CFA Level 1 - Economics Session 5 - Reading 18 (Notes, Practice Questions, Sample Questions) 1. The expansion phase of a business cycle is least likely characterized by: A)increasing inﬂationary pressures. B)increasing unemployment. (Explanation: Unemployment is typically decreasing during the expansion phase of a business cycle ) C)a positive rate of economic growth 2. During an economic contraction: A)inﬂation pressures are typically decreasing. (Explanation: An economic contraction (recession) is typically characterized bydecreasing inﬂationary pressures, increasing unemployment, andlow or negative real GDP growth ) B)the unemployment rate typically decreases.C)real GDP growth is greater than its sustainable long-term rate 3. A peak in the business cycle is most likely associated with: A)decreasing inﬂation pressure. B)the highest level of economic output during thecycle.(Explanation: The peak phase of a business cycle represents the highest level of economic output (real GDP) reached during thatcycle. Inﬂation pressure that built during the expansion may continue
into the early part of the contraction that follows the peak.Employment typically does not begin to decline until sometime afterthe peak. ) C)payroll employment turning from positive to negative 4. An economy has been producing at its full-employment level of output and the price level has been stable. Businesses thenbegin experiencing unintended decreases in their inventorylevels. What does this most likely imply about the short-runoutlook for economic growth and inﬂation?Economic growth Inﬂation A)Increasing Increasing(Explanation: Starting from conditions of long-run equilibrium, unintended decreases in inventory levelssuggest that aggregate demand has increased. Producers will respondin the short run by increasing output and prices, so economic growthand inﬂation will increase ) B)Increasing DecreasingC)Decreasing Increasing 5. As an economic expansion approaches its peak, the economy is most likely to show: A)a decrease in inventory levels.B)accelerating sales growth. C)an increase in the inventory-to-sales ratio.(Explanation: As the economy approaches its peak, sales growth begins to slow, unsoldinventories begin to accumulate, and the inventory-to-sales ratioincreases )
6. A ﬁrm’s most likely initial response to a cyclical increase in the inventory-to-sales ratio is to adjust their utilization of labor by: A)reducing overtime. (Explanation: As a cyclical indicator, an increase in the inventory-to-sales ratio is a sign of slowing economicgrowth. When decreasing their utilization of labor in response to aslowing economy, ﬁrms typically ﬁrst reduce overtime. Firms tend tobe slow to lay o workers until it is clear that an economiccontraction is underway ) B)adding new workers.C)laying o employees. 7. Which of the following statements is most accurate regarding monetarists? Monetarists believe that: A)discretionary monetary policy is the best way to moderateﬂuctuations in prices and output. B)steady, predictable money growth is the best monetary policy.(Explanation: Monetarists believe that the Fed’s tools are powerful and should not be used to moderate ﬂuctuations in prices andoutputs. Thus, steady, predictable growth is the best monetary policy.They believe in the power of the money supply, not ﬁscal policy, toa ect prices and outputs ) C)ﬁscal policy is the most powerful of all government tools usedto a ect prices and output 8. Which of the following most accurately describes the Monetarist school of macroeconomic thought in relation toaggregate demand and aggregate supply? Monetarists believethat the money supply should be:
A)increased by a predictable rate annually. (Explanation: Monetarists believe that to keep aggregate demand stable andgrowing, the central bank should follow a policy of steady andpredictable increases in the money supply. Furthermore, monetaristsbelieve that recessions are caused by inappropriate decreases in themoney supply and that recessions can be persistent because moneywage rates are downward sticky. ) B)reduced during inﬂationary periods and increased duringrecessionary periods.C)increased during inﬂationary periods and reduced duringrecessionary periods 9. According to Austrian school theory, business cycles are caused by: A)long-run structural changes in real economic variables.B)excessive optimism or pessimism among business managers. C)government intervention in the economy (Explanation: In Austrian school business cycle theory, cycles are caused bygovernment intervention that reduces interest rates below what theywould be without government intervention, which leads to anartiﬁcial economic boom that must eventually collapse because theeconomy lacks the physical capital to support it ) 10. According to Keynesian school theory, business cycles are caused by: A)changes in technology over time.B)inappropriate variations in the growth of the money supply. C)excessive optimism or pessimism among business managers.(Explanation: In Keynesian business cycle theory, business cycles are caused primarily by changes in expectations about economic growth.
Business managers overinvest when they are excessively optimisticand underinvest when they are excessively pessimistic ) 11. When economists are speaking of the labor-force participation rate, they are referring to which of the following?The labor-force participation rate is the percentage of the: A)working-age population who are working.B)labor force who are new entrants (less than one year of workexperience). C)working-age population who are either working or activelylooking for work (Explanation: The labor-force participation rate is the percentage of the working-age population who are employedor actively seeking employment. The labor-force participation ratecan be calculated as: (the labor force / working-age population) ×100 ) 12. Unemployment can be divided into the following three categories: A)Frictional, seasonal, cyclical.B)Technical, frictional, seasonal. C)Frictional, cyclical, structural (Explanation: Unemployment can be divided into frictional, cyclical, or structural unemployment ) 13. Which of the following is the most accurate deﬁnition of the labor force? A)All people of working age.B)Those people of working age who are not retired or in prison.
C)Those people of working age who are either employed orseeking employment (Explanation: The labor force includes people of working age (16+) who are either employed or seekingemployment. People who are not employed or seeking employment(e.g., homemakers, full-time students, "discouraged" workers) arenot counted as part of the labor force ) 14. Which of the following is the most accurate deﬁnition of the unemployment rate? The unemployment rate is the number of: A)unemployed individuals divided by the number of employedindividuals.B)individuals employed divided by the number of people who areunemployed and retired. C)unemployed individuals divided by the total labor force(Explanation: The unemployment rate of a country is the percentage of people in the labor force who are unemployed. It is calculated as:unemployment rate = (number of unemployed / labor force) × 100.The labor force includes those individuals who are employed or areactively seeking employment. ) 15. When individuals are unemployed because they do not have perfect information concerning available jobs, this is: A)structural unemployment. B)frictional unemployment. (Explanation: Frictional unemployment exists because workers and employers do not haveperfect information and must expend time and resources on searchactivities ) C)natural unemployment
16. Which of the following is the least likely one of the types of unemployment? A)Frictional.B)Structural. C)Temporal (Explanation: There are three types of unemployment: frictional, cyclical, and structural.Frictional unemployment is due to constant changes in the economythat prevent qualiﬁed workers from being immediately matched withexisting job openings.Cyclical unemployment is when the economy is operating at less thanfull capacity.Structural unemployment is due to structural changes in the economythat eliminate some jobs while generating job openings for whichunemployed workers are not qualiﬁed ) 17. Which type of unemployment describes situations where qualiﬁed workers are not immediately matched with existing jobopenings? A)Frictional. (Explanation: Frictional unemployment will prevent qualiﬁed workers from being immediately matched with existing jobopenings. Two causes are imperfect information and the job searchconducted by both employers and employees ) B)Structural.C)Cyclical. 18. Which type of unemployment describes a situation where workers who have been laid o due to economic changes andthey are unable to ﬁnd work due to a lack of education or thenecessary skills to move into another available job?
A)Frictional.B)Cyclical. C)Structural. (Explanation: Structural unemployment is due to structural changes in the economy that eliminate some jobs whilegenerating job openings for which unemployed workers are notqualiﬁed. Cyclical unemployment is when the economy is operatingat less than full capacity ) 19. Which of the following is best described as an example of structural unemployment? A)Smith was laid o due to negative growth of GDP, and did notseek other employment until he was recalled to his job.B)Although there were jobs available, Johnson was unable to ﬁndan employer with a satisfactory opening. C)When the plant was modernized, Jones lost her job becauseshe did not have the skill needed to operate the new equipment.(Explanation: Structural unemployment exists when changes in the economy eliminate some jobs while generating new job openings forwhich unemployed workers are not qualiﬁed ) 20. Which one of the following is most likely to experience loss of wealth from an increase in the inﬂation rate? A)An individual investor who recently purchased a substantialamount of variable rate bonds. B)A commercial bank that has a large quantity of ﬁxed-ratemortgages in its loan portfolio. (Explanation: If an economy experiences inﬂation, the losers are those who hold long-termcontracts in which they are to receive ﬁxed payments. A bank that hasa large quantity of ﬁxed-rate mortgages in its loan portfolio (i.e.,they are investments for the bank) is receiving ﬁxed-rate payments.
Both remaining choices are investors who are either making ﬁxedrate payments (the homeowner) or receiving ﬂoating-rate payments(the investor in variable rate bonds) ) C)An individual investor who ﬁnanced the purchase of a homewith a 30-year ﬁxed rate mortgage 21. Which of the following statements regarding inﬂation is most accurate? A)As a result of inﬂation, all borrowers gain at the expense oflenders.B)The purchasing power of money increases as a result ofinﬂation. C)Inﬂation is a persistent increase in the general price level ofgoods and services (Explanation: Inﬂation is deﬁned as a persistent increase in the price level over time. Inﬂation indicates thatthere has been a general decline in the purchasing power of acurrency. Fixed-rate borrowers gain at the expense of lenders wheninﬂation is greater than expected ) 22. Which of the following statements regarding inﬂation is most accurate? A)Inﬂation occurs when there is a steady increase in the relativeprices of key commodities.B)Inﬂation is present if the prices of some goods and services areincreasing. C)An economy experiences inﬂation when there is a persistentincrease in the prices of almost all goods and services(Explanation: Inﬂation is a persistent increase in the price level over time. Inﬂation occurs when there is a sustained increase in the prices
of almost all goods and services. Inﬂation indicates a decline in thepurchasing power of a currency. ) 23. Joe Lebow, an analyst, is discussing the di erence between inﬂation and price level. Lebow states: "The higher the pricelevel in the current year compared to the price level in theprevious year, the higher is the inﬂation rate of a country. Anyincrease in the price level is evidence of positive inﬂation."Lebow's statement is: A)correct.B)incorrect because it inaccurately describes the calculation of aninﬂation rate. C)incorrect because not all increases in the price level indicateinﬂation. (Explanation: Lebow is incorrect because a one-time increase in the price level is not necessarily inﬂation. Inﬂation is anon-going process, not a one-time increase in the price level ) 24. An economy with a consistently negative inﬂation rate is best described as experiencing: A)disinﬂation. B)deﬂation. (Explanation: Deﬂation is a sustained decline in the price level, which is reﬂected in a negative inﬂation rate. Disinﬂationrefers to a decrease in the inﬂation rate over time but does not implya negative inﬂation rate. Hyperinﬂation is an extremely high andaccelerating inﬂation rate ) C)hyperinﬂation.
25. The current annual inﬂation rate, as measured by using the Consumer Price Index (CPI), is best deﬁned as: A)percentage change in the CPI from a year ago. (Explanation: The inﬂation rate is the percentage change in the price index from ayear earlier ) B)percentage change in the CPI from its base period.C)increase in the CPI from a year ago. 26. Which of the following statements most accurately describes the di erence between headline inﬂation and core inﬂation? A)Headline inﬂation is a better measure of the underlying trendin prices. B)Core inﬂation does not include food and energy prices.(Explanation: Core inﬂation excludes food and energy and is thus a better measure of the underlying trend in prices ) C)Core inﬂation refers to producer prices. 27. Consumer price indexes are least likely to: A)be calculated for stages of processing. (Explanation: Stages of processing are components of producer price indexes. Consumer priceindexes compare the current prices of a typical consumption basket toprices in a base year ) B)reﬂect the typical purchasing patterns of consumers.C)compare current prices to prices in a base year
28. Which of the following types of price index is most likely to include a sub-index for raw materials? A)GDP deﬂator. B)Wholesale price index. (Explanation: Wholesale or producer price indexes typically include sub-indexes for ﬁnished goods,intermediate goods, and raw materials or crude goods ) C)Consumer price index 29. Which of the following statements about biases that a ect the consumer price index (CPI) is least accurate? A)The basket of goods on which the CPI is based becomes a lessaccurate measure of household costs as new goods appear on themarket. B)The net e ect of built-in biases in the CPI is to underestimateinﬂation. (Explanation: The CPI is generally believed to overestimate inﬂation by about 1% per year. Upward biases includequality improvements (price increases due to improving quality donot represent inﬂation but are reﬂected in the CPI), new and moreexpensive goods replacing older and less expensive goods, andcommodity substitution (consumers substitute less expensive goodsfor more expensive ones, rather than continuing to consume a ﬁxedbasket of goods) ) C)Price increases that result from quality improvements arereﬂected as increases in the CPI
30. Which of the following is least likely a source of bias in CPI data? A)Sample selection (Explanation: The three sources of bias associated with CPI data are: new goods, quality changes, andsubstitution ) B)Quality changesC)Substitution 31. A Laspeyres price index tends to: A)overstate the inﬂation rate, because its market basket is ﬁxed.(Explanation: A Laspeyres price index tends to overstate the inﬂation rate because it uses ﬁxed market basket weights from a baseperiod. This does not consider that consumers will substitute awayfrom goods that have risen dramatically in price ) B)understate the inﬂation rate because its market basket is ﬁxed.C)overstate the inﬂation rate because its market basket isvariable. 32. A price index that is calculated using the current weights of the index’s basket of goods and services is known as a: A)chained price index. (Explanation: A chained or chain-weighted price index uses updated weights for each good and service in itsmarket basket. A price index that is not chain-weighted, such as aLaspeyres index, is calculated using weights for each good and servicein the market basket as of the index’s base period. Hedonic pricing isa technique used to adjust a price index for upward bias from qualitychanges of goods in its market basket ) B)Laspeyres price index.C)hedonic price index.
33. Which of the following factors would least likely result in demand-pull inﬂation? An increase in: A)exports.B)the quantity of money. C)energy prices. (Explanation: Demand-pull inﬂation can result from any factor that increases aggregate demand, including increasesin the money supply, increases in exports, and increases ingovernment purchases. Increases in the prices of productive inputswould result in cost-push inﬂation as aggregate supply decreases ) 34. Which of the following statements is most accurate? Cost-push inﬂation: A)often occurs because of an increase in short-run aggregatesupply.B)results from excess short-run aggregate demand. C)typically results from a signiﬁcant price increase in aproduction input. (Explanation: Cost-push inﬂation typically results from a signiﬁcant price increase in a production input thatcauses a decrease in short-run aggregate supply ) 35. The inventory-to-sales ratio for manufacturing and trade is classiﬁed as a: A)leading indicator. B)lagging indicator. (Explanation: The inventory-to-sales ratio for manufacturing and trade is considered a lagging indicatorbecause it peaks after the economy does, even though it is sometimesused in forecasting economic activity )
C)coincident indicator. 36. Average weekly initial claims for unemployment insurance are classiﬁed as a: A)lagging indicator.B)coincident indicator. C)leading indicator. (Explanation: Initial claims for unemployment insurance are considered a leading indicator ) 37. Manufacturing and trade sales are best described as a: A)lagging indicator.B)leading indicator. C)coincident indicator. (Explanation: Manufacturing and trade sales are a coincident indicator that generally reﬂects the currentphase of the business cycle ) 38. Which of the following economic indicators is classiﬁed as a leading indicator for the United States economy? A)Industrial production. B)Index of consumer expectations. (Explanation: Consumer expectations are a leading indicator. Industrial production is acoincident indicator. Average duration of unemployment is a laggingindicator . ) C)Average duration of unemployment. 39. At a recent board meeting of Pembroke Financial Inc., members of the board were discussing recent ﬁscal and
monetary policy changes in the U.S. It became a heateddiscussion when each member expressed their opinions on whatwill be happening to long-run aggregate supply (LAS), aggregatedemand, and the overall economy as a result of policy shifts. JoeFrankel and Martin Bentz, two vocal members of the board, madethe following statements during the meeting:Frankel: LAS can be thought of as the potential GDP of theeconomy. Potential GDP is positively related to the quantity oflabor in the economy and the technology level of the economy,but is inversely related to the quantity of capital in the economy.So, potential GDP will rise if the quantity of labor increases, thelevel of technology increases, or the quantity of capital decreases.Bentz: The level of real output on the LAS curve is the economy’slevel of production when it is operating at zero unemployment. Azero unemployment rate is referred to as full employment.With respect to these statements: A)only Bentz is incorrect.B)only Frankel is incorrect. C)both are incorrect. (Explanation: LAS can be thought of as the potential real output of the economy. The potential real output of aneconomy is positively related to: the quantity of labor in the economy;the quantity of capital (productive resources) in the economy, and thetechnology that the economy possesses.The level of real output (real GDP) on the LAS curve is the economy’slevel of production when the economy is operating at fullemployment. However, full employment does not mean zerounemployment. There will always be some unemployment.Therefore, there is a natural rate of unemployment corresponding tothe level of real GDP along the LAS curve, and that level is referred toas full employment GDP )
40. The most recent economic indicators show rising stock prices, an increase in average weekly hours in manufacturing,and lengthening periods of unemployment. Which phase of thebusiness cycle is most consistent with these changes? A)Expansion. (Explanation: Increases in stock prices and average hours predict expansion. The fact that unemployment is stilllengthening suggests the economy has been in recession sinceunemployment is a lagging indicator, but does not preclude thebeginnings of an expansion ) B)Peak.C)Contraction. 41. The spread between the yield on 10-year government bonds and the overnight bank lending rate has decreased from 300basis points to 200 basis points. As an economic indicator, thismost likely suggests that the business cycle: A)has passed a trough.B)has entered a contraction. C)is approaching a peak. (Explanation: The slope of the yield curve, as measured by the spread between long-term and short-terminterest rates, is considered a leading indicator of the business cycle. Adecline in the yield spread is consistent with expectations that anexpansion is near its peak ) 42. An economic forecaster points to declining stock prices, money supply, and building permits, along with improvingvendor performance and a narrowing of the spread between10-year Treasuries and the federal funds rate in order to justifyher economic viewpoint. She is most likely:
A)stating that the economy is currently at a trough. B)predicting a recession. (Explanation: All the indicators she cites are leading indicators that show deteriorating economic conditions,consistent with a forecast of recession ) C)expecting an economic recovery.