CFA Level 1 - Economics Session 5 - Reading 17 (Notes, Practice Questions, Sample Questions) 1. Which of the following least accurately describes a component of gross domestic product? A)Net imports. B)Investment.C)Consumption. Explanation: (A) The components of GDP are consumption, investment, government spending, and net exports, which is exports minus imports 2. Which method of calculating gross domestic product requires data from each stage of production of goods? A)Sum of value added method. B)Value of ﬁnal output method.C)Income method Explanation: (A) The sum-of-value-added method of calculating GDP requires data on the value added to goods at each stage of production anddistribution. The value-of-ﬁnal-output method only requires data on theﬁnal values of goods and services. The income approach to calculatingGDP measures the total income of households and companies, rather thanthe value of goods and services
3. The GDP deﬂator is the percentage difference between: A)nominal GDP and real GDP. B)GDP calculated using the income and expenditure approaches.C)GDP calculated using the value-of-ﬁnal-output method and thesum-of-ﬁnal-output method Explanation: (A) The GDP deﬂator is the percentage difference between nominal GDP and real GDP, reﬂecting inﬂation since the base period 4. The difference between personal income and personal disposable income is: A)ﬁxed expenses.B)savings. C)taxes Explanation: (C) Personal disposable income equals personal income minus taxes 5. Total investment is one of the components of a country’s GDP. Which of the following is least likely to be considered a source of funds forinvestment? A)Household expenditures. B)National savings.C)Foreign borrowing Explanation: (A) Total investment is one of the major components of GDP (the others are consumption, government spending, and net exports).Investment is deﬁned as expenditures allocated to ﬁxed assets andinventory. The sources of funds for investment are national savings,foreign borrowing, and government savings
6. The relationship between savings (S), investment (I), government spending (G), government tax revenue (T), exports (X), and imports (I) is: A) (G − T) = (S − I) + (X − M). B) (S − I) = (G − T) + (X − M). C) (X − M) = (S − I) + (G − T) Explanation: (B) The fundamental relationship of saving to investment, the ﬁscal balance, and the trade balance is S = I + (G − T) + (X − M),or (S − I) = (G − T) + (X − M). This relationship can be solved for theﬁscal balance, (G − T) = (S − I) − (X − M), or for the trade balance,(X − M) = (S − I) − (G − T). 7. If a ﬁscal budget deﬁcit increases, which of the following factors must also increase if all other factors are held constant? A)Investment. B)Savings. C)Trade surplus. Explanation: (B) The relationship between the ﬁscal balance, savings, investment, and the trade balance is (G − T) = (S − I) − (X − M). Anincrease in a ﬁscal budget deﬁcit (G − T) must be funded by an increase insavings (S), a decrease in investment (I), or a decrease in net exports (X− M), which would decrease a trade surplus or increase a trade deﬁcit 8. An increase in real interest rates can be expected to: A)decrease investment and increase net exports.B)increase government spending and decrease consumption. C)decrease investment and decrease consumption
Explanation: (C) An increase in real interest rates can be expected to decrease business investment and decrease consumption. The impact ongovernment spending and net exports is not clear-cut 9. Which of the following is least likely a reason that the aggregate demand curve slopes downward? A)The wealth effect causes consumers to spend less when the price levelrises.B)Business investment declines as a rising price level increases interestrates. C)Because entitlements are adjusted for inﬂation, a rising price levelforces government spending to increase Explanation: (C) The aggregate demand curve plots real GDP against the price level. Rising entitlement payments that result from an increasingprice level affect nominal GDP, but not real GDP. Both remaining choicesdescribe reasons why the consumption and investment components of realGDP decrease when the price level increases 10. Which of the following statements concerning aggregate demand is most accurate? A)When price levels rise, real wealth increases, and individuals will spendmore. B)When price levels rise, real wealth decreases, and individuals willspend less. C)When price levels fall, real wealth increases, and individuals will spendless Explanation: (B) When price levels rise, real wealth decreases, and we would expect individuals to spend less. If the converse were also true—if
price levels were to fall—real wealth should increase, and we would expectindividuals to spend more, all else being equal 11. The long-run aggregate supply curve is best described as: A)elastic because most input prices are variable in the long run.B)perfectly elastic because input prices are sticky in the long run. C)perfectly inelastic because input prices change proportionately withthe price level in the long run. Explanation: (C) The long-run aggregate supply curve is perfectly inelastic because in the long run, wages and other input prices adjust tochanges in the overall price level. Long-run aggregate supply equalspotential GDP 12. Which of the following events is least likely to cause a decrease in short-run aggregate supply? A)Inﬂation increases from 4% to 7%. B)A labor stoppage causes the price of steel to rise.C)Oil exporting countries reduce their production levels Explanation: (A) Changes in the price level represent movement along the short-run aggregate supply curve. The other items listed are events thatare likely to shift the short-run aggregate supply curve to the left(decrease SRAS) 13. Which of the following factors is most likely to increase long-run aggregate supply? A)The average rate of labor productivity increases. B)Wage rates increase.
C)Aggregate demand decreases. Explanation: (A) Factors that shift the long-run aggregate supply curve (LAS) to the right include improvements in technology and productivity,increases in the supply of resources, and institutional changes thatincrease the efﬁciency of resource use. An increase in the productivity ofthe average worker is likely to shift the LAS curve to the right. Wage ratechanges shift the short-run aggregate supply curve (SAS) but not the LAScurve. A decline in consumer demand would represent a move down theLAS curve but not a shift in LAS 14. Which of the following factors is most likely to increase aggregate demand? A)Increasing real interest rates. B)An increase in real wealth. C)An expected decrease in future prices. Explanation: (B) While an increase in real wealth will shift the AD curve to the right, an increase in the real rate of interest will shift the AD curveto the left as consumers and businesses reduce their borrowing andspending. An expected decrease in prices will shift the AD curve to the leftas households and businesses postpone their consumption in anticipation oflower prices in the future 15. When incomes in foreign countries increase, aggregate demand in the U.S. is most likely to: A)increase because foreign consumers will tend to buy more U.S. exportgoods. B)decrease because U.S. interest rates will tend to increase.C)decrease because foreign consumers will tend to buy fewer U.S. exportgoods
Explanation: (A) When incomes in foreign countries increase, it is unlikely to have a direct effect on interest rates in the U.S. However,increased foreign income is likely to result in greater foreign purchases ofU.S. exports. Thus, aggregate demand in the U.S. is likely to increase 16. The sustainable growth rate of real GDP is most likely to be increased by: A)an increase in government spending.B)an increase in the propensity to consume by households. C)the discovery of untapped oil ﬁelds Explanation: (C) Sustainable growth in real GDP is deﬁned as the growth rate in real GDP that is sustainable over the long term. The sustainablegrowth rate is positively affected by increases in the supply of naturalresources, the supply of physical capital, or the supply or productivity oflabor. An increase in government spending does not increase an economy’ssustainable growth rate 17. Which of the following is most likely to occur in the short run aggregate demand decreases due to a reduction in business and consumeroptimism? A)A higher rate of inﬂation.B)An increase in real GDP. C)An increase in the rate of unemployment. Explanation: (C) If business and consumer optimism wanes, consumers will spend less and defer current consumption and save more of theirdisposable income. With reduced product demand, businesses will reducetheir capital expenditures and investments. These actions will lead
businesses to reduce their number of employees, thereby increasing therate of unemployment. Moreover, current output will decrease and theprice level will fall 18. If the economy is in short-run disequilibrium below full employment, the most likely explanation is that: A)money wage rates have decreased.B)long-run aggregate supply has decreased. C)aggregate demand has decreased Explanation: (C) A decrease in aggregate demand can reduce output below its full-employment level. A decline in long-run aggregate supplywould mean the full-employment output level itself has decreased. Wagerates are assumed to be ﬁxed in the short run, but the long-run effect ofdecreases in wage rates would be to increase (shift) short-run aggregatesupply, leading to an increase in output 19. When potential real GDP is less than actual real GDP, the economy is most likely experiencing: A)recession.B)underemployment. C)inﬂation Explanation: (C) The economy is in an inﬂationary phase if actual real GDP is greater than potential real GDP. When actual real GDP equalspotential real GDP, the economy is said to be at full employment. Theeconomy is in a recessionary phase if real GDP is less than potential GDP 20. Which of the following is most likely to cause an increase in aggregate demand?
A)Relative appreciation in the country’s currency.B)An increase in the general price level. C)High capacity utilization rates Explanation: (C) As capacity utilization rates increase to high levels (typically 80% to 85%), business investment in plant and equipmentincreases, shifting the AD curve to the right. A change in the price levelrepresents a movement along the demand curve, not a shift in it.Appreciation of the country’s currency increases the cost of exports andreduces the cost of imports, which shifts the aggregate demand curve tothe left (net exports decrease) 21. Sources of long-run economic growth most likely include increases in: A)labor supply, physical capital, and technology. B)human capital, money supply, and natural resources.C)government spending, labor supply, and physical capital Explanation: (A) Sources of sustainable long-run economic growth (increases in long-run aggregate supply) include increases in the laborforce, human capital (the education and skill level of the labor force), thestock of physical capital, the supply of natural resources, and the level oftechnology. Increases in the money supply or government spendingincrease aggregate demand but do not increase long-run aggregate supply 22. An economist wanting to determine the sources of an increase in a country’s GDP using the production function approach would most likelyinvestigate: A)growth in productivity, the labor force, and the capital stock. B)shifts in the aggregate supply curve.C)increases in industrial production
Explanation: (A) The production function approach relates a country’s economic output to its inputs of capital and labor and its levels ofproductivity 23. Growth in total factor productivity is best described as driven by growth in: A)technology. B)capital.C)labor Explanation: (A) Total factor productivity represents the productivity that cannot be directly accounted for by increases in either capital or labor, andis generally considered to be driven by changes in technology