Use this review after the Unit 2 diagnostic. Each of its six questions combines several topics.
Big ideas of the unit
- Three indicators, one economy. GDP measures output, the unemployment rate idle labour, and a price index inflation. Most questions need two at once.
- GDP is new final output. Spending, income and value added all give the same total. See Topic 2.1.
- GDP is not well-being. It misses home production, the informal economy, leisure and environmental damage, and ignores who gets the income. See Topic 2.2.
- Unemployment depends on who is looking. The rate divides by the labor force, so discouraged workers lower it while joblessness stays high. See Topic 2.3.
- One method converts every nominal value. Divide by a price index (CPI for wages and prices, the deflator for GDP) and multiply by 100. See Topic 2.4 and Topic 2.6.
- Surprises redistribute. Contracts fix valdas, not goods, so unexpected inflation helps borrowers and hurts lenders; unexpected deflation does the reverse. See Topic 2.5.
- The cycle is read in real GDP. Direction gives the phase; the level compared with potential gives the output gap. See Topic 2.7.
- Output gap and unemployment are two views of one fact. At potential output, unemployment equals the natural rate; below it, cyclical unemployment is positive.
Key relationships and methods
| Idea | Relationship or method | Topic |
|---|---|---|
| Expenditure approach | GDP = C + I + G + (exports − imports); leave out transfers, used goods, shares and intermediate goods | 2.1 |
| GDP per person | GDP ÷ population (convert billions and millions first) | 2.2 |
| Labour market rates | Unemployment rate = unemployed ÷ labor force × 100; participation = labor force ÷ adult population × 100 | 2.3 |
| Natural and cyclical unemployment | Natural = frictional + structural; cyclical = actual − natural | 2.3 |
| CPI and inflation | CPI = basket cost ÷ base-year cost × 100; inflation = % change in the index | 2.4 |
| Real value | Nominal ÷ price index × 100, or scale by (later index ÷ earlier index) | 2.4, 2.5 |
| Real GDP and deflator | Deflator = nominal ÷ real × 100; real = nominal ÷ deflator × 100 | 2.6 |
| Output gap | Actual − potential real GDP; as a %, divide by potential | 2.7 |
The questions
These are original Marlbridge practice questions, not past exam questions. The rubrics are a suggested Marlbridge rubric, not official scoring. All questions use Valdoria, a fictional country whose currency is the valda (VD); all data are fictional. Only the stated changes happen.
Question 1 (multiple choice · mixed)
Valdoria’s inflation rate has been 7% a year for some time, and lenders and borrowers expect it to continue. Banks make one-year fixed-rate loans on that basis. During the year inflation unexpectedly falls to 3%. Which statement is correct?
- (A) Prices still rise, and lenders on these loans gain at borrowers’ expense.
- (B) Valdoria has deflation, so borrowers gain because prices fall.
- (C) Prices still rise, so borrowers gain because they repay in valdas that buy less.
- (D) Neither side gains, because inflation stayed positive.
Answer and explanation
Answer: (A). A fall from 7% to 3% is disinflation: prices still rise, but more slowly. The loans were priced for 7%, so each valda repaid buys more than planned. Lenders gain; borrowers lose.
- (B) Deflation needs negative inflation, and it would hurt borrowers, not help them.
- (C) Valdas buy less, but by less than expected; compare with the expected rate, not zero.
- (D) What matters is the surprise (4 percentage points), not the sign of inflation.
Question 2 (multiple choice · mixed)
Over one year, Valdoria’s nominal GDP rises by 8%, its GDP deflator rises by 5% and its population rises by 3%. What happened to real GDP per person?
- (A) It rose by 8.00%.
- (B) It rose by 2.86%.
- (C) It fell by 0.14%.
- (D) It rose by 4.85%.
Answer and explanation
Answer: (C). Real GDP grows by 1.08 ÷ 1.05 = 1.0286 (2.86%). Per person: 1.0286 ÷ 1.03 = 0.9986, a fall of 0.14%.
- (A) adjusts for neither prices nor population.
- (B) is real GDP growth; it forgets the population.
- (D) divides by population but forgets prices (1.08 ÷ 1.03).
Question 3 (constructed response · mixed)
Valdoria’s figures for 2026 (VD billion, current prices). The base year is 2025, when nominal GDP was VD 1,150 billion.
| Item | VD billion |
|---|---|
| Household spending on new goods and services | 820 |
| Households buying second-hand cars | 25 |
| Business spending on new machinery and buildings | 150 |
| New homes built | 70 |
| Increase in firms’ inventories | 10 |
| Government purchases (including 30 to clean up a chemical spill in a river) | 300 |
| Pensions and unemployment benefits | 110 |
| Households buying government bonds | 60 |
| Exports | 260 |
| Imports | 290 |
(a) Calculate C, I, G and net exports, and Valdoria’s 2026 GDP. Explain why two of the excluded items are left out. (b) The 2026 GDP deflator is 110. Calculate real GDP in 2026 and the growth rate of real GDP. Compare it with nominal growth. (c) In 2026 the average working week in Valdoria also rose from 40 to 45 hours. Using this and the table, explain two reasons why real growth may overstate the rise in Valdorians’ well-being.
Worked solution and suggested Marlbridge rubric
(a) C = 820; I = 150 + 70 + 10 = 230; G = 300; Xn = 260 − 290 = −30. GDP = 820 + 230 + 300 − 30 = VD 1,320 billion. Left out: second-hand cars were produced in earlier years; pensions and benefits are transfer payments with nothing produced in return; bonds are a financial transaction.
(b) Real GDP = 1,320 ÷ 110 × 100 = VD 1,200 billion. 2025 is the base year, so its real GDP is VD 1,150 billion. Real growth = (1,200 − 1,150) ÷ 1,150 × 100 = 4.35%, against nominal growth of (1,320 − 1,150) ÷ 1,150 × 100 = 14.78%. Most of the rise was higher prices.
(c) First, the VD 30 billion clean-up counts as output but only repairs the river; the damage is never subtracted. Second, some extra output came from longer hours, and GDP gives no value to the leisure lost.
| Point | What earns it |
|---|---|
| 1 | C, I, G and Xn all correct (I includes new homes and inventories) |
| 1 | GDP = VD 1,320 billion |
| 1 | Two exclusions correctly explained |
| 1 | Real GDP = VD 1,200 billion |
| 1 | Real growth 4.35%, compared with nominal growth 14.78% |
| 1 | The clean-up adds to GDP but only repairs damage |
| 1 | Longer hours raise output, but GDP ignores the leisure given up |
Total: 7 points. Accept values carried forward. Counting the bonds or benefits in (a) loses the first two points.
Question 4 (constructed response · mixed)
Valdoria’s statistics office prices a basket of 30 kg of rice, 40 bus fares and 100 units of electricity. The base year is 2024.
| Item | 2024 price | 2025 price |
|---|---|---|
| Rice (per kg) | VD 2.00 | VD 2.20 |
| Bus fare | VD 1.25 | VD 1.50 |
| Electricity (per unit) | VD 0.40 | VD 0.42 |
(a) Calculate the cost of the basket in each year, the 2025 CPI and the inflation rate. (b) At the start of 2025 a bank lent VD 20,000 for one year at a fixed nominal rate of 6%; both sides expected 3% inflation. Treat the CPI as 100 at the start of 2025 and 112 at the end. Calculate the repayment, its value in start-of-year valdas and the change in the bank’s purchasing power. State who gains. (c) Ama’s pension of VD 1,000 a month is fixed in valdas. Calculate its 2025 value in 2024 valdas. The government then indexes pensions to the CPI. State her new pension. (d) Bus fares rose fastest, and many people began to cycle. Explain why indexing to the CPI may slightly over-compensate pensioners.
Worked solution and suggested Marlbridge rubric
(a) 2024: 30 × 2.00 + 40 × 1.25 + 100 × 0.40 = 60 + 50 + 40 = VD 150. 2025: 66 + 60 + 42 = VD 168. CPI 2025 = 168 ÷ 150 × 100 = 112. Inflation = 12%.
(b) Repayment = 20,000 × 1.06 = VD 21,200. In start-of-year valdas: 21,200 × 100 ÷ 112 = VD 18,928.57, a change of −5.36%. The bank planned a real return of about 6 − 3 = 3%, but 12% inflation was a surprise of 9 points. The borrower gains and the bank loses.
(c) 1,000 × 100 ÷ 112 = VD 892.86, a loss of 10.71% in purchasing power. Indexed pension = 1,000 × 1.12 = VD 1,120.
(d) Fares rose 20%, against 10% for rice and 5% for electricity. People who cycle avoid much of the fare rise, but the fixed basket still prices 40 fares. This substitution bias makes the CPI overstate the cost of living, so an indexed pension rises slightly faster than true costs.
| Point | What earns it |
|---|---|
| 1 | Basket costs VD 150 and VD 168 |
| 1 | CPI 112 and inflation 12% |
| 1 | Repayment VD 21,200 worth VD 18,928.57 in start-of-year valdas (−5.36%) |
| 1 | Borrower gains and bank loses, because inflation was higher than expected |
| 1 | Pension worth VD 892.86 in 2024 valdas |
| 1 | Indexed pension VD 1,120 |
| 1 | Fixed basket ignores the switch to cycling (substitution bias), so the CPI overstates |
Total: 7 points. Accept values carried forward from (a).
Question 5 (constructed response · mixed)
Valdoria’s quarterly spending (VD billion, constant prices). Fixed investment is spending on new machinery, buildings and homes.
| Quarter | C | Fixed investment | Change in inventories | G | Net exports | Potential real GDP |
|---|---|---|---|---|---|---|
| 1 | 300 | 70 | 0 | 100 | −10 | 460 |
| 2 | 290 | 70 | +12 | 100 | −8 | 462 |
| 3 | 288 | 66 | −6 | 100 | −7 | 464 |
| 4 | 292 | 66 | −2 | 100 | −8 | 466 |
(a) Calculate real GDP in each quarter. (b) Households cut spending in Quarter 2, yet real GDP rose. Explain how. (c) Identify the peak and the trough, and the phase of the cycle in Quarters 3 and 4. (d) Calculate the output gap in Quarter 3 in VD billion and as a percentage of potential output. (e) In Quarter 3, firms lay off workers they expect to rehire when sales recover. The natural rate is 5.0% and the unemployment rate is 7.4%. Identify the type of unemployment, calculate it, and explain why the natural rate does not change.
Worked solution and suggested Marlbridge rubric
(a) Q1: 300 + 70 + 0 + 100 − 10 = 460. Q2: 290 + 70 + 12 + 100 − 8 = 464. Q3: 288 + 66 − 6 + 100 − 7 = 441. Q4: 292 + 66 − 2 + 100 − 8 = 448 (VD billion).
(b) GDP measures production. Firms kept producing, and unsold goods were added to inventories (+12), which counts as investment. Net exports also rose slightly.
(c) Peak: Quarter 2 (464). Trough: Quarter 3 (441). Quarter 3 is in recession (real GDP fell). Quarter 4 is in expansion (real GDP rose to 448), even though output is still below potential.
(d) 441 − 464 = −VD 23 billion, or −23 ÷ 464 × 100 = −4.96%: a recessionary gap.
(e) Cyclical unemployment: 7.4% − 5.0% = 2.4 percentage points. The natural rate counts only frictional and structural unemployment. These workers’ skills still match jobs that return when spending recovers, so it is unchanged.
| Point | What earns it |
|---|---|
| 1 | All four GDP values correct |
| 1 | Unsold output counts as inventory investment (production, not sales) |
| 1 | Peak Quarter 2 and trough Quarter 3 |
| 1 | Quarter 3 recession and Quarter 4 expansion, judged by the direction of real GDP |
| 1 | Gap −VD 23 billion and −4.96% of potential |
| 1 | Cyclical unemployment of 2.4 percentage points |
| 1 | Natural rate unchanged because it excludes cyclical unemployment |
Total: 7 points. In (c), calling Quarter 4 a recession “because output is below potential” earns no point.
Question 6 (constructed response · mixed)
Valdoria’s annual data. The base year is 2024; the adult population is 40.0 million throughout; the natural rate of unemployment is unknown.
| Year | Nominal GDP (VD billion) | GDP deflator | Potential real GDP (VD billion) | Employed (million) | Unemployed (million) |
|---|---|---|---|---|---|
| 2024 | 800.0 | 100 | 800 | 23.75 | 1.25 |
| 2025 | 856.8 | 105 | 810 | 24.30 | 1.00 |
| 2026 | 873.6 | 112 | 820 | 23.20 | 1.60 |
(a) Calculate real GDP each year and the real growth rates for 2025 and 2026. Identify the year of recession. (b) Calculate the unemployment rate and the labor force participation rate in each year. (c) Use the 2024 data to explain what Valdoria’s natural rate of unemployment is. (d) Calculate the output gap and cyclical unemployment in 2025 and 2026, and explain why their signs agree. (e) In 2026, 0.3 million people who lost jobs stopped searching and are counted outside the labor force. Calculate the unemployment rate if they were counted as unemployed, and explain what this shows.
Worked solution and suggested Marlbridge rubric
(a) Real GDP = nominal ÷ deflator × 100: 800, 816 and 780 (VD billion). Growth: 2025 +2.00%; 2026 (780 − 816) ÷ 816 × 100 = −4.41%. 2026 is the recession year, although nominal GDP still rose by 1.96%.
(b) Labor force = employed + unemployed: 25.0, 25.3 and 24.8 million. Unemployment rates: 1.25 ÷ 25.0 = 5.00%, 1.00 ÷ 25.3 = 3.95%, 1.60 ÷ 24.8 = 6.45%. Participation rates (÷ 40.0): 62.50%, 63.25%, 62.00%.
(c) In 2024 real GDP equals potential, where unemployment equals the natural rate: 5.0%.
(d) 2025: gap 816 − 810 = +VD 6 billion (+0.74%); cyclical 3.95 − 5.0 = −1.05 points. 2026: gap 780 − 820 = −VD 40 billion (−4.88%); cyclical 6.45 − 5.0 = +1.45 points. Above potential, firms hire more and unemployment falls below the natural rate; below potential, the reverse happens.
(e) (1.6 + 0.3) ÷ (24.8 + 0.3) × 100 = 7.57%, against the official 6.45%. Leaving out discouraged workers makes the official rate understate joblessness; falling participation is the clue.
| Point | What earns it |
|---|---|
| 1 | Real GDP 800, 816, 780 and growth +2.00%, −4.41% |
| 1 | 2026 identified as the recession year from falling real GDP |
| 1 | All three unemployment rates |
| 1 | All three participation rates |
| 1 | Natural rate 5.0%, because 2024 output equals potential |
| 1 | Both gaps and both cyclical rates, with matching signs explained |
| 1 | 7.57%, explaining that discouraged workers make the official rate understate joblessness |
Total: 7 points. Accept values carried forward. Dividing the unemployed by the adult population earns no point in (b).
How did you do?
If you lost marks on:
- Q3: GDP and its limits. Use the Topic 2.1 checklist and the Topic 2.2 checklist.
- Q5(e) or Q6(b)–(e): labor market rates and the natural rate. Use the Topic 2.3 checklist.
- Q4(a) or (d): building and judging a price index. Use the Topic 2.4 checklist.
- Q1 or Q4(b)–(c): who gains from surprises. Use the Topic 2.5 checklist.
- Q2, Q3(b) or Q6(a): real values. Use the Topic 2.6 checklist.
- Q5(c)–(d) or Q6(d): phases and the output gap. Use the Topic 2.7 checklist.
If several topics feel shaky, return to the Unit 2 diagnostic.