Economics Level N - AP Macroeconomics

Economics Level N (AP Macroeconomics) - Solutions

Chapter 1 - The Nature of Macroeconomics
Section 1 Understanding the Principles of Economics
(1) 1.

 Land is a natural resource that includes forests, mineral and oil deposits, and water
resources.
 Labor is a human resource that involves mental and physical effort such as the work done
by doctors, clerks, and construction workers.
 Capital refers to man-made products, such as machines and equipment, that help generate
additional wealth.
 Enterprise refers to the initiatives to make decisions and take risks with regard to
allocating resources such as business owners and managers.
(2) 2.

a) Labor
b) Capital
c) Capital
d) Land
(3) 3. Scarcity is the main economic problem addressed by economics because human wants are

unlimited, whereas economic resources are limited.

(4) 4.
a) This is a normative statement because it stipulates what should be done.
b) This is a positive statement because it is a description of a fact.
(5) 5. The economic resources are used to produce a good or a service and include land, labor,

capital, and enterprise. Since they are all scarce, they require making choices.
(6) 6. [G] Scarcity refers to the limited availability of resources and factors of production. It

results in making choices and giving up alternatives. The next best alternative forgone is the
opportunity cost.
(7) 7. [G] There are four main resources known as factors of production:

• Land: natural resources that include raw materials

• Labor: mental and physical efforts by people
• Capital: man made machines and other tools that allow further income to be generated
• Entrepreneurship or enterprise: decision making and risk taking in return for profit.
(8 8. [T]

a) Microeconomic question
b) Macroeconomic question
c) Macroeconomic question
d) Microeconomic question

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(9) 9. [T]
a) Positive economic analysis
b) Normative economic analysis
c) Positive economic analysis
d) Positive economic analysis

Section 2 The Production Possibilities Curve (PPC)

(10) 10.
Option a) is the opportunity cost if Tom accepts the new job as the additional time spent
commuting could be spent doing something else.

(11) 11.

Note that the labels of the x-axis and y-axis can be switched.

(12) 12. a)

b) The combination of 500 bags and 800 books lies beyond the PPC, which means that this
combination is unattainable given the existing resources. Producing 500 bags would only allow
for producing up to 600 books.
c) 100 bags
d) The slope is negative and gets steeper from left to right as the opportunity cost is increasing.

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(13) 13.
a) The production of consumer goods results in an increasing opportunity cost in terms of
capital goods. Consequently, the PPC is bowed outwards.
b) Points R and V represent inefficient production due to underutilized resources. Points
U and S represent efficient production as they are on the PPC. However, point T
represents an unattainable production combination given the existing resources.

(14) 14.

(15) 15.
[G] The production possibilities curve represents the maximum combinations of two
productions given the available resources. The model is used to show the tradeoffs associated
with the allocation of resources between these productions. The graph is usually represented with
an outward bowing curve to show the increasing opportunity cost.

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(16) 16.
[G] The PPC shows the maximum possible quantity of one good that can be produced,
given the quantity of another good produced.

(17) 17. [G]

a) Any point on the PPC is equally efficient. In this case, B, D, and C show that the
maximum possible output is produced.
b) Point A since it is inside the PPC with underutilized resources.
c) Point X since additional resources are need to shift the PPC outwards.
(18) 18. [T]

a) The next favorite profession forgone that Sally could have chosen
b) The other facilities that could have been constructed instead
c) The money that the employee could have earned if he stayed in his job
(19) 19. [T]

a) To move from point B to C, the number of books produced will have to be reduced
from 10 to 5 to produce 4 additional videogames (from 8 to 12).
b) The country should become better at producing videogames.
c) Points B, C, and D are productively efficient.
d) A movement from point G or E to point B, C, or D.

Section 3 Comparative Advantage and Gains from Trade

(20) 20.
a) Country A: 1 computer for 0.5 bicycles Country B: 1 computer for 1.5 bicycles
b) Country B, since it can produce 50 bicycles more than Country A
c) Country A has a comparative advantage in the production of computers because it can produce
each computer at a lower opportunity cost than that of Country B.
d) Country A will import bicycles because it has a higher opportunity cost incurred from their
production than Country B.
e) For trade to be beneficial, 1 computer should be traded for at least 0.5 bicycles.

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(21) 21.
a) Country A: 1 car for 4 units of textile
Country B: 1 car for 6 units of textile
b) Country A, because it can produce more cars
using the same resources as Country B.
c) Country A: 1 unit of textile for 0.25 cars
Country B: 1 unit of textile for 0.16 cars
Since Country B can produce each unit of textile at a lower opportunity cost than Country
A, then Country B has a comparative advantage in producing textile.

(22) 22. a)

b) Country A: 1 pack of chips for 0.6 pizzas, and 1 pizza for 1.67 packs of chips.
Country B: 1 pack of chips for 0.8 pizzas, and 1 pizza for 1.25 packs of chips.
Country A has the comparative advantage in producing chips since it can produce chips
at a lower opportunity cost than Country B, and Country B has a comparative advantage
in producing pizzas.
c) Neither A nor B has the absolute advantage in producing chips, since they both
produce the same amount using the same resources. However, country B has absolute
advantage in producing pizzas (40 versus 30).
d) i.

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ii. Country B now has absolute advantage in producing the packs of chips (100 versus 50) and
Country A now has comparative advantage in producing pizzas, because it can produce 1 pizza
at a lower opportunity cost than Country B, as follows:
Country A: 1 pizza for 1.67 packs of chips.
Country B: 1 pizza for 2.5 packs of chips.

(23) 23.

a) Country B has absolute advantage in the production of tables and computers since it
can produce more than Country A using the same resources.
b) In country A, 1 table involves an opportunity cost of 0.375 computers.
c) In country B, 1 table involves an opportunity cost of 0.5 computers. Therefore,
Country A will specialize in the production of tables and Country B will import them.
d) Country B will gain since they will be receiving 3 tables for 1 computer which is
higher than their opportunity cost of making computers (2 tables).
Country A will not gain, since they will be receiving 0.33 computers for 1 table, which is
lower than their opportunity cost of producing tables (0.375 computers)
(24) 24. Free trade is related to specialization, which allows countries to import and export their

goods and services without being subject to trade restrictions. The opportunity cost of each
country would determine which goods/services to import and export, thereby increasing their
productivity and allowing them to access new resources.
(25) 25. Since in Italy a worker can produce more using the same resources, Italy will have

absolute advantage in the production of bags.

(26) 26.
a) Country B, since it can produce more given the same resources.
b) Country B, since it can produce more given the same resources.
c) Country B since it has a lower opportunity cost (1 machine per bag) than Country A (3
machines per bag).
d) Country B, since it has a higher opportunity cost in machines.
e) Each bag should be between 1 and 3 machines or each machine should be between 1/3
and 1 bag.
f) The country will fail to produce beyond its PPC using the same resources. However, it
will be able to consume beyond it due to international trade.
(27) 27. [G] A country, business, or individual have absolute advantage when they are able to

produce more of a good or service than another country, business, or individual using the same
resources. Comparative advantage is achieved when the production of a good or service incurs a
lower opportunity cost.
(28) 28. [G] A country enjoys a comparative advantage in the production of a good if that good

can be produced at lower cost in terms of other goods. However, a country enjoys an absolute
advantage over another country in the production of a good if it uses fewer resources to produce

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that good than the other country does.

(29) 29. [G] Beneficial terms of trade fall between the values of the opportunity costs. For one car,
it should be traded between ¼ and ½ machines for the countries to benefit. This will allow them
to consume beyond the PPC.
In Country A, the opportunity cost of 1 machine is 4 cars.
In Country B, the opportunity cost of 1 machine is 2 cars.
Therefore, for trade to be beneficial, the terms of exchanging one machine should be between 2
and 4. Otherwise, the countries will not be able to gain from trade since the opportunities will not
lead to a consumption beyond the PPC.
(30) 30. [G] In order to determine the beneficial terms of trade, the two opportunity costs should

be calculated and compared. Any number in between the calculated values would be acceptable.
In Country A, 1 ton of coal is given up for 2 tons of steel and 1 ton of steel is given up for 0.5
tons of coal.
In Country B, 1 ton of coal is given up for 4 tons of steel and 1 ton of steel is given up for 0.25
tons of coal.
Therefore, acceptable terms of trade for coal would fall between 2 and 4 tons of steel. For
example, by exchanging them for 3 tons of steel. Alternatively, beneficial terms of trade for each
ton of steel would fall between 0.25 and 0.5 tons of coal. For example, 1/3 units of coal.
(31) 31. [T]

a) i. Country B
ii. Country A
b) i. Country B
ii. Country A
(32) 32. [T]

a) Any combination of production that lies on Country A’s PPC would be efficient, such
as 16 cars and 0 phones or 13 cars and 6 phones.
b) 0.5 cars need to be given up to produce one phone.
c) Between 0.25 and 0.5 cars for each phone
(33) 33. [T] a) Italy would sell sofas because it incurs a lower opportunity cost.

b) France would buy sofas from Italy because it has a higher opportunity cost.
(34) 34. [T] Joanna will have comparative advantage in wedding cakes and will specialize in

producing them. On the other hand, Salim will specialize in preparing birthday cakes.
(35) 35. [T] a) Country A because it has a higher opportunity cost (1 instead of 2/3 in Country B).

b) Each car should be between 2/3 and 1 machine. Any value in between results in
beneficial trade.
(36) 36. [T]

a) i. Alice has absolute advantage in preparing sandwiches.

ii. Alice has absolute advantage in preparing burgers.
b) Each sandwich is given up for 1/2 burgers for Alice and 1/2 burgers for Roy.
Therefore, there will be no beneficial trade.

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Chapter 3 - The Circular Flow of Income and the GDP

Section 1 Calculation of the GDP Using the Circular Flow of Income Diagram
(58) 1.

(59) 2.
[G] The circular flow of income or circular flow is a model of the economy in which the
major exchanges are represented as flows of money, goods, and services between economic
agents.

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(60) 3.
[G] In calculating GDP, we can sum up the value added at each stage of production or we
can take the monetary value of all goods and services produced within the borders of the country
during a specific period of time. We do not use the value of total sales in an economy to measure
how much output has been produced. GDP does not count transactions in which money or goods
changes hands but in which no new goods and services are produced.

Section 2 Measurement, Uses, and Limitations of the GDP

(61) 4. GDP = C + I + G + Xn
= $320 + $120 + $65 + ($255 ‒ $310) = $450
(62) 5.

a) 75 + 60 = 135 units
b) 135 ‒ 5 = 130 units
(63) 6. Disposable income = personal income ‒ personal taxes = $7,000 ‒ $2,000 = $5,000.
(64) 7. GDP is the total monetary value of all final goods and services produced within a country’s

borders during a specific period of time. It is calculated by adding the monetary value of all the
previously mentioned goods and services, or by adding the total added values (the difference
between the value of sales and the value of inputs purchased.)
(65) 8.
a) Excluded, since they are transfers of payments.
b) Included
c) Excluded, to avoid double counting.
d) Excluded, since they are transfer payments.
e) Excluded, since it is a non-market activity.
f) Excluded, since the production will be counted in the GDP of the other country.
g) Included
(66) 9. When gross investment > depreciation, since net investment = gross investment -

depreciation.
(67) 10. $0, to avoid double counting.
(68) 11. The real GDP per capita will decrease, meaning that the country will have a lower

standard of living, since real GDP per capita = real GDP ÷ population size.
(69) 12.
a) Excluded, as the play stations are secondhand products (they have been counted before
when they were produced).
b) Included, as a service is provided.
c) Included, as income is earned from work.
d) Excluded, as production occurred in another country (will be counted in China’s
GDP).
e) Included, as it is a service provided to tourists.

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(70) 13. [G] Production will be added to the GDP of the country where this factory is located.
(71) 14. [G] There are three approaches including the income, expenditure and added value. They
all yield the same results. Nominal GDP = C + I + G + Xn using the expenditure method with Xn
being the difference between exports and imports. Nominal GDP = rent + wages + profit +
interest under the income approach, and it is equal to the sum of all added values (the difference
between the selling price and cost of units purchased) under the added-value approach.
(72) 15. [G] Despite being a good indicator about the economic performance of a country, the

nominal GDP has the following limitations:

- It does not include black market or hidden economy’s transactions.
- It does not count non-market activities.
- It fails to reflect the quality of life and the standard of living.
- It ignores the negative externalities.
- It does not show how output is distributed.
(73) 16. [G] An increase in output without having inflation since real GDP reflects production at

constant prices. This is usually accompanied with an increase in aggregate demand.

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Chapter 4 - Unemployment and the Business Cycle – Answers
Section 1 The Unemployment Rate as an Economic Indicator
(74) 1.

(75) 2.

a) The participation rate will decrease because the elderly will retire and no longer be part
of the labor force.
b) The unemployment rate increases because the number of retired people lowers the size
of the labor force.

(76) 3. a) Labor force = employed + unemployed = 2 + 1 = 3 million.

(77) 4. Labor force participation rate = labor force ÷ population of working age between 16 and 65
= (20 + 5) ÷ 50 × 100 = 50%
(78) 5. The unemployment rate decreases and the labor force participation rate decreases.
(79) 6.

a) Seasonal unemployment
b) Not counted in the labor force (neither employed nor unemployed)
c) Frictional unemployment
d) Not counted in the labor force (deliberately not searching for a job)
e) People who stop searching for a job are not considered unemployed. They are not
counted in the labor force because they are discouraged workers.
f) Not counted in the labor force (neither employed nor unemployed)

(80) 7. [G] An individual becomes unemployed when he/she is jobless, within the working-age
range (above the school-leaving age and below the retirement age — usually between 16 and
65), actively seeking a job, and readily available to work.
(81) 8. [G] The unemployment rate is the percentage of the unemployed in the labor force

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unemployed. It is calculated by dividing the number of the unemployed by the labor force × 100.
(82) 9. [G] The labor force participation rate is the percentage of the working population (between

16 and 65) that is part of the labor force. It increases when more people enter the labor force and
reflects the percentage of people who are economically active. It decreases when the number of
discouraged workers increases.
(83) 10. [G] The labor force participation rate measures the active workforce. It is the sum of those

employed and unemployed divided by the total non-institutionalized or civilian working-age

population. For example, if the total population is 100,000 with 10,000 being unemployed,
50,000 being employed, and 15,000 being children, the total labor force participation rate would
be ((50,000 + 10,000)/85,000) = 70.5%.
(84) 11. [G] The labor force refers to the working-age population above 16 and below 65 who is

willing and able to work or is seeking employment. It excludes people in the military,
housewives, or non-institution civilians.
(85) 12. [G] The unemployment rate is a percentage of those unemployed to the labor force. For

example, if the employed are 30 million and the unemployed are 10 million, the unemployment
rate would be equal to (10/(30 + 10)) = 25%
(86) 13. [G] The labor force participation rate changes whenever the labor force increases or

decreases. For instance, when the number of discouraged workers increases, the labor force
decreases and the labor force participation rate decreases because when a person stops looking
for work, they are no longer counted as unemployed and also no longer in the labor force.
(87) 14. [G] The unemployment rate understates the actual unemployment situation because it

counts part-time workers as full-time employees, it does not count the discouraged workers and
the underemployed in the labor force, and it does not count the underemployed as unemployed.
(88) 15. [T]

Section 2 The Types of Unemployment and Full Employment

(89) 16.

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a)
 Higher benefits paid to the unemployed
 Increased restrictive practices of trade unions
 Geographical and occupational immobility of labor
b) When the economy fails to create enough jobs for all those who are able and willing to
work, the potential production of goods and services decreases because resources will be
underutilized, and the economy will operate inside the PPC.
(90) 17.

a) The natural rate of unemployment decreases because frictional unemployment

decreases.
b) Greater access to the Internet facilitates job searches and increases the potential of
finding employees. As a result, frictional unemployment and NRU decrease.
c) Since strong unions negotiate wages above the equilibrium level, they contribute to a
higher level of structural 12. unemployment. A decline in union membership will reduce
structural unemployment and NRU.
(91) 18.

a) Structural unemployment
b) Frictional unemployment
(92) 19.

a) When actual output is equal to potential output, the actual unemployment rate will be
equal to the natural rate of unemployment. However, when potential output exceeds
actual output, the actual unemployment rate will be above NRU, and the opposite is true.
b) The unemployment rate will not change because part-time and full-time workers are
considered employed. However, if this creates more job opportunities for the
unemployed, the unemployment rate would eventually decrease.
(93) 20. Unemployed individuals will have an incentive to work. This would reduce the natural

rate of unemployment.
(94) 21.
a) Frictionally unemployed individuals are in a transitional stage between two jobs, facing a time
lag between leaving their current job and joining a new one. For example, a teacher who
voluntarily quits his job to look for a supervisor’s position is frictionally unemployed.
b) Structural unemployment occurs due to a mismatch between the skills required for a job and
the number of job vacancies, as in the case when a the skills of typewriting are no longer
compatible with the skills required for a secretarial position.
c) Cyclical unemployment occurs in times of economic downturns when the aggregate demand
falls (recession). This is the most serious type of unemployment as it results in mass
unemployment.

(95) 22.
[G] Cyclical unemployment occurs when the aggregate demand in the economy
decreases. Consequently, output decreases and employees are laid off as the economy faces a

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downturn.
Cyclical unemployment can be corrected through macroeconomic policies, such as fiscal policy
and monetary policy to increase aggregate demand.
(96) 23. [G] Some of the individuals who are not working may be in a transitional stage between

two jobs. Individuals who are frictionally unemployed are subject to a time lag between leaving
their current job and joining a new one.
(97) 24. [G] • The natural rate of unemployment (NRU) is the unemployment rate that is

consistent with full employment.

• At the NRU, the economy is said to be producing its potential output.
• The NRU is the sum of frictional and structural unemployment and it occurs when cyclical
unemployment is zero.
• The NRU or full employment can never be zero, because frictional and structural
unemployment are unavoidable.
(98) 25. [G] The NRU mainly composed of frictional and structural unemployment. Therefore,

factors that affect these types of unemployment will alter the natural rate. These factors include
changes in:
• Characteristics of the labor force
• Labor unions and institutions
• Government policies
(99) 26. [G] Because it lowers output and the standard of living. It increases crime rates,

vandalism, stress and other social problems. In addition, it is a burden to governments and tax
payers.
(100) 27. [T]

b) Unemployment results in lost output and leads to psychological and social problems.
In addition, it increases the burden on the government and the taxpayers.
c) Cyclical unemployment is the most serious type of unemployment as it occurs at a
mass level.

Section 3 The Business Cycle

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(101) 28.

 Point 1: Boom or peak

 Point 2: Slump or trough
 Point 3: Recovery or growth
 Point 4: Recession
(102) 29. [G]

(103) 30. [G] A recession is a period of decline in total output, income, and employment. This
downturn, which lasts 6 months or more, is marked by the widespread contraction of business
activity in many sectors of the economy. Along with declines in real GDP, significant increases
in unemployment occur. Recessions are primarily caused by a decline in aggregate demand.
(104) 31. [G] The potential output is achieved when the resources are fully utilized in an efficient

manner. At this output level, the natural rate of unemployment is equal to the unemployment
rate, with zero cyclical unemployment.

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