CFA Program — Economics

Correct answer: A) Consumption, Investment, Government Spending, and Net Exports

The expenditure approach to GDP sums consumption (C), investment (I), government spending (G), and net exports (exports minus imports): GDP = C + I + G + (X - M).

Correct answer: C) Inelastic

A price elasticity of demand with an absolute value less than 1 indicates inelastic demand, meaning quantity demanded changes proportionally less than price.

Correct answer: B) Horizontal at the market price

In perfect competition, individual firms are price takers, facing a perfectly elastic (horizontal) demand curve at the prevailing market price, since they cannot influence price by changing output.

Correct answer: C) An increase in consumer confidence and spending

Aggregate demand shifts rightward with increases in any of its components (consumption, investment, government spending, net exports); higher consumer confidence typically raises consumption spending, shifting AD right. A change in the price level itself causes movement along the curve, not a shift.

Correct answer: B) Combat inflation by discouraging borrowing and spending

Raising the policy rate increases the cost of borrowing, which tends to reduce consumption and investment spending, cooling demand-pull inflationary pressure.

Correct answer: D) Monopoly

A monopoly consists of a single seller with significant pricing power due to high barriers to entry, in contrast to the many sellers found in perfect competition and monopolistic competition, or the few large sellers in an oligopoly.

Correct answer: D) Zero economic profit, as free entry drives economic profit toward zero over time, though the firm may retain some pricing power from product differentiation.

In monopolistic competition, low barriers to entry mean that any short-run economic profits attract new entrants, competing away those profits until, in the long run, firms earn approximately zero economic profit, even though they retain some pricing power due to product differentiation.

Correct answer: C) Government decisions about spending and taxation used to influence the economy.

Fiscal policy refers to government spending and taxation decisions used to influence aggregate demand and economic activity, distinct from monetary policy, which is conducted by a central bank through tools like interest rates and the money supply.

Correct answer: B) A corresponding net inflow of foreign capital (a capital/financial account surplus).

Under the balance of payments accounting identity, a current account deficit (such as a trade deficit) must be offset by a capital/financial account surplus, meaning the deficit is financed by net capital inflows from abroad.

Correct answer: A) The responsiveness of quantity supplied to a change in price.

Elasticity of supply measures how much the quantity supplied of a good changes in response to a change in its price, analogous to how elasticity of demand measures responsiveness of quantity demanded.

Correct answer: D) Increase the money supply and lower long-term interest rates, particularly when short-term policy rates are already near zero.

Quantitative easing involves large-scale asset purchases by a central bank to inject liquidity into the financial system and put downward pressure on longer-term interest rates, typically used when conventional short-term rate cuts have limited room to go further (rates near the zero lower bound).

Correct answer: C) A measure of the overall price level of goods and services included in GDP, used to convert nominal GDP into real GDP.

The GDP deflator is a price index reflecting the overall level of prices for goods and services included in GDP, calculated as (Nominal GDP / Real GDP) x 100, used to adjust nominal GDP for inflation.

Correct answer: C) Perfectly (horizontally) elastic at the prevailing market price.

A price-taking firm in perfect competition faces a horizontal (perfectly elastic) demand curve at the market price, since it can sell any quantity at that price but would sell nothing above it, given the presence of many close substitutes from other firms.

Correct answer: D) Unemployment resulting from the normal time it takes workers to search for and transition between jobs.

Frictional unemployment reflects the normal, temporary unemployment that occurs as workers search for new jobs, change careers, or enter the workforce for the first time, distinct from structural or cyclical unemployment.

Correct answer: C) Increase the domestic price of steel and protect domestic steel producers, while raising costs for domestic industries that use steel as an input.

A tariff on imported steel raises the price of imported steel, making domestically produced steel relatively more competitive and protecting domestic producers, but it also raises costs for domestic firms that use steel as an input, and generally raises prices for end consumers.

Correct answer: D) Unemployment arising from a mismatch between workers' skills and the skills demanded by available jobs, often due to technological change or shifting industries.

Structural unemployment results from a fundamental mismatch between the skills workers have and the skills employers need, often driven by technological change, automation, or shifts in which industries are growing or declining, and it can persist longer than frictional unemployment.

Correct answer: A) Quantitative easing (large-scale asset purchases)

When conventional interest rate cuts are constrained by the zero lower bound, central banks may turn to unconventional tools like quantitative easing, purchasing large quantities of government bonds or other assets to inject liquidity and lower longer-term borrowing costs.

Correct answer: B) New building permits issued

Leading indicators, like new building permits or stock market performance, tend to change direction before the broader economy does, making them useful for anticipating future economic activity, unlike lagging indicators (like the unemployment rate) or roughly coincident indicators.

Correct answer: A) Decrease by 4%

Price elasticity of demand = %ΔQ / %ΔP. With elasticity = −0.4 and %ΔP = +10%: %ΔQ = −0.4 × 10% = −4%.

Correct answer: B) Zero economic profit

In long-run equilibrium under perfect competition, free entry drives economic profits to zero. Firms earn only a normal profit (accounting profit covering opportunity costs).

Correct answer: C) Reduce aggregate demand by increasing borrowing costs

A higher policy rate raises borrowing costs, discourages consumer credit and business investment, reducing aggregate demand. This is a standard contractionary monetary policy effect.

Correct answer: B) Shift the IS curve right and raise interest rates

Expansionary fiscal policy shifts the IS curve right. With an unchanged LM curve, equilibrium income rises and interest rates increase, partially crowding out private investment.

Correct answer: B) Price levels of a common basket of goods across countries

PPP states that exchange rates will adjust so that identical goods cost the same in different countries when expressed in a common currency, eliminating arbitrage opportunities.

Correct answer: A) A surplus in its capital and financial account

The balance of payments must balance. A current account deficit (net outflow) must be offset by a capital and financial account surplus (net inflow of foreign capital).

Correct answer: D) Inelastic, since the absolute value of elasticity is less than 1.

When the absolute value of price elasticity of demand is less than 1, demand is described as inelastic, meaning quantity demanded responds proportionally less than the price change -- a 1% price increase would lead to a smaller than 1% decrease in quantity demanded.

Correct answer: C) A proportional increase in the price level (inflation), holding velocity constant.

The quantity theory of money (MV = PY) implies that if velocity (V) and real output (Y) are held constant, an increase in the money supply (M) leads to a proportional increase in the price level (P) -- i.e., inflation.

Correct answer: B) Marginal revenue equals marginal cost.

In perfect competition (and more generally under standard profit maximization), a firm maximizes profit by producing at the output level where marginal revenue equals marginal cost (MR = MC); producing beyond this point means each additional unit costs more to produce than it earns in revenue.

Correct answer: A) Cool down an overheating economy and control inflation by making borrowing more expensive.

Central banks typically raise policy rates to slow economic activity and control inflation by making borrowing more costly, which tends to reduce consumption and investment spending, cooling aggregate demand.

Correct answer: D) A cost imposed on third parties who are not part of a transaction, such as pollution from a factory affecting nearby residents.

A negative externality occurs when a transaction imposes uncompensated costs on third parties outside the transaction, such as pollution affecting people who are not buyers or sellers in the market for the polluting good.

Correct answer: C) At a lower opportunity cost relative to other goods, compared to another country.

Comparative advantage is based on opportunity cost, not absolute cost: a country has a comparative advantage in producing a good if it can produce that good giving up less of other goods (a lower opportunity cost) than another country would have to give up.

Correct answer: B) A normal good, since income elasticity of demand is positive, meaning quantity demanded rises as income increases.

A normal good is one for which quantity demanded increases as consumer income rises, corresponding to a positive income elasticity of demand. This is in contrast to an inferior good, for which quantity demanded falls as income rises (negative income elasticity).

Correct answer: C) A Pigouvian tax on the factory's output, set to reflect the external cost imposed on third parties, which raises the factory's private cost closer to the true social cost of production.

A Pigouvian tax is designed to correct a negative externality by imposing a tax roughly equal to the external cost imposed on third parties, aligning the producer's private cost more closely with the good's true social cost and thereby discouraging overproduction relative to the socially optimal level.

Correct answer: B) The unemployment rate that persists in a stable, long-run equilibrium economy, reflecting frictional and structural unemployment, once cyclical unemployment is eliminated.

The natural rate of unemployment reflects the level of unemployment consistent with a stable long-run equilibrium, comprising frictional and structural unemployment, once cyclical unemployment (associated with the business cycle) is excluded. It is sometimes referred to as the non-accelerating inflation rate of unemployment (NAIRU).

Correct answer: A) The trough

The trough marks the lowest point of the business cycle, representing the end of a contraction and the point at which economic activity begins to turn upward into the subsequent expansion phase, as distinguished from the peak, which marks the high point before a contraction begins.

Correct answer: D) Yes, both countries can still gain from trade if each specializes in producing the good for which it has a comparative (relative opportunity cost) advantage, even if one country has an absolute advantage in producing both goods.

The principle of comparative advantage shows that mutually beneficial trade can occur based on relative (opportunity cost) advantages, even when one country holds an absolute advantage in producing every good. Each country gains by specializing in the good for which its opportunity cost of production is lowest relative to the other country.

Correct answer: C) Rival firms will match a price decrease (to avoid losing market share) but will not match a price increase (allowing the price-raising firm to lose customers to competitors).

The kinked demand curve model assumes that if an oligopolist raises its price, rivals will not follow, causing the firm to lose significant market share (elastic demand above the kink), while if the firm cuts its price, rivals will match the cut to avoid losing customers, limiting the firm's gain in market share (inelastic demand below the kink). This asymmetry helps explain price rigidity commonly observed in oligopolies.