This diagnostic helps you find which Unit 5 topics to revisit. It has one or two questions on each topic, 5.1 to 5.7. Answer them all before opening any answer; allow about 30 minutes.
These are original Marlbridge practice questions, not past exam questions. The set is not calibrated, so it gives no predicted score. Valdoria and Kestria are fictional countries using the valda (VD); all data are fictional. A four-function calculator is enough. Only the stated change happens.
Question 1 (multiple choice · 5.1)
Valdoria has a recessionary gap, and its central bank works with ample reserves. Which combination would help close the gap?
- (A) Raise transfer payments; lower the interest rate the central bank pays on reserves
- (B) Raise transfer payments; raise the interest rate the central bank pays on reserves
- (C) Cut taxes; sell government bonds on the open market
- (D) Cut government spending; lower the interest rate the central bank pays on reserves
Answer and explanation
Answer: (A). Both policies must be expansionary. Higher transfers raise consumption; with ample reserves, the central bank cuts rates by lowering administered rates such as the rate paid on reserves.
- (B) A higher rate on reserves is contractionary.
- (C) A bond sale is a contractionary, limited-reserves tool.
- (D) A spending cut is contractionary.
If you missed this: read “Choosing the direction: match the gap” in the Topic 5.1 study guide.
Question 2 (multiple choice · 5.2)
Valdoria’s natural rate of unemployment is 4.5%. A fall in AD has moved the economy along its short-run Phillips curve (SRPC) from (unemployment 4.5%, inflation 3%) to (5.5%, 1%). With no policy action, what happens in the long run?
- (A) The SRPC shifts left; unemployment returns to 4.5% with inflation below 3%.
- (B) The SRPC shifts right; unemployment returns to 4.5% with inflation above 3%.
- (C) The economy moves back up the same SRPC to 4.5% and 3%.
- (D) The LRPC shifts right to 5.5%, the new long-run equilibrium.
Answer and explanation
Answer: (A). The point is right of the LRPC: a recessionary gap. Nominal wages and expected inflation fall, so SRAS shifts right and the SRPC shifts left.
- (B) describes adjustment from an inflationary gap.
- (C) Moving back up the same SRPC needs a new rise in AD.
- (D) A fall in AD does not change the natural rate.
If you missed this: read “Equilibrium and gaps on the graph” and Worked example 1(d) in the Topic 5.2 study guide.
Question 3 (multiple choice · 5.2)
Kestria’s natural rate of unemployment is 5%, and its SRPC crosses its LRPC at 4% inflation. The economy is on that SRPC at 6% unemployment and 2.5% inflation. Which statement is correct?
- (A) People expect inflation of about 4%, and there is a recessionary gap.
- (B) People expect inflation of about 2.5%, and there is an inflationary gap.
- (C) The natural rate is now 6%, because the economy is on its SRPC.
- (D) People expect inflation of about 4%, and there is an inflationary gap.
Answer and explanation
Answer: (A). Where the SRPC meets the LRPC, actual inflation equals expected inflation, so people expect about 4%. At 6% the economy is right of the LRPC: a recessionary gap, with inflation below what people expected.
- (B) treats today’s inflation as expected inflation, and reverses the gap.
- (C) The LRPC still stands at the natural rate, 5%.
- (D) Right of the LRPC means a recessionary gap.
If you missed this: read “Equilibrium and gaps on the graph” and Worked example 1(d) in the Topic 5.2 study guide.
Question 4 (multiple choice · 5.3)
For several years Valdoria’s money supply grows 6% a year, velocity falls 1% a year and full-employment real GDP grows 3% a year. What is the best estimate of inflation?
- (A) 2%
- (B) 3%
- (C) 4%
- (D) 8%
Answer and explanation
Answer: (A). Inflation ≈ %ΔM + %ΔV − %ΔY = 6 + (−1) − 3 = 2%.
- (B) ignores velocity: 6 − 3.
- (C) flips the sign of the velocity change: 6 + 1 − 3.
- (D) adds real growth: 6 − 1 + 3.
If you missed this: read “The quantity theory in growth rates” and “When velocity changes” in the Topic 5.3 study guide.
Question 5 (multiple choice · 5.4)
Kestria starts the year with a balanced budget and a debt of VD 500 billion. A recession cuts tax revenue by VD 12 billion and raises unemployment benefits by VD 8 billion; nothing else changes. Deficits are borrowed. What are the budget balance and the debt at the end of the year?
- (A) Deficit VD 20 billion; debt VD 520 billion
- (B) Deficit VD 12 billion; debt VD 512 billion
- (C) Deficit VD 4 billion; debt VD 504 billion
- (D) Deficit VD 20 billion; debt VD 500 billion
Answer and explanation
Answer: (A). The balance moves from 0 to 0 − 12 − 8 = −20. The deficit is borrowed, so the debt rises to 500 + 20 = VD 520 billion. These are automatic stabilizers.
- (B) leaves out benefits, which are budget spending though not part of G.
- (C) nets the two changes, but both push towards deficit.
- (D) Any deficit, planned or not, adds to the debt.
If you missed this: read “Deficit and debt: flow and stock” and “Why deficits happen” in the Topic 5.4 study guide.
Question 6 (multiple choice · 5.5)
A teacher models a new government deficit in the loanable funds market as a fall in national saving. Using this method, which is correct?
- (A) Supply shifts left; the real interest rate rises and the equilibrium quantity (private investment) falls.
- (B) Supply shifts left and demand shifts right; private investment falls by the full deficit.
- (C) Supply shifts left; the real interest rate falls and private investment rises.
- (D) Supply shifts right, because savers can buy government bonds; the real interest rate falls.
Answer and explanation
Answer: (A). A deficit is negative public saving, so supply shifts left. The real interest rate rises and private investment is crowded out.
- (B) shows the same deficit twice. Use one method, never both.
- (C) A leftward supply shift raises the real interest rate.
- (D) Selling bonds is how the government borrows; it does not add to supply.
If you missed this: read “Another way to draw it” after Worked example 1 in the Topic 5.5 study guide.
Question 7 (multiple choice · 5.6)
Valdoria’s real GDP rises 6% in a year as unemployment falls from 8% to its natural rate of 5%. The labour force, capital and technology do not change. Which statement is correct?
- (A) It is a recovery: the economy moves from inside its PPC to the curve; LRAS does not shift.
- (B) LRAS shifts right by 6%, because real GDP rose 6%.
- (C) The PPC shifts outward, because more workers are employed.
- (D) It is long-run growth, because real GDP removes inflation.
Answer and explanation
Answer: (A). Idle workers went back to work. Output rose, but capacity did not, so the PPC and LRAS stay put.
- (B) Real GDP rising to Yf is a move to LRAS, not a shift of it.
- (C) Employing existing workers uses existing capacity.
- (D) Real GDP removes inflation, but long-run growth means more capacity.
If you missed this: read “Showing growth on graphs: the PPC and LRAS” in the Topic 5.6 study guide.
Question 8 (multiple choice · 5.7)
Which policy would raise Valdoria’s real GDP per capita mainly through labour force participation rather than productivity?
- (A) Research grants for new battery technology
- (B) A tax credit for firms that buy new equipment
- (C) Longer free preschool hours, so more parents can take full-time jobs
- (D) More places at vocational colleges
Answer and explanation
Answer: (C). More adults join the labour force, so a larger share of people work, even with output per worker unchanged.
- (A) works through technology.
- (B) works through physical capital per worker.
- (D) works through human capital per worker.
If you missed this: read “Policies that raise productivity or participation” in the Topic 5.7 study guide.
Question 9 (short answer · 5.1)
Valdoria’s real GDP is VD 780 billion and full-employment output is VD 810 billion. The MPC is 0.8.
(a) Identify the gap and its size, and calculate the spending and tax multipliers. (b) A cut in the policy rate raises investment by VD 2 billion. Calculate the shift in AD. (c) Calculate the minimum rise in transfer payments that, with (b), would close the gap. (d) State the effect of the combined policy on the price level and on the nominal interest rate.
Worked answer
(a) A recessionary gap of 810 − 780 = VD 30 billion. Spending multiplier = 1 ÷ 0.2 = 5; tax multiplier = −0.8 ÷ 0.2 = −4.
(b) 5 × 2 = +VD 10 billion.
(c) AD must still rise by 30 − 10 = 20. Transfers work like a tax cut (multiplier 4): 20 ÷ 4 = VD 5 billion.
(d) The price level rises. The nominal interest rate is uncertain: the central bank lowers it, but higher income raises money demand.
If you missed this: read Worked example 1 in the Topic 5.1 study guide.
Question 10 (short answer · 5.3)
Valdoria’s money supply is VD 150 billion and nominal GDP is VD 900 billion. Real GDP is at full employment, VD 750 billion.
(a) Calculate velocity and the price level. (b) M rises to VD 165 billion; V is constant. State the short-run effect on real output, then calculate the long-run price level and the percentage changes in M and P. (c) Next year full-employment output grows 4%, with V unchanged. What money supply keeps P at its value in (b)?
Worked answer
(a) V = 900 ÷ 150 = 6. P = 900 ÷ 750 = 1.20 (index 120).
(b) Output rises above VD 750 billion in the short run, then returns to 750 as wages adjust. P = (165 × 6) ÷ 750 = 1.32. M and P both rose 10%: money is neutral in the long run.
(c) Y = 750 × 1.04 = 780. M = (1.32 × 780) ÷ 6 = VD 171.6 billion: 4% growth, matching real growth.
If you missed this: read Worked examples 1 and 2 in the Topic 5.3 study guide.
Question 11 (short answer · 5.6)
Data for Kestria; capital and technology do not change.
| Year 1 | Year 2 | |
|---|---|---|
| Real GDP (VD billion) | 240 | 249.6 |
| Employed workers (million) | 6.0 | 6.4 |
| Population (million) | 10.0 | 10.4 |
(a) Calculate the growth rates of real GDP and of real GDP per capita. (b) Calculate labour productivity in each year. (c) Use the aggregate production function to explain (b). Did living standards rise?
Worked answer
(a) Real GDP: (249.6 − 240) ÷ 240 × 100 = 4.00%. Per capita: 240 billion ÷ 10.0 million = 249.6 billion ÷ 10.4 million = VD 24,000, so growth = 0.00%.
(b) Year 1: 240 billion ÷ 6.0 million = VD 40,000 per worker. Year 2: 249.6 billion ÷ 6.4 million = VD 39,000, a fall of 2.5%.
(c) Output rose, but with the same capital, capital per worker fell (by 6.25%), so each worker produced less. Living standards did not rise: real GDP per capita is unchanged.
If you missed this: read “Labour productivity” and Worked example 2 in the Topic 5.6 study guide.
Your next step
| Topic | Question(s) | If you missed it, read |
|---|---|---|
| 5.1 Policy actions in the short run | 1, 9 | 5.1 study guide |
| 5.2 The Phillips curve | 2, 3 | 5.2 study guide |
| 5.3 Money growth and inflation | 4, 10 | 5.3 study guide |
| 5.4 Deficits and the national debt | 5 | 5.4 study guide |
| 5.5 Crowding out | 6 | 5.5 study guide |
| 5.6 Economic growth | 7, 11 | 5.6 study guide |
| 5.7 Public policy and economic growth | 8 | 5.7 study guide |
How to use your result
- No mistakes in a topic: tick it off; try its practice set before the exam.
- One mistake: read the section named in the answer, then redo the question without looking.
- Two or more mistakes, or a guess: work through that topic’s study guide and practice set. If most slips mix up the short and long run, revisit 5.2, 5.3 and 5.6 together.
Then try the mixed unit review, whose questions combine topics.