II. Economic Concepts and Analysis

Question 1

In the pharmaceutical industry where a diabetic must have insulin no matter the cost and where there is no other substitute, the diabetic’s demand curve is best described as

Perfectly elastic.
Perfectly inelastic.
Elastic.
Inelastic.

Answer 1

Perfectly inelastic.

Demand for the product is perfectly inelastic because the diabetic will purchase the product regardless of the price.

Question 2

Increased demand for product A increases the demand for resources used to produce product A. What is the best explanation for the increase in the demand for resources?

The theory of derived demand is working.

Product A is in an expanding industry.

The theory of the invisible hand is working.

The demand for product A is highly elastic.

Answer 2

The theory of derived demand is working.

Derived demand is the demand for a good or service that results because it is an input needed in order to provide another good or service for which there is demand. The demand for a good or service is derived from the demand for another good or service. The theory of derived demand explains why an increase in product A increases the demand for resources used to produce product A.

Question 3

Which of the following balanced scorecard perspectives examines a company’s success in targeted market segments?

.Financial.

.Customer.

.Internal business process.

.Learning and growth.

Answer 3

.Customer.

The customer perspective evaluates the organization’s success in targeted customer and market segments.

Question 4

A financial institution looking to assess its investment portfolio’s exposure to price changes most likely would use which of the following techniques?

.Market value at risk analysis.

.Cash flow at risk analysis.

.Earnings at risk analysis.

.Back testing analysis

Answer 4

.Market value at risk analysis.

A financial institution would most likely assess its investment portfolio’s exposure to price changes using market value at risk analysis. The risk of changes in the price of an investment portfolio is, as the concept implies, the potential for decline in the market price, or market value, of the investment portfolio.

Question 5

An expansionary [List A] policy will have [List B] effect on net exports.

• List A - List B
  _________________________
  .Fiscal A negative

.Fiscal No

.Monetary A negative

.Monetary No

Answer 5

.Fiscal A negative

An increase in governmental spending causes an increase in domestic interest rates and international capital inflows. These capital inflows cause the domestic currency to appreciate, which has a negative effect on net exports.

Question 6

A rise in a country’s exports would most likely cause which one of the following shifts to be the most immediate effect?

.The aggregate supply curve would shift outward.

.The aggregate demand curve would shift outward.

.The aggregate supply curve would shift inward.

.The aggregate demand curve would shift inward.

Answer 6

The aggregate demand curve would shift outward.

A rise in the exports of a country most likely would shift the aggregate demand curve outward as the most immediate effect, i.e., there would be an increase in aggregate demand.

Question 7

In a perfect monopoly, which of the following describes the relationship between the marginal revenue curve and the demand curve?

.The marginal revenue curve is the demand curve.

.The marginal revenue curve is above the demand curve and the curves diverge as the quantity increases.

.The marginal revenue curve is below the demand curve and the curves diverge as the quantity increases.

.The marginal revenue curve is below and parallel to the demand curve.

Answer 7

.The marginal revenue curve is below the demand curve and the curves diverge as the quantity increases.

In a perfect monopoly market structure, the marginal revenue curve is below the demand curve and the curves diverge as the quantity increases. The basic reason for the relationship is that, facing a downward-sloping demand curve, the firm must continuously lower its selling price in order to sell more units; therefore, marginal revenue must be below demand.

Question 8

If the central bank of a country raises interest rates sharply, the country’s currency will most likely

.Increase in relative value.

.Remain unchanged in value.

.Decrease in relative value.

.Decrease sharply in value at first and then return to its initial value.

Answer 8

.Increase in relative value.

If the interest rate is increased investors will be able to get a larger return on investment in the country. Therefore, demand for the currency will increase for investment purposes, and the relative value of the currency will increase.

Question 9

In microeconomics, the distinguishing characteristic of the long run on the supply side is that

.Only supply factors determine price and output.

.Only demand factors determine price and output.

.Firms are not allowed to enter or exit the industry.

.All inputs are variable.

Answer 9

.All inputs are variable.

The distinguishing characteristic of the long-run production function is that all costs are variable.

Question 10

Which of the following statements is correct regarding the variety and price of products produced under monopolistic competition as compared to production under perfect competition?

.The monopolistically competitive industry produces a greater variety of products at a lower cost per unit.

.The monopolistically competitive industry produces a greater variety of products at a higher cost per unit.

.The monopolistically competitive industry produces a smaller variety of products at a lower cost per unit.

.The monopolistically competitive industry produces a smaller variety of products at a higher cost per unit.

Answer 10

.The monopolistically competitive industry produces a greater variety of products at a higher cost per unit.

Under monopolistic competition, there will be a greater variety of products produced at a higher unit cost than under perfect competition. Under perfect competition, there are a large number of buyers and sellers, each of which is too small to separately affect the price of the good or service, selling a homogeneous good or service, and entry into (or exit from) the market is easy. Since each firm must accept the price set by the market (be a “price taker”), a firm’s marginal revenue (MR) is equal to the price (P) it can charge. Optimum production output occurs where MR = marginal cost (MC) = P. If firms are making a profit at that level of output, more firms will enter the market, which will increase market supply and drive market price down so that each firm just breaks even. In a monopolistically competitive market, a large number of providers sell differentiated products or services for which there are close substitutes. Because there is product differentiation, the MR and demand (D) curves have downward slopes, with the MR below D. As in perfect competition, optimum output occurs where MR = MC. At that level of output (MR = MC), P will be greater than MC and greater than P under perfect competition. Therefore, a monopolistically competitive industry produces a greater variety of products at a higher cost per unit than would occur in perfect competition.

Question 11

If both demand and supply have traditional curves, a higher equilibrium price may be caused by which one of the following?

.A decrease in demand.

.An increase in demand.

.An increase in supply.

.A production technology innovation.

Answer 11

.An increase in demand.

A higher equilibrium price (and quantity) would be caused by an increase in demand.

Question 12

The full-employment gross domestic product is $1.3 trillion, and the actual gross domestic product is $1.2 trillion. The marginal propensity to consume is 0.8. When inflation is ignored, what increase in government expenditures is necessary to produce full employment?

$100 billion

$80 billion

$20 billion

$10 billion

Answer 12

$20 billion

In order to reach full employment, gross domestic product needs to increase by $.1 trillion (i.e., $1.3 trillion @ full employment - $1.2 trillion @ current = $.1 trillion shortfall). Because of the multiplier effect, additional government expenditures needed to increase gross domestic product by that amount is $20 billion. The formula is:

Multiplier Effect = Initial Change in Spending × (1/(1 - MPC))

Where: Initial Change in Spending = X, and substituting known values:

$.1T = X × [1/(1-.8)] [NOTE: .1T = 100B.]; therefore:

$100B =	 X × [1/.2]
$100B =	 X × 5
X =	 $100B/5
X =	 $20B
A $20B increase in government expenditures would result in $100 billion increase in gross domestic product.

Question 13

Assume that the Gross Domestic Product (GDP) Deflator index is:

Year	GDP Deflator
Year 1	175
Year 2	180
Year 3	184
If nominal GDP for Year 3 is $11,500 billion, which of the following amounts is closest to real GDP for Year 3?

$11,058 billion.

$11,275 billion.

$9,660 billion.

$6,250 billion.

Answer 13

$6,250 billion.

Real GDP is determined by adjusting nominal (current dollar) GDP for the effects of inflation, such that current-year GDP is expressed in terms of base period dollars (price level). The Year 3 GDP deflator of 184 shows that the price level has increased by 84% since the base period. The calculation is:

100 - 184 = 84 = .84
100 100
Thus, Year 3 prices are 184% of the base period prices. To get real GDP, nominal GDP is divided by 1.84. Thus, $11,500/1.84 = $6,250 billion. In terms of base period dollars, Year 3 GDP would be $6,250 billion.

Question 14

The U.S. M1 measure of money supply includes:

Paper Currency, Check-Writing Deposits, Savings Deposits

• Yes Yes Yes
• Yes Yes No
• Yes No Yes
• Yes No No

Answer 14

-Yes Yes No

The M1 measure of money supply includes paper currency, coins, and check-writing deposits, which are the primary financial instruments used for transactions.

Check-writing deposits are amounts held by banks, savings and loan associations, and credit unions for which ownership can be transferred by writing a check. Savings deposits are not an element of the M1 definition of money.

Question 15

An improvement in technology that in turn leads to improved worker productivity would most likely result in

• A shift to the right in the supply curve and a lowering of the price of the output.
• A shift to the left in the supply curve and a lowering of the price of the output.
• An increase in the price of the output if demand is unchanged.
• Wage increases.

Answer 15

-A shift to the right in the supply curve and a lowering of the price of the output.

If the cost of producing a good declines, more will be supplied at a given price. Therefore, the supply curve will shift to the right.

Question 16

In a perfect monopoly market structure, which of the following is characteristic of a natural monopoly?

A firm has control of an essential input to the production process.

A firm has increasing returns to scale.

A firm owns a secret formula.

A firm has a government-granted exclusive franchise.

Answer 16

A firm has increasing returns to scale.

A natural monopoly results from conditions in which there are increasing returns to scale, such that a single firm can produce at a lower cost than two or more firms. Typically, fixed costs are extremely high, making it inefficient for a second firm to enter the market.

Question 17

A short-term speculative rise in the worldwide value of the domestic currency could be moderated by a central bank decision to

• Sell domestic currency in the foreign exchange market.
• Buy domestic currency in the foreign exchange market.
• Sell foreign currency in the foreign exchange market.
• Increase domestic interest rates.

Answer 17

-Sell domestic currency in the foreign exchange market.

A short-term speculative rise in the worldwide value of the domestic currency could be moderated by a central bank deciding to sell domestic currency in the foreign exchange market. The sale of domestic currency would increase the supply of the domestic currency in the market and, thus, dampen the rising value of the domestic currency.

Question 18

The consensus of economic forecasts indicates that consumer prices are likely to increase because of increases in aggregate demand. Which of the following outcomes is most likely to occur as prices increase?

• Quantity of output increases if there is capacity to produce.
• Unemployment increases.
• Profits fall if all costs are fixed.
• Profits rise even if cost increase.

Answer 18

-Quantity of output increases if there is capacity to produce.

Output will increase to meet the increase in aggregate demand, which is the basis for demand-pull inflation.

Question 19

In a macroeconomic free-market flow model, which one of the following would not be considered an “injection”?

• Government spending.
• Investment spending.
• Government subsidies.
• Imports.

Answer 19

-Imports.

In a macroeconomic free-market flow model, injections are the sources of amounts added to domestic production that do not result from domestic consumption expenditures, including government spending, government subsidiaries, investment spending, and amounts received from exports, but not amounts paid for imports.

Question 20

Assuming that the real rate of interest is the same in both countries, if country A has a higher nominal interest rate than country B, then the currency of country A will likely be selling at a

• Forward discount relative to the currency of country B.
• Forward premium relative to the currency of country B.
• Spot discount relative to the currency of country B.
• Spot premium relative to the currency of country B.

Answer 20

-Forward discount relative to the currency of country B.

If the real rates of interest are the same, the country with the higher nominal interest rate is expected to experience a higher rate of inflation. A higher rate of inflation is associated with a devaluing currency so the currency of the country with the higher nominal interest rate will likely be selling at a forward discount.