CC-Economics Revised

8/13/2019 CC-Economics Revised

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Crash Course forEconomics

CFA Level-I Exam

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Economics



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Micro Economics

Elasticity Market & Efficiency Competitive Market Markets for factors ofProduction

Elasticity of SupplyElasticity of Demand

Price elasticity of Demand = % change inQuantity demanded / %change in Price%change = change in value / Average ValueIf absolute value > 1, demand is elastic;If absolute value < 1, demand is inelasticIf absolute value = 1, demand is unit elastic.

Elastic demand: A small price increase causes alarge decrease in quantity demandedInelastic demand: A large price increase causesa small decrease in quantity demandedPerfectly elastic demand: A small priceincrease reduces the quantity demanded to 0.Perfectly inelastic demand: A price changedoes not affect the quantity demanded.

Income Elasticity Cross Elasticity



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Price elasticity has two main determinants:Availability of substitutes: If substitute goods are available, consumer mayswitch to a substitute good if price rise. The presence of many substitutesmay tend to increase demand elasticityShare of budget spent on product: goods that occupy relatively small portionof your budget will tend to be price inelasticAn inferior good has -ve income elastic

An normal good has +ve income elastic

Income elasticity of Demand =%change in Quantity demanded

/ %change in real income

Cross elasticity of Demand =%change quantity demanded /

%change in price of substituteor complement

Income Elasticity Cross Elasticity

Q.The cross elasticity of demand for asubstitute good and the incomeelasticity for an inferior good are:Cross elasticity Income elasticityA. < 0 > 0, < 1B. < 0 < 0C. > 0 > 0, < 1D. > 0


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Price elasticity of supply = % change inQuantity supplied / %change in Price

Two main determinants:

Available substitute for raw materialsused to produce the goods

Time elapsed since the last pricechange

Micro Economics




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Elasticity of Demand, Supply& Tax Incidence

Consumer &Producer Surplus

Efficient ResourceAllocation

Idea AboutFairness

Market in Action

Q. Which of the following is least likely to

result in DWL?Indian RailwaysIndian OilMTNLAns. Indian railways operate in monopolymarket & Indian Oil sells subsidized good.In both cases DWL are bound to getcreated, whereas MTNL operates in acompetitive telecom market

Price ceiling is an upper limit onthe price a seller can charge.Price floor is the lowest limit onthe price that a buyer can offer fora good or service.A deadweight loss resultsbecause less than the efficientquantity is produced or consumed

Tax revenue fromsellers

Elastic Supply Curve

Tax revenue frombuyers

Ptax

PE

Ps

Price

SD

DWL

Quantity

Dtax

Qtax QE

Ttax revenue from sellers

Taxtax revenue from buyers

PPE

Ptax

Dtax

E

Inelastic Supply Curve

Price

SD

DWL

Quantity

Qtax QE

Elastic Demand Curve



Ptax

PE

PS

Price

S

D

DWL

Quantity

S

tax

Qtax QE

Inelastic Demand Curve



Ptax

PE

PS

Price

SD

DWL

Quantity

S tax

Qtax

QE

Micro Economics




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Ptax

PE

Ps

Price

S

D

DWL

Quantity

Dtax

Qtax

QE

TTax revenue from sellers

TaxTax revenue from buyersPPE

Ptax

Dtax

E


Price

SD

DWL

Quantity

Qtax QE




Ptax

PE

PS

Price

S

D

DWL

Quantity

S tax

Qtax

QE

Inelastic Demand Curve



Ptax

PE

PS

Price

SD

DWL

Quantity

S tax

Qtax

QE




Consumer surplus is the difference b/wwhat a consumer is willing to pay for a good

or service & what he actually pays for itProducer surplus is the difference b/w theprice a producer receives for a unit output &minimum supply price for (opportunity costof) that unit.Marginal social benefit is the sum of allconsumersmarginal benefit from a good orservice. The marginal social benefit curve isthe market demand curve for the good orservice

Idea AboutFairness

Market in Action

Q. If a consumer is ready to pay $300 for i-phone, but has to pay only $199, thedifference of $101 is?A) Consumer deficit B) Producer surplus C)Consumer surplusAns. Consumer surplus

Micro Economics








Idea AboutFairness

Market inAction

Obstacles to Efficient ResourceAllocationPrice ControlsTaxes, Subsidies & Production quotas

MonopolyExternal BenefitsPublic Goods & Common Resources

Utilitarianismis the idea that the valueof an economy is maximized wheneach individual owns an equal amountof the resources.The Symmetry Principle implies that

when an economy is based on privateproperty & voluntary exchange ,individual get goods & services that areequal in value to their contribution tothe economy




Ptax

PE

Ps

Price

S

D

DWL

Quantity

Dtax

Qtax QE

TTax revenue from sellers

TaxTax revenue from buyersPPE

Ptax

Dtax

E


Price

SD

DWL

Quantity

Qtax QE




Ptax

PE

PS

Price

S

D

DWL

Quantity

S tax

Qtax QEInelastic Demand Curve



Ptax

PE

PS

Price

SD

DWL

Quantity

S tax

Qtax

QE

Micro Economics





Parameter PerfectCompetition

Monopoly Monopolistic Market Oligopoly

Product Type Homogenous Well-definedproduct withno substitute

similar yet notperfectly substitutable

Similar ordifferentiated

Number of

Producers

Large no. ofindependent

producers

Single firm A large no. ofindependent sellers

A small no. offirms

Market Share Very Small Near 100% Small High

Barriers to Entry No barriers Very high Low High

Price Commanding

Power

Price Takers PriceSearchers

Very Low Follow

Demand Curve PerfectlyInelastic

DownwardSloping

Downward sloping DownwardSloping or

kinked

Price

discrimination

No Yes Low No

Four Firm

Concentration

Ratio

Below 40% 100% 40%-60% Greater than60%

Herfindahl

Hirschman Index

Less than 1,000 10,000 1,000-1,800 Greater than1,800

Micro Economics





Macro Economics

Inflation Aggregate Demand &Supply

Monetary & FiscalPolicyMoney

Rate of change in priceindex over a given periodof timei = [current price index -last period price index] /last period price index

Jobs & Price Level

Aggregate supply Shift in Curve Aggregate Demand

QWhich of the following events is least likely to causea downward shift in short-run aggregate supply?a)A labor stoppage causes the price of steel to rise.b) Inflation increases from 4% to 7%.c) Oil exporting countries reduce their productionlevelsAns: B




Aggregate Supply Shift in Curve Aggregate Demand

Full EmploymentReal O/P

Long run Aggregate

supply (SAS)

Price Level

Real O/P (GDP)

Short run Aggregate

supply (SAS)

Aggregate supply in Long run and Short run

Q Which of the following events is least likely tocause a downward shift in short-run aggregatesupply?a)A labor stoppage causes the price of steel to rise.b) Inflation increases from 4% to 7%.c) Oil exporting countries reduce their productionlevels

Aggregate supply - amount ofgoods and services produced by aneconomy.Function of the price level - higherprices bring about a greater amountof supply in the short run.

The SAS and LAS curves will both shift when:

The full-employment quantity of labor changes

The amt of available capital in the economy changesAs technology improves the productivity capital, labor,or both.

There are some factors that will shift SAS, but notaffect LAS.

If the wage rate or prices of other productiveinputs increase, the SAS curve will shift to theleft, a decrease in short-run aggregate supply.

When businesses observe a rise in resourceprices, they will decrease their output as the profitmaximizing level of output declines.

Macro Economics



Jobs & Price Level





GDP1 GDP*

Price Level

P0PSRPLR

LASSAS1

SAS0

AD0

AD1

Real O/P GDP

Adjustment to a decrease in aggregate demand

LAS

P2P1P0

SAS1

Real GDP

Price Level

Resulting increase in aggregate demand

SAS0

AD1

AD0

Decrease in AD from AD0to AD1willlead to a new short-run equilibriumwith the price level at PSR & realGDP at GDP1which is less than full-employment GDP (a recession)

From an initial state of long-runequilibrium at the intersection of AD0with LAS, assume that aggregatedemand increases to AD1. The newshort-run equilibrium will be at over fullemployment with real GDP at GDP1

Macro Economics



Jobs & Price Level





Components of aggregate demand:Consumption (C)Investment (I)Government spending (G)Net exports (X), which is exports minusimports

Aggregate demand = C + I + G + X

Factors affecting Aggregate Demand:

Expectations about future incomes (C),inflation (C), and profits (I)

Fiscal policySpending G

Taxes or Transfer Payment (SocialSecurity) C

Monetary policy

Money supply Interest rate C and I AD

World economy : If country's exchangerate AD

Q. Increase in money supply will causeGDP to1. Increase in both short run and long

run2. Increase at higher rate in short run

and temporarily increase in longrun

3. Increase in short run andtemporarily increase in long run

Ans. Increase in money supply willcause GDP to increase at higher rate inshort run due to multiplier effect andtemporarily increase in long run whichreverses and GDP returns to fullemployment GDP level

Macro Economics



Jobs & Price Level




Jobs Price LevelUnemployment & Inflation

Rate of unemployment: No. ofunemployed / no. of people in laborforce.Labor-force participation rate: Civilianlabor force / civilian population age 16 orolder.Employment-to-population ratio: %ageof working-age population who areemployedAggregate hours: Total hours worked ina year by all employed people.

Real wage rate: Money wages adjustedfor changes in the price level

Key Labor Market Indicators Types of Unemployment

Frictional unemployment arises from constantchanges in the economy that prevent qualifiedworkers from being matched with existing jobopenings in a timely manner.

Structural unemployment is caused bystructural changes in the economy that eliminatesome jobs while generating job openings forwhich unemployed workers are not qualified.

Cyclical unemployment is caused by a changein the general level of economic productivity.When the economy is operating at less than full

capacity, positive levels of cyclical unemploymentwill be present.

Q. Which of the following is most likely to be an example of structural unemployment?A) Jack was unable to find new job with a lucrative salary, though he was offered a salaryhike of 15% by another employerB) Demand for the actuarial candidates are quite high compared to insurance agentC) John is searching for a new job as he donthave expertise in handling new high risecrane, which his employer has installed recentlyAns: C

Macro Economics



Jobs & Price Level





Unanticipated inflation: Anunexpected decrease i``n thepurchasing power of (real value of)currency.Effects:Long-term contracts of fixed futurepayments decrease in value.Decreases the value of a fixed-payment mortgage held by a bank,Gains and losses in the labormarket:

- real value of the wagesdecreases

- gain for employers at theexpense of employeesEven when inflation rates arecorrectly anticipated, it has adverseeffectsHigher transaction costs: Time &effects diverted from producingactivity reduces real GDPTax effects: Real after tax returns oninvestment are distorted by inflation

Demand Pull & CostPush Inflation

Phillips CurveUnanticipated &Anticipated Inflation

SR Phillips curveintersects the LR Phillipscurve at the expectedrate of inflation.

1

Short run PC whenexpected inflation=6%

Short run PC when

expected inflation=8%

GDP

F

12%

10

%

8%

6%

4%

Unemployment

Phillips Curve

Long Run PhillipsCurve

PC1

PC2Inflation

2GDP1 GDP2

Price Level

P3P2P1

LRASSRAS1

SRAS2

AD2

AD1

Real GDP

Demand Pull Inflation

SRAS1

GDP2GDP1GDP1

PriceLevel

P3

P2

P1

LRAS

SRAS2

AD2

AD

1

RealGDP

Cost Pull

Inflation

Macro Economics



Jobs & Price Level





CPI measures the average price for a defined"basket" of goods and services that representsthe purchasing patterns of a typical urbanhousehold.CPI= [(cost of basket at current prices) / (cost ofbasket at base period prices)] x 100

CPI biasCPI overstates inflation due to:New goods: Older products replaced bynewer but initially more expensive productsQuality changes: If the price of a productincreases because the product has improvedCommodity substitution:When 2 goods aresubstitutes for each other, consumers increasetheir purchases of the relatively cheaper good &buy less of the relatively more expensive good.Outlet substitution: When consumers shift

their purchases toward discount outlets & awayfrom convenience outlets, they reduce their costof living in a way the CPI does not capture.

Q. Price of common salt was 5 cents in year 1990and is presently sold at 20 cents. During the sameperiod CPI has increased from 154.5 to 365.8. Whathas been the change in real price of salt over thisperiod?Ans: CPI Multiplier = 365.8/154.5= 2.36, CPIAdjusted Salt Price = 5*2.36 = 11.8, Real Increase =

20/11.8=> 69.5%

Macro Economics



Jobs & Price Level




Function of Money Quantity of MoneyTheory

Demand & Supply forMoney

Federal Reserve &Supply of Money

DepositoryInstitution

LAS

P2P1P0

SAS1

Real GDP

Price Level

Resulting increase in aggregate demand

SAS0

AD1

AD0

5%

4%

Demand for

Money

MS0

Real Money

Interest Rate

Increase in Money Supply

MS1

(SR)

(LR)

(SR)

Medium of Exchange

Unit of ACCOUNT

Store of value

Macro Economics



Jobs & Price Level








Q. What is the maximum increasein the money supply on Feddecision if (a) Fed buys $2billion insecurities in the open market(b)required reserve ratio is 10%and (c)Currency drain is 2%?1. $20 bn2. $17 bn3. $16 bnAns. Change in quantity of money= (1.02)/(.12)= 8.5; 2 X 8.5 =17

What determines the demand formoney:

Interest rates: Most criticalInflation: Increase the demandfor nominal money

Real GDP growth: Alsoincreases the demand for money(nominal & real)

Money supply measures:

M1 refers to all currency in the

form of traveler's checkingaccount deposits of individuals &firms and currency not held inbanks,.

M2 refers to M1 plus timedeposits, savings deposits, &money-market mutual fundbalances

Money Multiplier: The moneymultiplier for a change in the

monetary base thus depends onboth the required reserve ratio andthe currency drain:

money multiplier = (1+ c) /(r + c)

Macro Economics



Jobs & Price Level



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Discount rate is a rate atwhich banks can borrow

reserves from the fed.Lower Discount rate =>increased money supply,decreased interest rates;Higher rates => decreasedmoney supply & increaseinterest rate.

Reserve Requirement:Higher %age reduces themoney supply & increasesinterest rates; lower %ageincrease the money supply& decreases interest rates.

Opening marketoperations: Fed buying &selling of treasury securities.Fed purchases increasecash available for lending,decreasing interest rates.Fed sales remove cash,increasing interest rates

Fedsbalance sheetAssets: Gold, deposit withother central banks, IMFspecial drawing rights;Treasury securities; loansto bank at the discount rateLiabilities: U.S. currency incirculation; banks reservedeposits





Macro Economics



Jobs & Price Level



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Equation of exchange

money supply x velocity =price x real o/p= GDP

Velocity: average number oftimes per year each dollar isused to buy goods andservices (velocity = GDP /money supply),

BanksThrift institutionsMutual Funds

Their FunctionsCreate liquidity: Use short-termdeposits to make long-term loansAct as financial intermediaries:Lend at lower cost than borrowerscould achieve by seeking outindividual lenders.Pool default risks: Hold a portfolioof loans & monitor their risks

Risk management by Depository:Proportion of various types of loansPercentage of depositsTypes of depositsShare of ownerscapital

Deposit expansion multiplier = 1 /required reserve ratioPotential increase in money supply =deposit expansion multiplier *

increase in excess reserves





Macro Economics



Jobs & Price Level



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Fiscal Policy refers to Government's use of spending andtaxation, referred as supply side effects.

Monetary PolicyAutomatic Stabilizer

0%100% Laffer Curve

Taxrate

TaxRevenue

Taxes Savings Investment Capital Real GDPRicardo Barro effect refers to increase in fiscal

deficit shall cause higher taxes in future

Investment

Sources of investment financingNational savingsBorrowing from foreignersGovernment savingsThe crowding-out effect occurs whenbudget deficits (negative Govt. saving)caused by expansionary fiscal policylead to higher interest rates & lowerprivate investment.

Macro Economics



Jobs & Price Level



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Importance of Timing in Fiscal Policy:Recognition Delay: Time it takespolicy to recognize that a policychange is necessary.Administrative or law making delay:Time lag b/w recognition & finalpassage of law or policy change.Impact delay: Time lag b/w passageof the law or policy & when its impactis felt in the economy

Fiscal Multiplier& factor affecting

fiscal Multiplier

Generational effects of Fiscal policy:The difference b/w the PV of futurebenefits promised to voters (such as

Medicare insurance in the US) & thecurrently collected taxes is referred toas a generational imbalance.

When government expenditures increases, aggregate demand& GDP increases by some multiple, as wages & paymentsreceived by workers & capital owners lead to future increasesin aggregate expenditures. This is referred to as theexpenditures (Govt. purchases) multiplier.

Government purchases multiplier: Adollar of government spendingcauses more than a $1 increase in

aggregate demand.

Tax multiplier: Tax cuts also havemagnified effects on aggregatedemand, less than government

purchases as some of the tax is saved.

Balanced budget multiplier:Combined program of governmentpurchases & taxes, an increase inspending and equal increase intaxes will have a stronger positiveeffect on aggregate demand



Macro Economics



Jobs & Price Level



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Automatic Stabilizer

Automatic stabilizers are built-in fiscal devicesthat ensures surplus in a recession & deficitsduring booms. Automatic stabilizers minimizethe problem of proper timing. There are 2main stabilizers:

Induced Taxes: Peopledrop from the tax rolls

during downturns & areadded to tax rolls (orenter higher brackets)during booms.Corporate tax collectionis lower duringeconomic downturns

Needs-testedspending: Moremoney is paid

out as morepeople becomeunemployed

Business Cycle

A business cycle is characterizedby fluctuations in economicsactivity & has 2 phases(contraction & expansion) & 2turning points (through & peak)

Key determinants of businesscycle:Real GDPReal incomeEmploymentIndustrial ProductionWholesale-retail sales

Average

Expansion

Contraction(Recession)

Time

Business Cycle

Business Peak

RealGDP

Recessionary Trough



Macro Economics



Jobs & Price Level



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Impact of expansionary monetary policy on

Inflation rate Small IncreaseReal GDP o/p &

employmentIncrease

Impact of restrictive monetary policy on:

Inflation rate Small Decrease

Real GDP o/p &employment

Decrease

Effects of change in Monetary Policy

Alternative monetary policy strategies Fed include:The McCallum rule, talks about the growth rate of the monetary base. Its main drawback is that shifts in thedemand for money can cause f luctuations in interest rates and aggregate demand.A rule that targets the growth rate of the money supply may also present problems in that changes in bothmoney demand and money velocity can cause volatility in aggregate demand and interest rates.Keeping the foreign exchange rate with other countries currencies stable would cause the domestic inflation

rate to match that of the other countries, over which the Fed has no control.Inflation rate targeting is used by many central banks, the notable exceptions being those of the U.S. & Japan.The performance of strict inflation targeting, compared to the Feds method of monetary policy determination is

still subject to debate.



Macro Economics



Jobs & Price Level



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Macro Economics

Inflation Aggregate Demand& Supply


Jobs & Price Level International Trade andCapital Flows

Recardian Model of TradeHas only one factor of

production- labor

Heckscher & Ohlin Model ofTrade- Redistribution of wealthwithin each country betweenlabor and owners of capital

Reasons for Trade restrictions:1.Infant Industry

2. National Security

Types of trade restrictions include:Tariffs- Taxes on imported goods collected by govt.

Quota- Limits on the amount of imports allowed over someperiod.

Export subsidiesGovt. payments to firms that exportgoods.

Minimum Domestic Content- requirement that some %ageof product content must be from the domestic country.

Voluntary Export Restraint- A country voluntarily restrictsthe amount of goods that can be exported.



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Macro Economics

Inflation Aggregate Demand& Supply


Jobs & Price Level International Trade andCapital Flows

Effect of tariffs and quotas Types of TradingBlocs

Free Trade AreasCustom Union

Common MarketEconomic UnionMonetary Union

Balance Of Paymentsinclude:1. Current Accountconsists of:

A> Merchandise andservicesB> Income ReceiptsC> Unilateral Transfers2. Capital Accountconsists of:A> Capital transfersB> Sales and purchaseof non financial assets3. Financial Account

include:A> Govt. owned assetsabroadB> Foreign owned assetsin the country



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Trade restrictions:1. Tariffs2. Quotas3. Voluntary Export restraints

Arguments for trade restriction:1. Developing Industries2. Anti-dumping agreement3. National defense industries to be protected

Trade restriction which have little support:1. Protect jobs2. Create jobs

3. Low wage countries depress wage rates in high wagecountries

Economics

ForeignExchange

Exchange Rate &Balance of Payments

Trading withthe World



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Nominal & realexchange rate

Balance ofPayments

The nominal exchange rateis Amount of currency thatis required to buy one unitof other currencyThe real exchange ratereflects the cost ofpurchasing an identicalbasket of goods with 2different currenciesReal exchange rate=E*(P/P*)

Demand & supply inforeign exchange

current a/c + capital a/c + Officialreserve a/c =0Current account: Records trade ingoods and services, transferpayments, net profits and interests

earned on assets abroadCapital account : Recordstransactions in financial assets andlandOfficial settlement account :

Records changes in official reserveswhich are gold, foreign currency,SDRs

Exchange rate policies:

There are 3 fundamental typeof exchange rate policies:Fixed RateFloating RateCrawling exchange rate

Economics

ForeignExchange





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D0

D1

E1

E0

USD per INR

S1 S0

Quantity of INR

Decrease in

supply of INR

Increase in demand

for INR

Demand and Supply shifts in the foreign Exc hange markets

Nominal & realexchange rate

Balance ofPayments

Demand & supply inforeign exchange

There are 3 factors that determine thedemand for & supply of the currencyInterest rates for deposits in thecurrency

Future exchange rate expectationDemand for domestic products ininternational market is

Exchange rate policies:

There are 3 fundamental typeof exchange rate policies:Fixed RateFloating RateCrawling exchange rate

Economics

ForeignExchange





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Direct & IndirectQuotes

Cross CurrencyRates

Direct Quotes: Domestic currency perunit of foreign currencyIndirect Quotes: Foreign currency perunit of domestic currency

Spot Rate &Forward rate

Cross rates are the Exchangerates between two currenciesderived from exchange ratewith a common third currencyWhen rates quoted bydealer/bank are different fromcross rates obtainedtheoretically, triangulararbitrage may be possible

Forward Discount& Premium

Bid Price: price, the dealer will pay for1unit of base currency. It is smaller &listed firstAsk Price: price, at which dealer will sell

1unit of base currency. It is higher &listed second% Spread = 100

priceask

pricebidpriceask

Q. The bid ask quote for GBP in India is78.2078.50 (GBP:INR) . In New York thebid ask quote for Indian Rupee is 46

46.30 (USD:INR). What is the GBP:USDask as a cross rate.Ans. GBP:USDask = 78.5/46 = 1.7065

Economics

ForeignExchange





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Direct & IndirectQuotas

Cross CurrencyRates

Spot Rate &Forward rate

Spot rates are the exchange rates forthe immediate delivery of the currencyForward rates are the exchange ofcurrencies in future at the exchangerate agreed todayCovered Interest Arbitrage: It is thetrading strategy that exploits mispricingb/w spot & fwd rates.

Q. Let the exchange rate for USD and GBP is 1.65$ per GBPand forward rate is 1.60$ per GBP. Assuming Interest rateparity holds then in which country will be the interest ratehigher.

Ans.Forward price of a $ is quoting a lower price than the

current spot p[rice indicating that $ is expected to appreciategoing forward and thus quoting a premium in forward market.Assuming interest rate parity to hold true UK must be havinghigher interest rate relative to US, because of which GBP isexpected to depreciate.

Forward Discount& Premium

Forward Premium (discount) =

If forward price of Rs/$ is lesserthan spot price of Rs/$ Then, Rs isquoted as forward premium

dayscontract

forwardofno.

360

ratespot

ratespotrateforward

Economics

ForeignExchange





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Question 1

The demand for home dcor doubles when the average family income of Saunderland

increases from $15,000 per annum to $20,000 p.a. The income elasticity for homedcor is

A. Greater than 1, and Less than 2

B. Less than 1

C. Greater than 2



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Answer 1

C.

33.217500/5000

5.1/1IncomeAvgI/

QQ/Avg



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Question 2

Production at B leads to a loss due to inefficient production. This loss in efficiency is

known asA.Deadweight loss

B.Utilitarian loss

C.Producer loss



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Answer 2

A.

When production occurs at a point other than the equilibrium point the consumersurplus & the producer surplus is decreased by an amount. This is known asdeadweight loss.



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Question 3

If the price of the product does not change when the supply of the product increases

from zero to infinity. Then the supply elasticity for the product is most likelyA. Perfectly elastic

B. Unit Elastic

C. Perfectly inelastic



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Answer 3

A.

Perfectly Elastic

PriceElasticityPrice

Quantity/Time



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Question 4

John notices that when the price of a Product Z is increased from $15 to $25. The

demand declines from 40 units to 35 units. He also notices that the income elasticity ofthe product is negative. The price elasticity of the product is closest to and the productis an

A. 0.27 ; inferior good

B. 0.47; normal good

C. 0.30 ; normal good



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Answer 4

A.

Price elasticity = %Q = 5/37.5 = 0.27%P 10/20

When demand reduces with an increase in income the good is an inferior good & theincome elasticity is negative.



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Question 5

The least likely method of government intervention in farm production is through

A. Production quotasB. Taxes

C. Subsidies



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Answer 5

B.

The two methods of government intervention in farm production are through the use ofa) production quotas and b) subsidies. Taxes are a form of intervention but aregenerally not used to control farm production.



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Question 6

In the case of Enron scandal, the principal-agent problem occurred least likely in whichof the following two cases;

Principal Agent

A. Stockholders CEO

B. Stockholders Auditors

C. CEO Stakeholders



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Answer 6

C.

Stockholders/stakeholders are the ultimate principal. They have a stake in thecompany and the CEO is an agent appointed by them to oversee the companysactivities



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Question 7

The HHI for the silicon wafer industry in Saunderland is closest to

Firm Market ShareA 50%

B 10%

C 10%

D 5%

E 5%

ROI* 20%

*ROI Rest of Industry constituting 8 firms each with 2.5% market share

A. 3150

B. 2800

C. 5950



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Answer 7

B.

Herfindahl-Hirschman Index is calculated for the industry as follows:

HHI = 502 + 102 + 102 + 52 + 52 + 8 * (2.52) = 2,800



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Question 8

A shoemaker Zeebok requires producing 150 units per day. The cost of labor is $20and the cost of capital is $550 per unit. Calculate the most likely economical method ofproduction

Quantity of Inputs

Labor Capital

Manual Method 220 50

Automated Method 10 120

A. Automated and requires $56,400 per day

B. Manual and requires $31,900 per day

C. Manual and requires $34,500 per day



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Answer 8

B.

Manual Method requires = $ 20*220 + 550*50 = $31,900Automated Method requires = $ 20*10 + 550*120= $66,200



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Question 9

ZenithCorp. a major utility company runs 4 thermo-nuclear generators supplyingelectricity to the Greater Manhattan region. The company is planning to set up a 5thgenerator to meet the ever increasing demand for electricity. While analyzing thebusiness plan the company CFO notices that by adding one more units there is apositive but declining increase in marginal cost. This indicates that the total cost curveand the average total cost curve is most likely

Total Cost Curve Average Total Cost

A. Increasing DecreasingB. Increasing Increasing

C. Decreasing Increasing



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Answer 9

A.

When marginal cost increases in a declining manner the total costs increases howeverthe average total cost starts decreasing.



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Question 10

When an additional unit of labor is added to a companys work force then the marginal

returns increase initially but decline after a certain point. This is most likely the result of

A. Economies of scale

B. Law of diminishing returns

C. Diseconomies of scale



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Answer 10

B.

The law of diminishing returns occurs when the marginal product of an additionalworker is less than the marginal product of the previous worker. As more workers areadded there is less for them to do.



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Question 11

Which of the following statements best explains how automatic stabilizers work? Evenwithout a change in fiscal policy, automatic stabilizers tend to promote:

A. A budget deficit during a recession and a budget surplus during an inflationaryexpansion.

B. A budget surplus during a recession and a budget deficit during an inflationaryexpansion.

C. A budget deficit during a recession but do not promote a budget surplus during an

inflationary expansion.This files has expired at 30-Jun-13


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Answer 11

A.

A Budget deficit during a recession and a budget surplus during an inflationaryexpansion

Automatic stabilizers such as unemployment compensation, corporate profits tax, andthe progressive income tax run a deficit during a business slowdown but run a surplusduring an economic expansion. Therefore, they automatically implementcountercyclical fiscal policy without the delays associated with policy changes that

require legislative action.This files has expired at 30-Jun-13


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Question 12

In a perfectly competitive market the lowest possible long run average total cost occursmost likely at the point where MC (Marginal Cost) SR Firm Supply Curve, ATC (

Average Total Cost)

A. MC > SR Firm Supply Curve=ATC

B. MC=SR Firm Supply Curve=ATC

C. MC


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Answer 12

B.

MCATC

AVC

Quantity

Price



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Question 13

The benefit that a person receives from consuming one or more unit of a good orservice is known as

A. Allocative benefit

B. Increasing benefit

C. Marginal benefit



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Answer 13

C.

Marginal benefit (MB) is the benefit that a person receives from consuming one ormore unit of a good or service. The MB is measured as the maximum amount that aperson is willing to pay for one or more unit of the good or service.



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Question 14

A public good is a good or service that is consumed by everyone, even if they dont pay

for it, then which of the following describes an external benefit

A. Benefit that accrues to people other than the buyer of the good or service

B. Benefit that accrues due to external factors like exchange rates, inflation etc.

C. Benefits that accrues to the consumer of a good or service



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Answer 14

A.

When an old building is restored or a park is built in a locality the benefit accrues toother people other than the owner of the building or the owner of the land on which thepark was built. An external benefit is thus the benefit that accrues to other people otherthan the buyer of a good.



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Question 15

Which of the following is least likely an obstacle in achieving the efficient allocation ofresources

A. Price Ceiling

B. Monopoly

C. Competition



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Answer 15

C.

The five items that are a significant obstacle to an efficient allocation of resources inthe market economy are: a. price ceilings & price floors b. taxes, subsidies & quotas c.monopoly d. external costs & benefits e. public goods & common resources.



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Question 16

Consider a firm in an oligopoly market that believes the demand curve for its product ismore elastic above a certain price than below this price. This belief fits most closely towhich of the following models?

A. Dominant firm model.

B. Kinked demand model.

C. Variable elasticity model.



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Answer 16

B.

The correct answer is Kinked demand model.The kinked demand model assumes that each firm in a market believes that at someprice, demand is more elastic for a price increase than for a price decrease.


Q ti 17


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Question 17

An insulin user is most likely to pay the entire tax when the demand and supply curvesfor insulin injectibles are respectively;

Demand Curve Supply Curve

A. Inelastic Elastic

B. Elastic Perfectly Inelastic

C. Perfectly inelastic Elastic


A 17


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Answer 17

A.

The buyer pays the tax when the demand curve is perfectly inelastic and the supplycurve is perfectly elastic. The seller will pay it when the demand curve is perfectlyelastic and the supply curve is perfectly inelastic.


Q ti 18


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Question 18

A high concentration ratio is most likely observed in

A. Perfect competitive marketB. Oligopoly

C. Monopolistic competition


A 18


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Answer 18

B.

In an oligopoly there is a high concentration ratio and the HHI is more than 1,800.


Q ti 19


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Question 19

A corporation has all of the following advantages except

A. Owners have limited liability

B. Professional management

C. Ease of set up


A 19


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Answer 19

C.

Advantages of a corporate setup is that owners of shares in a corporation have alimited liability and they can take advantage of a professional management.Proprietorships and partnerships are easy to set up.


Question 20


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Question 20

Sally has decided to give up working as an Investment Banker and set up a restaurantin London, all of the following can be considered as an opportunity cost except

A. interest on restaurant loan

B. salary foregone

C. perks foregone


Answer 20


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Answer 20

A.

The opportunity costs include a) explicit cost b) implicit cost. Wages foregone &interest on deposits foregone are examples of implicit costs.


Question 21


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Question 21

An employee stated that the electricity is being produced at ZenithCorp. at a pointabove the Production Possibility Frontier (PPF). This most likely indicates that

A. Production is inefficient

B. The employee is wrong

C. Production is efficient


Answer 21


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Answer 21

B.

All the points below the Production Possibilities Frontier (PPF) are possible thoughproduction is very inefficient. Maximum efficiency occurs on the PPF curve. Howeverall points above the curve are not possible.


Question 22


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Question 22

All of the following are the characteristics of a perfectly competitive market except

A. Many firms sell identical products to many buyers

B. No entry barriers

C. Information asymmetry between buyers & sellers


Answer 22


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Answer 22

C.

Characteristics of a perfectly competitive market are a) many firms in the market b)undifferentiated products c) no entry barriers d) no first mover advantage e) informationsymmetry


Question 23


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Question 23

The Laffer curve shows that an increase in the tax rate:

A. Will not change total tax revenue.

B. Will increase total tax revenue.

C. Can either increase or decrease total tax revenue


Answer 23


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Answer 23

C.

The correct answer is Can either increase or decrease total tax revenue.

The Laffer curve shows that at Sow tax rates an increase in rates will increase total taxrevenue, bur beyond some rate, further increases will actually decrease total taxrevenue.


Question 24


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Question 24

Which of the following would be counted as frictional unemployment?

A. Due to the negative growth of GDP, Smith was laid off.

B. Johnson was fired from his job after he got into an argument with his foreman, andhas not sought a new job.

C. Although there were jobs available, Jones was unable to find an employer with anopening.


Answer 24


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Answer 24

C.

The correct answer is Although there were jobs available, Jones was unable to find anemployer with an opening.

One of the causes of frictional unemployment is that information regarding prospectiveemployees and employers is costly and sometimes hard to find. The other cause offrictional unemployment is that both employees and employers may spend some timelooking for information that will match them up.


CC-Economics Revised

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