Economics - CFA

1. A market has the following characteristics: (i) a large number of independent sellers, (ii) each produces a differentiated product, (iii) low barrier to entry, (iv) producers face downward-sloping demand curves, (v) demand is highly elastic. This market is characterized as:

• A. a monopoly

• B. an oligopoly

• C. monopolistic competition

Answer explanation

• Monopolies and oligopolies have high barriers to entry and involve either a single seller (monopoly) or a small number of interdependent sellers.

The demand curves faced by monopolistic companies is

• A. elastic due to the availability of many close substitutes

• B. inelastic due to the availability of many complementary goods

• C. not sensitive to price due to absence of close substitutes

Answer explanation

The demand for products from monopolistic competitors is elastic due to the availability of many close substitutes. If a firm increases its product price, it will lose customers to firms selling substitute products.

A firm operating as a price taker will produce the quantity at which:

• A. Revenue is maximized

• B. it earns long-run economic profit

• C. Marginal revenue = marginal cost

Answer explanation

A firm operating as a price taker will produce the quantity where MC = MR, it will maximize profit and not revenue. In the long run, it will make zero economic profit.

The primary objective of a central bank is typically to:

• A. control inflation

• B. stabilize exchange rates

• C. achieve full employment

Promoting economic growth and price stability are the goals of

• A. fiscal policy, but not monetary polic

• B. monetary policy, but not fiscal policy

• both fiscal and monetary policy

Answer explanation

Both monetary and fiscal policies are used by policymakers with the goals of maintaining stable prices and producing positive economic growth.

An argument against being concerned with the size of a fiscal deficit is that a deficit can:

• A. aid in increasing GDP and employment if the economy is operating at less than potential GDP.

• B. lead to higher future taxes that will increase government revenues.

• cause government borrowing to crowd out private borrowing.

Answer explanation

One potential argument against being concerned about the size of fiscal deficits is that a deficit can help increase GDP and employment if output is below potential GDP and the spending does not divert capital from productive users. Higher deficits that lead to crowding out or higher future taxes that result in lower long-term economic growth are arguments for concern about the size of fiscal deficits.

Assuming the economy currently is experiencing high inflation, an example of appropriate discretionary fiscal policy is:

• A. increase the federal funds target rate

• B. reduce government expenditures on major government construction projects.

• C. reduce money supply

Answer explanation

Discretionary fiscal policy refers to the federal government's decisions regarding government spending and taxing. A reduction in government spending on major government construction projects is likely to lead a reduction in aggregate demand and less pressure on prices, reducing inflation.

The time it takes for policy makers to determine that the economy requires a fiscal policy action is best described as:

• A. action lag

• B. recognition lag

• C. impact lag

Answer explanation

Recognition lag refers to the time it takes for fiscal policy makers to discuss, enact, and implement fiscal policy measures. Impact lag is the time it takes for a fiscal policy measure to have its effect on the economy.

With respect to exchange rate regimes, crawling bands are most likely used in a transition toward:

• A. a fixed peg arrangement

• B. a monetary union

• C. floating exchange rates

Answer explanation

When exchange rates are managed within crawling bands, the margin around a target exchange rate increases over time. This technique is sometimes used in a transition from fixed exchange rates to freely floating exchange rates.

A government that wishes to reduce the volatility of domestic asset prices and protect domestic industries is most likely to:

• A. adopt voluntary export restraints.

• B. impose capital restrictions

• C. participate in regional trading agreements.

Answer explanation

Objectives commonly cited for imposing capital restrictions include reducing the volatility of domestic asset prices, protecting domestic industries, maintaining fixed exchange rates, and keeping domestic interest rates low.