B5-2 Flashcards Preview

BEC BECKER MCQ > B5-2 > Flashcards

Flashcards in B5-2 Deck (53):
1

From the following information, calculate the GDP for country Y.  $ Bn
 
Consumer spending on durable and non-durable goods and services $ 468
 
Exports 134
 
Imports 82
 
Income of proprietors 64
 
Employee wages 382
 
Government purchases of goods and services 121
 
Capital consumption allowance 96
 
Gross private domestic investment 112

a.

$542bn

b.

$1,083bn

c.

$649bn

d.

$753bn

 

Choice "d" is correct. Information is provided relating to the calculation of GDP under both the expenditure method and the income method, but complete information is only available for calculation under the expenditure method. Therefore, the income method information is unnecessary and should be ignored. Under the expenditure method, GDP will be 468 + (134 - 82) + 121 + 112 = $753.

Choices "b", "c", and "a" are incorrect, per the above explanation.

2

Assume the following data for the U.S. economy in a recent year:

Personal consumption expenditures

$ 5,015 billion

Exports

$ 106 billion

Government purchases of goods/services

$ 1,040 billion

M1

$ 262 billion

Imports

$ 183 billion

Gross private domestic investment

$ 975 billion

Open market purchases by Federal Reserve

$ 5 billion

Based on this information, which of the following was the U.S. GDP for the year in question?

a.

$7,215 billion.

b.

$6,958 billion.

c.

$6,953 billion.

d.

$6,691 billion.

 

Choice "c" is correct. GDP = G + I + C + E (Exports - Imports)

$ 1,040 billion

+

975 billion

+

5,015 billion

+

106 billion

183 billion

$ 6,953 billion

3

Which of the following is most likely to cause an increase in the amount of frictional unemployment in an economy?

a.

An increase in the average age of the work force.

b.

A reduction in the average age of the work force.

c.

A downturn in aggregate business activity.

d.

An invention that renders an industry obsolete.

 

Choice "b" is correct. Younger workers tend to move between jobs more frequently.

Choice "d" is incorrect. This would lead to structural unemployment.

Choice "c" is incorrect. This would lead to cyclical unemployment.

Choice "a" is incorrect. Older workers tend to be voluntarily between jobs less frequently than younger workers.

4

What type of unemployment is shown when individuals do not have the qualifications or skills necessary to fill available jobs?

a.

Frictional.

b.

Structural.

c.

Cyclical.

d.

Natural.

 

Choice "b" is correct. Structural unemployment occurs when the jobs available do not match the skills of the unemployed individuals or when the individuals do not live where jobs are available with their skills.

Choice "a" is incorrect. Frictional unemployment exists when workers are in the process of changing jobs or are temporarily laid off from their jobs.

Choice "d" is incorrect. The natural unemployment rate is the sum of frictional, structural, and seasonal unemployment or the unemployment rate that exists when the economy reaches its potential output level.

Choice "c" is incorrect. Cyclical unemployment is due to a downturn (recession) in the economy which leads to a decline in real GDP and higher unemployment.

5

When a worker quits work to stay at home with the children, it is an example of:

a.

Frictional unemployment.

b.

Structural unemployment.

c.

Cyclical unemployment.

d.

Not counted in unemployment figures.

 

Choice "d" is correct. Unemployment only tallies workers actively seeking employment; it does not count retirees or stay-at-home parents.

Choice "a" is incorrect. Frictional unemployment describes workers who leave work voluntarily to seek a better position.

Choice "b" is incorrect. Structural unemployment describes workers whose skills are no longer needed.

Choice "c" is incorrect. Cyclical unemployment describes workers unemployed due to the business cycle.

6

Which of the following statements regarding inflation is correct?

a.

Cost-push inflation can be caused by a decrease in nominal wages.

b.

Companies and individuals with fixed interest debt will be at a disadvantage during periods of inflation.

c.

Individuals holding monetary assets will be at a disadvantage during periods of inflation.

d.

Demand-pull inflation can be caused by tax increases.

Choice ''c'' is correct. In periods of inflation, holding net monetary assets will cause an individual to lose purchasing power, and, thus, be at a disadvantage.

Choice ''d'' is incorrect. Demand-pull inflation can be caused by tax decreases, not increases.

Choice ''a'' is incorrect. Cost-push inflation can be caused by an increase in nominal wages, not a decrease.

Choice ''b'' is incorrect. Owing fixed interest debt is an advantage in periods of inflation.

7

The CPI jumps from 131 in year 1 to 136.5 in year 2. What is annual inflation rate?

a.

3%

b.

13.8%

c.

1.38%

d.

4.2%

 

Choice "d" is correct. The inflation rate is measured as:

Inflation Rate = (CPI this - CPI last / CPI last ) X 100

= ( 136.5 - 131 / 131) X 100 = 4.2%

8

During a period of high inflation, which of the following groups in society would be most likely to gain?

a.

Those with a fixed amount of debt.

b.

Workers under contract without a cost of living adjustment.

c.

Those with a fixed income.

d.

Those holding a large amount of money.

Choice "a" is correct. During a period of high inflation, those with a fixed amount of debt will repay their debt with inflated dollars and are thus likely to gain.

Choice "c" is incorrect. Those with a fixed income will see the purchasing power of their income erode and are thus likely to be hurt.

Choice "d" is incorrect. Those holding a large amount of money will see the purchasing power of their money erode and are thus likely to be hurt.

Choice "b" is incorrect. Cost of living adjustments take inflation into account, but fixed wage contracts with no cost of living adjustments have less earnings power.

9

The following information is available for economic activity for Year 1:

 (In billions)

Financial transactions

$ 60

Second-hand sales

50

Consumption by households

40

Investment by businesses

30

Government purchases of goods and services

20

Net exports

10

 What amount is the gross domestic product for year 1?

a.

$160 billion.

b.

$90 billion.

c.

$210 billion.

d.

$100 billion.

 

Choice "d" is correct. Gross Domestic Product, using the expenditure approach, is computed as follows:

Government spending

$ 20

Investment (by private industry)

30

Consumer spending

40

Exports (net)

10

Gross Domestic Product

$ 100

Choices "c", "a", and "b" are incorrect based on the above calculation.

10

An increase in the money supply leads to:

a.

An increase in interest rates, a decrease in investment and a decrease in aggregate demand.

b.

An increase in the money supply has no effect on interest rates or investment.

c.

A decline in interest rates, an increase in investment and an increase in aggregate demand.

d.

A decline in interest rates, a decrease in investment and an increase in aggregate demand.

Choice "c" is correct. Expansionary monetary policy results when the Fed increases the money supply. Expansionary monetary policy affects the economy through the following chain of events: (1) an increase in the money supply causes interest rates to fall, (2) falling interest rates stimulate the desired levels of firm investment and household consumption, (3) increases in desired investment and consumption cause an increase in aggregate demand, and (4) aggregate demand shifts to the right causing real GDP and the price level to rise.

Choice "d" is incorrect. An increase in the money supply causes investment to increase, not decrease.

Choice "a" is incorrect. An increase in the money supply causes interest rates to decrease, not increase, investment to increase, not decrease and aggregate demand to increase, not decrease.

Choice "b" is incorrect per above explanation.

11

Which of the following economic terms describes a general decline in prices for goods and services?

a.

Recession.

b.

Inflation.

c.

Deflation.

d.

Expansion.

 

Choice "c" is correct. Deflation is defined as a sustained decrease in the general prices of goods and services. It occurs when prices on average are falling over time. Most economists believe deflation is a much bigger economic problem than inflation.

Choice "d" is incorrect. Expansion describes the composition of business cycles.

Choice "b" is incorrect. Inflation is defined as a sustained increase in the general prices of goods and services. It occurs when prices on average are increasing over time.

Choice "a" is incorrect. Recession describes a business cycle.

12

Under the expenditure approach, GDP can be calculated as the sum of:

a.

Consumption, money supply, government purchases, and exports.

b.

Consumption, investment, government purchases, and net exports.

c.

Consumption, investment, transfer payments, and imports.

d.

Consumption, investment, government purchases, and foreign exchange.

 

Choice "b" is correct. Under the expenditure approach, GDP is calculated as the sum of the following items summarized in the mnemonic GICE:

Government purchases

Investment expenditures

Consumption expenditures

Net Exports

Choice "a" is incorrect. The expenditure approach does not include money supply.

Choice "c" is incorrect. The expenditure approach does not include transfer payments.

Choice "d" is incorrect. The expenditure approach does not include foreign exchange.

13

The inflation rate measures:

a.

The rate at which nominal GDP increases.

b.

How the price of a particular good changes over time.

c.

How nominal interest rate changes over time.

d.

The rate at which the overall price level increases.

 

Choice "d" is correct. The inflation rate measures the rate of increase in the overall price level in the economy.

Choice "a" is incorrect. The inflation rate is associated with price level changes not changes in the nominal value of output.

Choice "b" is incorrect. Inflation refers to a sustained increase in the overall price level. Not the price of a particular good.

Choice "c" is incorrect. The inflation rate is associated with price level changes not interest rate changes.

14

The discount rate set by the Federal Reserve is the:

a.

Ratio of a bank's reserves to its demand deposits.

b.

Rate that commercial banks charge for loans to the general public.

c.

Rate that the central bank charges for loans to commercial banks.

d.

Rate that commercial banks charge for loans to each other.

Choice "c" is correct. The discount rate refers to the rate established by the Federal Reserve for short-term (often overnight) loans it makes to member banks.

Choice "d" is incorrect. The discount rate is the rate the Federal Reserve charges, not commercial banks.

Choice "b" is incorrect. The discount rate is the rate the Federal Reserve charges, not commercial banks.

Choice "a" is incorrect. This would be the bank's reserve ratio - not the discount rate.

15

Assume an economy is at the peak of the business cycle. Which of the following policy combinations is the most effective way to dampen the economy and prevent inflation?

a.

Reduce government spending, increase taxes, increase money supply, and increase interest rates.

b.

Increase government spending, reduce taxes, increase money supply, and reduce interest rates.

c.

Reduce government spending, reduce taxes, reduce money supply, and reduce interest rates.

d.

Reduce government spending, increase taxes, reduce money supply, and increase interest rates.

 

Choice "d" is correct. The economy can be dampened by reducing government spending and by increasing taxes (thus giving consumers less money to spend), both of which are fiscal policy. The economy can also be dampened by reducing the money supply (thus effectively increasing prices) and increasing interest rates (thus giving consumers less money to spend because they are spending more money on interest), both of which are monetary policy.

Choice "b" is incorrect. All of these policies would stimulate the economy further.

Choice "a" is incorrect. Increasing money supply will stimulate the economy, not dampen it.

Choice "c" is incorrect. Reducing both taxes and interest rates will stimulate the economy, not dampen it.

16

Which of the following types of unemployment typically results from technological advances?

a.

Short-term.

b.

Cyclical.

c.

Structural.

d.

Frictional.

Choice "c" is correct. Technological advances would likely result in structural unemployment. Structural unemployment is characterized by available jobs that do not match the skill sets of the workforce. Technological advances could create jobs that simultaneously make the skills of the workforce obsolete.

Choice "b" is incorrect. Cyclical unemployment results from declining GDP and would not likely be created by technological advances.

Choice "d" is incorrect. Frictional unemployment is normal unemployment resulting from workers routinely changing jobs. Frictional unemployment would likely not result from technological advances. 

Choice "a" is incorrect. Short term unemployment is a broad description that relates to the duration of an unemployment condition. The duration of unemployment can be caused by any number of factors, however, structural influences such as technological advancement that require workforce retraining would likely not be short term.

17

Which of the following would lead to a reduction in inflation?

a.

Decreasing aggregate demand and decreasing aggregate supply.

b.

Decreasing aggregate demand and increasing aggregate supply.

c.

Increasing aggregate demand and decreasing aggregate supply.

d.

Increasing aggregate demand and increasing aggregate supply.

 

Choice "b" is correct. Decreasing aggregate demand and increasing aggregate supply will reduce the inflationary pressures.

Choice "d" is incorrect. Increasing aggregate demand causes the price level to rise.

Choice "a" is incorrect. Decreasing aggregate supply causes the price level to rise.

Choice "c" is incorrect. Both of these would cause the price level to rise.

18

Which of the following individuals would be most hurt by an unanticipated increase in inflation?

a.

A saver whose savings was placed in a variable rate savings account.

b.

A borrower whose debt has a fixed interest rate.

c.

A union worker whose contract includes a provision for regular cost-of-living adjustments.

d.

A retiree living on a fixed income.

Choice "d" is correct. Inflation is the sustained increase in the general price of goods and services. A retiree living on a fixed income would be most hurt by an unanticipated increase in inflation because the retiree's income would not increase to offset the negative effects of the inflation.

Choice "b" is incorrect. A borrower whose debt has a fixed interest rate would benefit from inflation because the borrower would be paying back the debt in cheaper dollars.

Choice "c" is incorrect. A union worker whose contract includes a provision for regular cost-of-living adjustments theoretically would have cost of living increases to offset the effects of the inflation. There would be a lag since the cost-of-living adjustments would be after-the-fact, but at least there would be some protection.

Choice "a" is incorrect. A saver whose savings were placed in a variable rate savings account would have the same kind of protection as the union worker (in choice "c", above). The interest rate on the savings accounts would theoretically increase with the inflation. Again, there would probably be a lag, but at least there would be some protection.

19

Which of the following statements regarding increases in price levels is most true? A period of inflation:

a.

Enhances the positive relationship between the price level and the purchasing power of money.

b.

Increases the price level, which benefits those who are entitled to receive specific amounts of money.

c.

Harms anyone who has an obligation to pay a specific amount and benefits anyone who is entitled to receive a specific amount.

d.

Increases the price level, which is negatively related to the purchasing power of money.

Choice "d" is correct. A period of inflation increases the price level, which is inversely related to the purchasing power of money (inflation erodes the value of money).

Choice "b" is incorrect. When price levels increase, those with fixed amounts of money are hurt.

Choice "a" is incorrect. The relationship between price levels and the purchasing power of money is negative, or inverse.

Choice "c" is incorrect. Inflation helps anyone with a fixed obligation since the debt can be repaid in inflated dollars. Those receiving a specific fixed amount are harmed.

20

To address the problem of a recession, the Federal Reserve Bank most likely would take which of the following actions?

a.

Lower the discount rate it charges to banks for loans.

b.

Sell U.S. government bonds in open-market transactions.

c.

Increase the federal funds rate charged by banks when they borrow from one another.

d.

Increase the level of funds a bank is legally required to hold in reserve.

Choice "a" is correct. During a recession, real GDP has fallen and unemployment has risen. To stimulate the economy, the Federal Reserve can lower the discount rate. This causes the money supply to increase, which, in turn, causes aggregate demand to shift right. As a result, real GDP would increase and unemployment would decrease.

Choice "b" is incorrect. If the Federal Reserve sells U.S. government bonds in the open market, the money supply will decrease. This causes aggregate demand to shift left. As a result, real GDP would decrease and unemployment would increase.

Choice "c" is incorrect. Increasing the federal funds rate would increase interest rates. Higher interest rates cause the aggregate demand curve to shift left. As a result, real GDP would decrease and unemployment would increase.

Choice "d" is incorrect. An increase in the required reserve ratio causes the money supply to decrease. This causes aggregate demand to shift left. As a result, real GDP would decrease and unemployment would increase.

21

If the Federal Reserve wanted to implement an expansionary monetary policy, which one of the following actions would the Federal Reserve take?

a.

Raise the reserve requirement and the discount rate.

b.

Raise the discount rate and sell U.S. government securities.

c.

Lower the discount rate and raise the reserve requirement.

d.

Purchase additional U.S. government securities and lower the discount rate.

 

Choice "d" is correct. Federal Reserve Bank purchases of government securities increase the money supply (putting money into circulation), and lowering the discount rate encourages borrowing by member banks and increases the money supply. Hence, these measures would help implement an expansionary monetary policy.

Choice "a" is incorrect. Raising the reserve requirement and the discount rate would have the opposite effect of decreasing the money supply.

Choice "b" is incorrect. Raising the discount rate and selling government securities would reduce the money supply.

Choice "c" is incorrect. Raising the reserve requirement would decrease the money supply, but lowering the discount rate would increase the money supply.

22

Which of the following correctly lists the three ways to increase the money supply?

a.

Lower the required reserve ratio, decrease the discount rate, buy bonds in the open market.

b.

Raise the required reserve ratio, increase the discount rate, buy bonds in the open market.

c.

Lower the required reserve ratio, increase the discount rate, buy bonds in the open market.

d.

Raise the required reserve ratio, increase the discount rate, sell bonds in the open market.

 

Choice "a" is correct. The three ways the Fed can increase the money supply are: (1) buy (purchase) government securities in the open market, (2) lower the discount rate, and (3) lower the required reserve ratio.

Choice "d" is incorrect. Raising the required reserve ratio, increasing the discount rate, selling bonds in the open market decrease the money supply.

Choice "b" is incorrect. Raising the required reserve ratio and increasing the discount rate decrease the money supply.

Choice "c" is incorrect. Increasing the discount rate decreases the money supply.

23

Which of the following strategies would the Federal Reserve most likely pursue under an expansionary policy?

a.

Raise the reserve requirement and lower the discount rate.

b.

Reduce the reserve requirement while raising the discount rate.

c.

Raise the reserve requirement and raise the discount rate.

d.

Purchase federal securities and lower the discount rate.

 

Choice "d" is correct. Under an expansionary policy, the Federal Reserve would most likely purchase government securities. Purchasing these securities increases the money supply and expands the economy.

Choice "b" is incorrect. Raising the discount rate will dampen the economy, not expand it. Reducing the reserve requirement will expand the economy, not dampen it, because there will be more money to loan, but the reserve requirement is irrelevant because the choice is already incorrect.

Choices "a" and "c" are incorrect. Raising the reserve requirement will dampen the economy, not expand it, because there will be less money to loan. The discount rate is then irrelevant because the choice is already incorrect.

24

The controller of Gray, Inc. has decided to use ratio analysis to analyze business cycles for the past two years in an effort to identify seasonal patterns. Which of the following formulas should be used to compute percentage changes for account balances for year 1 to year 2?

a.

(Current balance - prior balance) / prior balance.

b.

(Prior balance - current balance) / prior balance.

c.

(Prior balance - current balance) / current balance.

d.

(Current balance - prior balance) / current balance.

 

Choice "a" is correct. The percentage change in account balances is most logically constructed as the current balance minus the prior balance divided by the prior balance. (Similar to the CPI computation.)

If account balances were to increase as follows, the percentage change would be computed using the formula proposed by the solution.

Year 2
Year 1
Change

Sales

$120,000

$100,000

$20,000

(Current balance $120,000 – Prior balance $100,000) / Prior balance $100,000 = 20%

If account balances were to decrease as follows, the percentage change would be computed (and automatically show a percentage decrease) as follows:

Year 2
Year 1
Change

Sales

$100,000

$120,000

($20,000)

(Current balance, $100,000 – Prior balance, $120,000) / Prior balance, $120,000 = (16.7%)

Choice "c" is incorrect. Computing the amount of the account change as a percentage of the current balance is not the percentage change from period to period.

Choice "b" is incorrect. The proposed formula computes the percentage change backwards, decreases in accounts would be expressed as increases and increases in accounts would be expressed as decreases.

Choice "d" is incorrect. Computing the amount of the account change as a percentage of the current balance is not the percentage change from period to period.

25

All of the following are components of the formula used to calculate gross domestic product, except:

a.

Gross investment.

b.

Foreign net export spending.

c.

Household income.

d.

Government spending.

Choice "c" is correct. Gross domestic product (GDP) is calculated in two different ways. The first, which is the expenditure approach and can be used to answer this question, is the mnemonic GICE, or government purchases plus private domestic investment plus personal consumption expenditures plus net exports. Household income is the only one of the answers that is not included in this mnemonic.

Choice "b" is incorrect. Foreign net export spending is included in the mnemonic (E) for GDP; although, it is called simply net exports in the mnemonic and not foreign net export spending.

Choice "d" is incorrect. Government spending is included in the mnemonic (G) for GDP.

Choice "a" is incorrect. Gross investment is included in the mnemonic (I) for GDP, although it is called private domestic investment in the mnemonic.

26

Which of the following would lead to the most inflation?

a.

Aggregate demand increases and aggregate supply decreases.

b.

Both aggregate demand and aggregate supply decrease.

c.

Both aggregate demand and aggregate supply increase.

d.

Aggregate demand decreases and aggregate supply increases.

 

Choice "a" is correct. This answer choice contains both demand-pull inflation (when the aggregate demand curve shifts right) and cost-push inflation (when the short-run aggregate supply curve shifts left). An increase in aggregate demand causes output to rise and the price level to rise. A decrease in aggregate supply causes output to fall and the price level to rise. Thus, an increase in aggregate demand and a decrease in aggregate supply is the most inflationary.

Choice "c" is incorrect. If aggregate supply increases, the price level will fall (reducing inflation).

Choice "b" is incorrect. If aggregate demand decreases, the price level will fall (reducing inflation).

Choice "d" is incorrect per above explanation.

27

As a measure of national income, the relationship between personal income and disposable income is best described as follows:

a.

Personal income is less than disposable income as adjusted for noncorporate revenues.

b.

Disposable income is less than personal income as adjusted for personal taxes.

c.

Personal income is expressed in nominal dollars while disposable income is expressed in constant dollars after adjustment for changes in the consumer price index.

d.

Personal income represents earnings from households and noncorporate businesses while disposable income purely represents household income.

Choice "b" is correct. Disposable income is computed as personal income (the income received by households and noncorporate businesses) net of personal taxes. Disposable income is the amount left over from personal income that is available either to spend or save.

Choice "a" is incorrect. Personal income is greater than disposable income. Personal income minus personal taxes equals disposable income.

Choice "d" is incorrect. Personal income represents income received by households and noncorporate businesses, while disposable income is the entire amount of personal income minus personal taxes for households and noncorporate businesses.

Choice "c" is incorrect. Personal income is not distinguished from disposable income by adjustments for inflation.

28

Cyclical unemployment results from:

a.

Seasonal decreases in demand for labor.

b.

The time it takes to match qualified workers with available jobs.

c.

Skills of workers not corresponding to jobs available.

d.

A recession in the economy.

Choice "d" is correct. Cyclical Unemployment is caused by the business cycle. It tends to rise during a recession and fall during an expansion.

Choice "c" is incorrect. Mismatch of skills and jobs in the economy is an example of structural unemployment, not cyclical unemployment.

Choice "b" is incorrect. The time lag that individuals experience between jobs is an example of frictional unemployment.

Choice "a" is incorrect. Fluctuations in employment as a result of seasonal demand is an example of seasonal unemployment.

29

Initially the nominal interest rate is 8 percent and the inflation rate is 6 percent. One year later, the nominal interest rate rises to 12 percent while the inflation rate rises to 10 percent. It follows that the real rate of interest:

a.

Has fallen.

b.

Has risen.

c.

Insufficient information given for an answer.

d.

Has remained the same.

Choice "d" is correct. The real interest rate equals the nominal interest rate minus the inflation rate. Thus, the real interest rate in the first year is: real interest rate = 8% − 6% = 2% and the real interest rate in the next year is: real interest rate = 12% − 10% = 2%.

30

All of the following actions are valid tools that the Federal Reserve Bank uses to control the supply of money, except:

a.

Raising or lowering the discount rate.

b.

Selling government securities.

c.

Changing the reserve ratio.

d.

Printing money when the money supply appears low.

 

Choice "d" is correct. The Treasury prints money. The Federal Reserve must increase the money supply through:

Federal open market committee (FOMC) purchasing or selling government securities,

Raising or lowering the discount rate, or

Changing the reserve ratio.

Choices "b", "c", and "a" are incorrect because they are all valid tools to control the supply of money.

31

Frictional unemployment refers to unemployment resulting from:

a.

Seasonal decreases in demand for labor.

b.

A recession in the economy.

c.

The skills of workers do not correspond to the skills demanded by employers.

d.

The time needed to match qualified job seekers with available jobs.

Choice "d" is correct. Frictional unemployment is the unemployment that arises from workers routinely changing jobs or from workers being temporarily laid off. It results from the time needed to match qualified job seekers with available jobs.

Choice "c" is incorrect. A mismatch between worker skills and available employment is an example of structural unemployment.

Choice "a" is incorrect. Fluctuations in seasonal demand for employees is an example of seasonal unemployment.

Choice "b" is incorrect. Recessions are low points in economic cycles that create cyclical unemployment.

32

Which of the following is not consistent with full employment?

a.

Frictional unemployment.

b.

Structural unemployment.

c.

An unemployment rate greater than zero.

d.

Cyclical unemployment.

Choice "d" is correct. When the economy is operating at full employment, there is no cyclical unemployment. When the economy is operating at full employment, there is still some unemployment known as the natural rate of unemployment, which does not include cyclical unemployment.

Choice "c" is incorrect. There is still some unemployment (frictional, structural, and seasonal) when the economy is operating at full employment.

Choice "b" is incorrect, per the above explanation.

Choice "a" is incorrect, per the above explanation.

33

During which of the following periods will prices generally increase the fastest?

a.

Hyperinflation.

b.

Deflation.

c.

Inflation.

d.

Recession.

 

Choice "a" is correct. Inflation is defined as an increase in prices over time, and hyperinflation occurs when a country sees very high (and often accelerating) price level increases.

Choice "b" is incorrect. Deflation is defined as a decrease in prices over time.

Choice "d" is incorrect. A recession is defined as two consecutive quarters of negative economic growth (output). Prices may rise or fall during a recession, depending on movements in aggregate demand and supply.

Choice "c" is incorrect. Although inflation is an increase in prices, hyperinflation is a more rapid and problematic level of price increases.

34

Which of the following statements represents the best definition of stagflation?

a.

High inflation rates.

b.

High unemployment rates.

c.

A combination of rising unemployment and rising real GDP.

d.

A combination of rising unemployment and a rising price level.

 

Choice "d" is correct. Stagflation occurs when the economy suffers a recession that is characterized by falling output, rising unemployment, and a rising price level.

Choice "c" is incorrect. Real GDP is falling during stagflation, not rising.

Choice "a" is incorrect. High inflation rates is just one aspect of stagflation; the other is falling output and rising unemployment.

Choice "b" is incorrect. High unemployment rates are just one aspect of stagflation; the other is a rising overall price level (high inflation).

35

The primary purpose of the consumer price index (CPI) is to:

a.

Establish a cost-of-living index.

b.

Identify the strength of an economic recovery.

c.

Help determine the Federal Reserve Bank's discount rate.

d.

Compare relative price changes over time.

Choice "d" is correct. The CPI is a measure of the overall cost of a fixed basket of goods and services purchased by an average household. It is primarily used to compare relative price changes over time.

Choice "a" is incorrect. The purpose of the CPI is not simply to establish a cost-of-living index, but also to compare relative price changes over time.

Choice "b" is incorrect. The CPI does not measure the strength of an economic recovery or any other phase of the business cycle.

Choice "c" is incorrect. Although CPI information may be considered by the Federal Reserve to determine the discount rate, that is not the primary purpose of the CPI.

36

Inflation can be caused by:

a.

Increases in aggregate demand and decreases in aggregate supply.

b.

Increases in aggregate demand only.

c.

Decreases in aggregate demand and increases in aggregate supply.

d.

Increases in aggregate supply only.

Choice "a" is correct. Both an increase in aggregate demand and a decrease in aggregate supply can cause inflation.

Choice "b" is incorrect. While an increase in aggregate demand can cause inflation, it is not the only cause of inflation.

Choice "d" is incorrect. An increase in aggregate supply would lower the overall price level, not increase the overall price level.

Choice "c" is incorrect. A decrease in aggregate demand and an increase in aggregate supply would lower the overall price level, not increase the overall price level.

37

A lender and a borrower signed a contract for a $1,000 loan for one year. The lender asked the borrower to pay 3% interest. Inflation occurred and prices rose by 2% over the next year. The borrower repaid $1,030. What is the amount worth in real terms, after inflation?

a.

$1,050.60

b.

$1,009.80

c.

$1,019.80

d.

$1,060.90

 

Choice "b" is correct. The $1,030 amount repaid is readily adjusted for the 2% inflation by dividing it by a factor of 1.02 ($1,030 / 1.02 = $1,009.80), which is 1 plus the 2% inflation rate. Remember inflation reduces purchasing power and will reduce the valuation of a transaction.

Choice "d" is incorrect. The $1060.90 is produced by multiplying the $1,030 final payment by 1.03, not by dividing it by 1.02. The 2% reflects the inflation. The 3% is the interest rate.

Choice "a" is incorrect. The $1,050.60 is produced by multiplying, not dividing, the $1,030 final payment by 1.02.

Choice "c" is incorrect. The $1,019.80 is produced by dividing the $1,030 final payment by 1.01. The 1% is apparently produced by subtracting the 2% inflation rate from the 3% interest rate.

38

An increase in the discount rate would cause:

a.

The money supply to decrease and interest rates to fall.

b.

The money supply to increase and interest rates to rise.

c.

The money supply to decrease and interest rates to rise.

d.

The money supply to increase and interest rates to fall.

Choice "c" is correct. An increase in the discount rate discourages borrowing by member banks and thus decreases the money supply. A decrease in the money supply causes interest rates to rise.

Choice "d" is incorrect. An increase in the discount rate causes the money supply to decrease, not increase.

Choice "b" is incorrect. An increase in the discount rate causes the money supply to decrease, not increase.

Choice "a" is incorrect. A decrease in the money supply causes interest rates to rise, not fall.

39

Which of the following actions is acknowledged as the best measure to combat a period of deflation?

a.

Increasing the money supply.

b.

Decreasing interest rates.

c.

Increasing interest rates.

d.

Decreasing the money supply.

 

Choice "a" is correct. Deflation is a general decline in the overall price level (i.e., when the inflation rate is negative). Increasing the money supply causes the overall price level to rise. As a result, it helps eliminate deflation.

Choice "c" is incorrect. Increasing interest rates causes aggregate demand to shift left. As a result, the aggregate price level will fall even further. This will exacerbate deflation.

Choice "b" is incorrect. While this answer choice also counteracts deflation, choice "a" is the best answer. A decrease in interest rates causes the aggregate demand curve to shift right. As a result, the aggregate price level will rise. This helps eliminate deflation. However, there are times when interest rates are already so low that lowering interest rates is not an option. Thus, the preferred or "acknowledged" preventative measure for deflation is increasing the money supply.

Choice "d" is incorrect. Decreasing the money supply causes the overall price level to fall. This would obviously exacerbate deflation.

40

Which of the following is correct regarding the consumer price index (CPI) for measuring the estimated decrease in a company's buying power?

a.

The CPI is measured only once every 10 years.

b.

The products a company buys should differ from what a consumer buys.

c.

The CPI is skewed by foreign currency translations.

d.

The CPI measures what consumers will pay for items.

Choice "b" is correct. The consumer price index measures the costs of a market basket of specific goods commonly purchased by consumers. It measures consumer buying power and is not distorted by items generally bought by industry.

Choice "a" is incorrect. The Consumer Price Index (CPI) represents monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.

Choice "d" is incorrect. The Consumer Price Index measures what has been paid for items, not what consumers will pay for items.

Choice "c" is incorrect. The Consumer Price Index measures what has been paid by consumers in over eighty urban areas in the United States. The amounts paid are denominated in US dollars and would not be skewed by foreign currency translations.

41

How does inflation distort reported income?

a.

Depreciation is not reflective of current fixed-asset replacement costs.

b.

Sales are not reflective of current product prices.

c.

Wages are not reflective of current labor rates.

d.

Interest expense is not reflective of current borrowing rates.

Choice "a" is correct. Depreciation represents a method of reasonable and rational allocation of the historical cost of fixed assets to benefitting accounting periods. Depreciation is a method of allocation, not valuation. Inflation will cause the consumption of non-monetary assets accounted for as depreciation to be undervalued since the total value used as the basis for depreciation is the asset's historical cost, not an inflation adjusted amount.

Choice "c" is incorrect. Wages will typically increase with inflation as workers negotiate higher wages to keep up with inflation and employers increase wages to compensate for purchasing power losses due to inflation as a means of attracting and retaining a talented work force.

Choice "b" is incorrect. Product prices in a free market will increase with inflation. Sales revenue will reflect inflation.

Choice "d" is incorrect. Although long term borrowing rates may be reflective of historical rates, they include an adjustment for anticipated long term inflation and current interest rates will automatically adjust for inflation as lenders change rates to compensate for changes in purchasing power.

42

Deflation is best defined as:

a.

A continuous decline in real GDP.

b.

A continuous decline in the overall price level.

c.

When the price of a particular good falls.

d.

A continuous rise in the overall price level.

Choice "b" is correct. Deflation is defined as a continuous or sustained decline in the overall price level.

Choice "c" is incorrect. Deflation refers to a sustained decline in the overall price level, not the price of a particular good.

Choice "d" is incorrect. This is the definition of inflation.

Choice "a" is incorrect. Deflation refers to the overall price level, not changes in real GDP.

43

What does the consumer price index measure?

a.

Rate of inflation.

b.

Cost of capital.

c.

Prime rate of interest.

d.

Average household income.

 

Choice "a" is correct. The consumer price index is a measure of the inflation rate (the percentage change of the consumer price index from one period to the next). It is only one measure of inflation; there are others, such as the producers price index, but the consumer price index is the most widely known and used. 

Choice "b" is incorrect. The consumer price index does not measure the cost of capital. The cost of capital is calculated as the weighted-average cost of capital (WACC). 

Choice "d" is incorrect. The consumer price index does not measure average household income. 

Choice "c" is incorrect. The consumer price index does not measure the prime rate of interest.

44

If consumption is $70b, investment $50b, government spending $20b, exports $7b, and imports $5b, what is GDP?

a.

$138b.

b.

$152b.

c.

$142b.

d.

$140b.

 

Choice "c" is correct. Using the expenditure approach, GDP equals the sum of the components from the mnemonic GICEas follows:

Government Spending

$ 20b

Investment

50b

Consumption

70b

Exports - Imports (7b - 5b)

2b

GDP

$ 142b

45

Which of the following Federal Reserve policies would increase money supply?

a.

Change the multiplier effect.

b.

Sell more U.S. Treasury bonds.

c.

Increase reserve requirements.

d.

Reduce the discount rate.

Choice "d" is correct. If the Federal Reserve wanted to increase the money supply, it would reduce the discount rate. A lower discount rate would reduce short-term interest rates, which would encourage more (short-term) borrowing at the lower interest rate (lower cost means more demand). More borrowing means more lending and more money in the economy. 

Choice "a" is incorrect. The Federal Reserve really cannot change the multiplier "effect." It can change the multiplier by changing the required reserve ratio (which it seldom does), but it cannot change the effect. The multiplier effect is the effect on the money supply of the multiplier itself. It is due to banks having to keep only a (small) portion of amounts deposited in reserve. 

Choice "c" is incorrect. Increasing reserve requirements would mean less lending because banks would have to hold a larger portion of amounts deposited in reserve. That would mean a reduced money supply, not an increased money supply.

Choice "b" is incorrect. Selling more U.S. Treasury bonds would reduce, not increase, the money supply since the bonds would have to be paid for with money out of the money supply. If the Federal Reserve were to buy U.S. Treasury bonds, that would increase the money supply.

46

If the nominal interest rate is 10% and the rate of inflation is 5%, the real interest rate is:

a.

5%

b.

2%

c.

50%

d.

15%

 

Choice "a" is correct. The real interest rate is equal to the nominal interest rate minus inflation.

Thus, the real interest rate = 10% - 5% = 5%.

47

When the overall price level is rising, nominal interest rates tend to be:

a.

Unaffected by changes in the price level.

b.

Rising.

c.

None of the answer choices are correct.

d.

Falling.

Choice "b" is correct. The relationship between nominal interest rates and inflation can be seen by rearranging the equation for real interest rates as follows:

Nominal Interest Rate = Real Interest Rate + Inflation

Thus, if real interest rates do not change, a 1% increase in the inflation rate will lead to a 1% increase in nominal interest rates.

48

A hospital is comparing last year's emergency rescue services expenditures to those from 10 years ago.  Last year's expenditures were $100,500.  Ten years ago, the expenditures were $72,800.  The CPI for last year is 168.5 as compared to 121.3 ten years ago.  After adjusting for inflation, what percentage change occurred in expenditures for emergency rescue services?

a.

0.6% decrease.

b.

13.8% increase.

c.

38.0% increase.

d.

18.1% decrease.

 

Choice "a" is correct. The consumer price index (CPI) is a measure of the overall cost of a fixed basket of goods and services purchased by an average household. The inflation rate is calculated as the percentage change in the CPI from one period to the next. By extension, nominal costs can be deflated to price level adjusted amounts by dividing a base year price index by the current year price index. The current fact pattern anticipates the following computation:

Base year – emergency rescue service

72,800

Current year costs times the ratio of base to current year indices: $100,500 × (121.3 / 168.5) =

72,348

Difference (decrease)

(452)

The percentage change in the expenses is simply the change divided by the base year computed as follows: (452) / 72,800 = .6% decrease.

Choice "c" is incorrect. The proposed solution does not adjust the costs for inflation.

Choice "b" is incorrect.  The proposed solution "inflates" the base year with the CPI index applicable to that year and then compares it to the unadjusted nominal value in the current year. The proposed solution ignores the idea that inflation adjustments are based on the relative change in economic measures.

Choice "d" is incorrect. The proposed solution "inflates" the base year with the CPI index applicable to the current year and then compares it to the unadjusted nominal value in the current year. The proposed solution ignores the idea that inflation adjustments are based on the relative change in economic measures.

49

If a CPA's client expected a high inflation rate in the future, the CPA would suggest to the client which of the following types of investments?

a.

Common stock.

b.

Precious metals.

c.

Treasury bonds.

d.

Corporate bonds.

 

Choice "b" is correct. Precious metals are a non-monetary asset whose value increases with inflation. Therefore, precious metals would likely serve as a better hedge against inflation than common stock or fixed income securities.

Choice "c" is incorrect. Treasury bonds are fixed in value and will not keep up with the purchasing power losses caused by inflation. Inflation will likely cause interest rates to increase and thereby reduce the value of fixed interest rate securities purchased at the beginning of an inflationary cycle.

Choice "d" is incorrect. Corporate bonds are assets that are fixed in value and will not keep up with the purchasing power losses caused by inflation. Inflation will likely cause interest rates to increase and thereby reduce the value of fixed interest rate securities purchased at the beginning of an inflationary cycle.

Choice "a" is incorrect. The value of common stock generally increases with inflation, but is also impacted by the value of the underlying company and market fluctuations that are impacted by numerous factors other than inflation. The use of equities may represent a long term hedge against inflation but equities would not be as effective as commodities in the short term.

50

To decrease the money supply, the Fed might:

a.

Lower the discount rate.

b.

Buy government securities on the open market.

c.

Decrease the required reserve ratio.

d.

Sell government securities on the open market.

Choice "d" is correct. To decrease the money supply, the Fed can: (1) sell government securities in the open market, (2) increase the discount rate, and (3) increase the required reserve ratio.

Choice "b" is incorrect. The Fed should sell (not buy) securities on the open market.

Choice "c" is incorrect. The Fed should increase (not decrease) the required reserve ratio.

Choice "a" is incorrect. The Fed should increase (not decrease) the discount rate.

51

The determination of gross domestic product (GDP) by the expenditure approach would include:

a.

Compensation to employees.

b.

Net exports.

c.

A capital consumption allowance.

d.

Business profits.

Choice "b" is correct. The expenditure approach to computing GDP includes exports and other components included in the mnemonic "GICE":

Government expenditures

Capital investment

Consumption

Net exports

Choice "d" is incorrect. Business profits are used in the income approach for computing GDP, not the expenditure approach.

Choice "a" is incorrect. Employee compensation is used in the income approach for computing GDP, not the expenditure approach.

Choice "c" is incorrect. The capital consumption allowance (depreciation) is used in the income approach for computing GDP, not the expenditure approach.

52

A sharp rise in the price of oil (a major input), would result in:

a.

Cost (Push) inflation.

b.

Demand (Pull) inflation.

c.

An increase in aggregate supply.

d.

An increase in aggregate demand.

 

Choice "a" is correct. Cost (Push) inflation is inflation caused by a shift left in aggregate supply. An increase in input costs, such as a sharp increase in the price of oil, will cause the short-run aggregate supply curve to shift left and thus increase the aggregate price level causing inflation.

Choice "b" is incorrect. Demand (Pull) inflation is inflation caused by a shift right in aggregate demand.

Choice "d" is incorrect. An increase in the price of oil causes the aggregate supply curve to shift, not the aggregate demand curve.

Choice "c" is incorrect. An increase in the price of oil will cause aggregate supply to decrease (shift left), not increase.

53