TUT 1

SOLUTIONS
1. What are the four primary questions in macroeconomics? (4)
1. What determines the cyclical behavior of output and employment? What causes
recessions?
2. What are the determinants of the rate of inflation? What role do macroeconomic
policies play in determining inflation?
3. What relationship exists between inflation and unemployment?
4. What determines the rate of growth in output over periods of one or two decades?

2. Explain the difference between actual output and potential output. What does the
difference between these variables represent? (3)

Potential output represents the long-run level of output that is potentially achievable if all
resources are used to their full utilization. Because potential output is a long-run concept, the
difference between actual and potential output represents cyclical, or short-run, deviations in
output from what is potentially achievable.

3.Explain the difference between the CPI and GDP deflator measures of inflation. Which one
is likely to measure inflation higher? Why? (3)

The GDP deflator measures the change in prices of all goods and services included in GDP
while the CPI measures the change in price of a basket of goods that typical households
consume. Because the CPI uses a fixed basket of goods, it ignores substitution to cheaper
goods as well as unmeasured changes in quality, new goods, and unmeasured changes in
shopping (such as the increased use of discount stores). As a result, the CPI tends to
overestimate inflation and measure inflation higher than the GDP deflator.
4.What two principles of mercantilism did the classicists attack? (2)

The belief that the wealth and power of a nation were determined by its stock of precious
metals and the belief in the need for state action to direct the development of the capitalist
system.
5.In the classical model, what is the impact of changes in the demand for goods and services
on aggregate output? Do they affect any real variables? (3)

Factors such as the quantity of money, the level of government spending, and the level of
demand for investment goods by the business sector are all demand-side factors and have no
role in determining output and employment. Also, changes in taxes, to the degree that they
affect the demand side, will neither affect output nor employment. The level of aggregate
demand has no effect on output because output and employment are supply-determined.

Multiple Choice: 1.A 2.E 3. C 4. B 5. A