion

The multiplier takes a while to work itself out and for the economy to get back to equilibrium GDP .

When the Fed purchases a bond / security it then gives the individual or institution that sold the bond some money in return for the bond. This money is then immediately deposited into the banking system. This then gives more reserves for the bank to make more loans and to therefore expand the total amount of deposits held by the bank system, in the same manner as any new deposit in the bank. The purchase of a bond by the Fed will have an expansionary effect on the money supply.

The monetary transmission mechanism for Keynesians is:

They contend there are loose links in the chain of events that lead a change in the money supply to a change in demand. They feel that investment is not always sensitive to changes in the interest rate and that a change in interest rates will not necessarily lead to a change in demand.

They question whether banks will always be anxious to lend and whether the public will always be eager to borrow based on interest rates alone.

The remaining increase in output per hour of work is attributed to technological change (and unidentified factors).

Example: Tariff protection for blue jeans - adding taxes to imported goods.

The figure above shows the effect that a tariff will have on the domestic market for jeans. Without foreign imports, jeans sell for $20, at point c. With trade foreign importers are able to bring in jeans for $10 per pair and the demand would be 12 million pairs, shown as point e. Domestic producers would only make 4 million pairs of jeans at that price level (a) while foreigners would bring in 8 million pairs. There would be a drop of production and loss of jobs associated with jean production in the domestic nation.

The government can protect the domestic blue jean industry by imposing tariffs on imported goods. If they decide to impose a $5 tariff on each pair of jeans (a 50% tariff rate), then domestic producers would still make 6 million pairs of jeans (b), and foreigners would bring in an additional four million pairs for a total supply of 10 million pairs (d). Fewer jobs are lost in the blue jean industry, and the government earns revenue of $20 million dollars. Of course, this is ultimately paid for by the buyers of blue jeans who pay more than the world price for jeans and the resulting increased revenue goes to the government.