CLEP Principles of Macroeconomics common mistakes
CLEP Principles of Macroeconomics · Understand the traps and how to avoid them.
When a price ceiling is set below equilibrium, predicting that quantity supplied rises or that the market simply splits the difference, instead of concluding that quantity supplied falls and a shortage opens up.
Candidates memorize 'price ceiling = shortage' as a slogan but never trace the supply and demand curves to the new quantity axis position, so they cannot distinguish a binding from a non-binding ceiling or predict the size of the gap.
What to do instead
For every control problem, redraw the axes, mark the equilibrium, then mark the legal price. Only if the legal price lies on the correct side of equilibrium does it bind. Read quantity supplied and quantity demanded off the curves at the legal price and subtract. Practice with a ceiling above equilibrium (no effect) and a floor below equilibrium (no effect) to lock in the binding condition.
Treating a movement along a demand curve and a shift of the demand curve as the same event, e.g. saying a price change shifts demand or that an income change causes a movement along the curve.
The graph looks identical in both cases, so candidates respond to the visual rather than to the cause. They also confuse the labels: the axis variable is price, so only a price change can move you along the curve.
What to do instead
Before answering, ask 'what changed?' If the changed variable is on an axis (price of the good, quantity), it is a movement along. If it is not on an axis (income, tastes, prices of related goods, expectations, number of buyers), it is a shift. Keep a written list of shifters for demand and a separate list for supply, and check the changed variable against the list.
Computing GDP by adding up the market value of all goods produced, including intermediate goods and secondhand sales, or excluding goods produced but not sold.
The expenditure identity (C + I + G + NX) is memorized without the underlying definition of what counts, so candidates double-count steel that went into a car and omit inventory investment on unsold output.
What to do instead
Apply three filters to every item: (1) Is it newly produced this period? (2) Is it a final good, or has its value already been captured? (3) Is it produced inside the country's borders? Then remember that unsold output is inventory investment and therefore inside I. Drill a mixed list of items (used car, new car, steel sold to a factory, Social Security payment, a foreigner's purchase of a domestic good) and classify each.
Mixing up nominal and real GDP, and therefore reporting inflation when output actually changed, or reporting growth when only prices rose.
Both series rise over time and candidates grab whichever number is printed first. They also forget which base year is being used, so they cannot tell which of the two is the price-adjusted measure.
What to do instead
Anchor on the definition: real GDP holds prices constant, nominal GDP lets prices move. When a question gives a price index, always divide nominal by (index/100) before calling anything growth. Practice one base-year problem where nominal and real are equal by construction, then change prices only and confirm real GDP is unchanged.
Assuming that because the economy is at full employment, cyclical unemployment is zero and the unemployment rate should therefore be zero.
Candidates collapse all unemployment into one category and forget frictional and structural unemployment persist even in equilibrium. The natural rate is confused with 'no unemployment'.
What to do instead
Separate the types explicitly: frictional (search and matching), structural (skills and geography mismatch), cyclical (deficient demand). At full employment only cyclical is zero, so the rate equals the natural rate, which is positive. When a question mentions a recessionary gap, add cyclical unemployment on top of the natural rate rather than replacing it.
Predicting that inflation rises whenever the price of one good rises, or that deflation is always good for an economy, without checking whether the change is general or isolated.
Headline news about gasoline or housing prices gets conflated with the general price level, and candidates do not distinguish a relative price change from inflation. Deflation is assumed to be the mirror image of inflation in its effects.
What to do instead
Define inflation as a sustained increase in the general price level, then ask whether the change is broad-based or confined to one market. For deflation, reason through debt: falling prices raise the real burden of nominal debt, so deflation can depress spending. Also note that unanticipated inflation helps borrowers and hurts lenders, while anticipated inflation shifts nominal rates via the Fisher effect.
Drawing the aggregate supply curve as upward-sloping in the long run, or shifting aggregate demand and aggregate supply in the wrong direction when a policy or shock is described.
The short-run upward slope is learned first and never overwritten by the long-run vertical case. Direction errors come from memorizing 'increase in spending shifts AD' without deciding which curve the event actually belongs to.
What to do instead
Fix the long-run picture first: potential output is set by resources and technology, so long-run AS is vertical at full employment. Then classify each event: does it change total spending at a given price level (AD) or the cost and capacity of production (AS)? A rise in input prices shifts AS left; a rise in government purchases shifts AD right. Draw the long-run vertical line before adding the short-run curve every time.
Believing that an increase in the money supply directly raises nominal interest rates, or that the Fed's purchases of bonds are unrelated to the federal funds rate.
The income and inflation effects on interest rates are learned alongside the liquidity effect, and candidates pick the wrong one for the short run. The mechanics of open market operations and the resulting reserve supply are not connected to the price of reserves.
What to do instead
Work the short-run chain in order: Fed buys bonds, bank reserves rise, the supply of loanable money shifts right, the federal funds rate falls, investment and consumption rise. Then note the later income and price effects can push rates back up. Keep the liquidity effect as the immediate answer and label the others as subsequent.
Describing expansionary policy as raising both output and the price level in the long run, rather than raising the price level only, and ignoring crowding out when government spending rises.
The short-run gain in real output is vivid and gets carried into the long-run answer. Crowding out is skipped because the loanable funds market is treated as a separate topic from fiscal policy.
What to do instead
Run every policy through two horizons. Short run: AD shifts, output and prices rise. Long run: expectations and wages adjust, short-run AS shifts back, output returns to potential and only the price level is higher. For fiscal expansion, add the loanable funds step: government borrowing raises the interest rate, which reduces private investment.
Treating a currency appreciation as making exports cheaper, or confusing a current account deficit with a capital account surplus and getting the direction of the financial flows backwards.
Appreciation and depreciation are described from the currency's point of view, not the exporter's, and candidates do not consistently track who is buying whose assets. The balance of payments identity is memorized without its meaning.
What to do instead
Translate every currency move into the price a foreign buyer pays: appreciation makes domestic goods more expensive abroad, so exports fall and imports rise. For the accounts, remember that a current account deficit must be financed by net inflows on the financial account, meaning the country is selling assets or borrowing abroad. Write the identity current account + financial account ≈ 0 on scratch paper before answering.