Diagnostic Test: Macroeconomics

Instructions: Attempt each question without referring to notes. Select the best answer from the four options provided. After completing all questions, check your answers against the key below.

1. Which of the following is a component of Aggregate Demand?

(A) Savings (B) Government spending (C) Imports (D) Tax revenue

2. A government increases spending by $50 billion while tax revenue remains unchanged. If the marginal propensity to consume is 0.75, what is the maximum expected change in national income?

(A) $50 billion (B)$125 billion (C) $200 billion (D)$37.5 billion

3. Which type of unemployment results from a mismatch between the skills of workers and the requirements of available jobs?

(A) Frictional unemployment (B) Structural unemployment (C) Cyclical unemployment (D) Seasonal unemployment

4. The central bank raises interest rates primarily to:

(A) Increase the rate of economic growth (B) Reduce the level of unemployment (C) Control inflation (D) Depreciate the exchange rate

5. Cost-push inflation is most likely caused by:

(A) An increase in consumer spending (B) A rise in raw material prices (C) An expansion of the money supply (D) A decrease in income tax rates

6. According to the Phillips curve, in the short run there is a trade-off between:

(A) Economic growth and exchange rate stability (B) Unemployment and inflation (C) Exports and imports (D) Government spending and taxation

7. A country runs a current account deficit. This can be financed by:

(A) A surplus on the capital account (B) Reducing government spending (C) Decreasing the money supply (D) Lowering interest rates

8. The Marshall-Lerner condition states that a currency devaluation will improve the trade balance if:

(A) The sum of PED for exports and imports is less than 1 (B) The sum of PED for exports and imports is greater than 1 (C) The exchange rate is fixed (D) Inflation is below the target rate

9. Which of the following is an automatic stabiliser?

(A) A one-off stimulus payment (B) A progressive income tax system (C) A change in the base interest rate (D) A government infrastructure programme

10. Real GDP differs from nominal GDP because real GDP:

(A) Includes the informal economy (B) Is adjusted for inflation using constant prices (C) Measures only goods, not services (D) Excludes government spending

flowchart TD
    A[Diag Macroeconomics] --> B[Key Concepts]
    A --> C[Core Principles]
    A --> D[Practical Applications]
    B --> E[Fundamental definitions]
    C --> F[Design patterns]
    D --> G[Real-world usage]

Macroeconomics is like reading the economy’s vital signs — GDP, inflation, and unemployment reveal the health of the system: Macroeconomic variables are interconnected — policies affecting one often have ripple effects across the economy

Why it matters: Understanding macroeconomics is essential for evaluating government policy and economic forecasts

The key insight: Macroeconomic variables are interconnected — policies affecting one often have ripple effects across the economy

1. (B) AD = C + I + G + (X - M). Government spending (G) is a direct component. Savings are a leakage from the circular flow; imports and tax revenue are not components of AD.

2. (C) The multiplier k = 1 / (1 - MPC) = 1 / (1 - 0.75) = 4. Maximum change in national income = initial injection x multiplier = $50 billion x 4 =$200 billion.

3. (B) Structural unemployment arises when there is a mismatch between workers’ skills, location, or experience and the jobs available. It is often caused by technological change, deindustrialisation, or globalisation.

4. (C) Raising interest rates increases the cost of borrowing, which reduces consumption and investment, thereby reducing aggregate demand and easing inflationary pressure.

5. (B) Cost-push inflation occurs when production costs rise, causing firms to raise prices. Increases in raw material prices, wages, or indirect taxes are typical causes.

6. (B) The short-run Phillips curve shows an inverse relationship between unemployment and inflation, implying policymakers face a trade-off between the two.

7. (A) A current account deficit must be offset by a surplus on the capital and financial account (through borrowing, selling assets, or drawing down reserves).

8. (B) When |PEDx + PEDm| > 1, the volume effect of devaluation (more exports, fewer imports) outweighs the price effect, improving the trade balance.

9. (B) Progressive income taxes automatically stabilise the economy: during expansion, rising incomes push taxpayers into higher brackets, dampening demand; during contraction, falling incomes reduce tax burdens, cushioning the fall in demand.

10. (B) Real GDP is adjusted for inflation by using constant base-year prices, allowing meaningful comparison of output across different time periods. Nominal GDP uses current prices and can rise due to inflation alone.

Confusing nominal with real values: Nominal values are in current prices. Real values are adjusted for inflation. Real GDP growth shows actual output changes, not just price changes.

Mixing up fiscal and monetary policy: Fiscal policy is government spending/taxation (controlled by government). Monetary policy is interest rates/money supply (controlled by central bank). Don’t confuse who controls what.

Assuming trade deficits are always bad: A trade deficit means importing more than exporting. It can be sustainable if funded by investment inflows. Don’t automatically equate deficits with problems.

• Fiscal Policy: Macroeconomics covers fiscal policy
• National Income: GDP is a macro indicator
• Exchange Rates: Exchange rates are macro variables