MANAGEMENT ADVISORY SERVICES
Economics Answers and Explanations
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1. (c) The requirement is to predict the market price
based on an increase in both supply and demand. The
correct answer is (c) because without additional
information about the extent of the change, the effect
on price is not determinable. Answers (a), (b), and (d)
are incorrect because the price elasticity of the demand
or supply function does not provide
enough information to determine the effect.
2. (a) The requirement is to describe the relationship
shown by a supply curve. A supply curve illustrates the
quantity supplied at varying prices at a point in time.
Therefore, the correct answer is (a). Answers (b) and
(c) are incorrect because they deal with demand.
Answer (d) is
incorrect because it deals with demand-supply
equilibrium.
3. (a) The requirement is to apply the concept of
priceelasticity of demand. If demand is inelastic an
increase in price will increase total revenue. Answer (a)
is correct because it accurately states this rule. Answer
(b) is incorrect because if demand is inelastic the
quantity demanded will not be affected significantly by a
change in price. Answer (c) is incorrect because if the
quantity demanded is not significantly affected by an
increase in price, total revenue will increase. Answer (d)
is incorrect because an increase in price may, or may
not, increase competition.
4. (c) The requirement is to identify the reason for the
shift in demand. The correct answer is (c) because a
shift in demand could result from a change in consumer
tastes. Answer (a) is incorrect because this would result
in movement along the existing demand curve. Answer
(b) is incorrect because a change in supply would not
affect the demand function. Answer (d) is incorrect
because a decrease in price of a substitute would result
in a shift of the curve to the left.
5. (a) The requirement is to determine the effect of the
shift in the demand function on the price of the product.
The correct answer is (a) because the shift (increase) in
demand will increase the price of the product. Answer
(b) is incorrect because a shift of the demand curve to
the left would have to occur to decrease price. Answers
(c) and (d) are incorrect because the effect on price will
not be to remain the same and it can be determined.
6. (c) The requirement is to identify the item that has an
inverse relationship with the demand for money. The
correct answer is (c) because as interest rates increase
the demand for money decreases. Answers (a), (b), and
(d) are incorrect because they do not have an inverse
relationship with the demand for money.
7. (a) The requirement is to describe the effect of an
improvement in technology that leads to increased
worker productivity. If the cost of producing a good
declines, more will be supplied at a given price.
Therefore, the supply curve will shift to the right and
answer (a) is correct. Answer (b) is incorrect because a
shift to the left would result in decreased supplies.
Answer (c) is incorrect because price would not
increase, and answer (d) is incorrect because wages
would not necessarily increase.
8. (b) The requirement is to identify the market feature
that is likely to cause a surplus of a particular product.
Answer (b) is correct because a price floor, if it is above
the equilibrium price, will cause excess production and a
surplus. Answer (a) is incorrect because a monopoly
market is likely to be characterized by underproduction
of the product. Answer (c) is
incorrect because a price ceiling, if it is below the
equilibrium price, will cause underproduction and
shortages. Answer (d) is incorrect because in a perfect
market with no intervention demand and supply will be
equal.
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October 2018
9. (d) The requirement is to describe the effect on
demand for a good if a complementary good decreases
in price. If the price of a complementary good
decreases, demand for the joint commodity will
increase. This is due to the fact that the total cost of
using the two products decreases. If demand for a
product increases the demand curve will shift to the
right. Therefore, answer (d) is correct. Answer (a) is
incorrect because a shift in the demand curve to the left
depicts a decrease in demand. Answers (b) and (c) deal
with supply and are not relevant.
10. (d) The requirement is to identify a characteristic of
a product with price inelastic demand. The correct
answer is (d) because price inelasticity means that the
quantity demanded does not change much with price
changes. This would be a characteristic of a good with
few substitutes. Answers (a), (b), and (c) are
characteristics of goods that have price elastic demand.
11. (d) The requirement is to apply the concept of price
elasticity of demand. If substitutes for a good are readily
available then the demand for the good is more elastic.
Answer (d) is correct because there are many
substitutes for luxury goods. Answers (a), (b), and (c)
are all considered to be necessities and demand for
them is less elastic.
12. (a) The requirement is to identify the relationship
between two products for which one has increased
demand when the other’s price increases. Answer (a) is
correct. Substitute goods are selected by a consumer
based on price. When the price of one goes up, demand
for the other increases. Answer (b) is incorrect because
superior goods are those whose demand is directly
influenced by income. Answer (c) is incorrect because
complementary goods are used together and when the
price of one goes up, demand for the other goes down.
Answer (d) is incorrect because a public good is one for
which it is difficult to restrict use, such as a national
park.
13. (b) The requirement is to calculate the marginal
propensity to save. Answer (b) is correct because the
marginal propensity to save is the change in savings
divided by the change in income [($700 –
$500)/($3,500 – $3,000) = .4]. Answer (a) is incorrect
because the average propensity to save would be
calculated by dividing the new savings by the new
income ($700/$3,500 = .2). Answer (c) is incorrect
because the marginal propensity to consume is the
change in spending divided by the change in income
[($2,800 – $2,500)/($3,500 – $3,000) = .6]. Answer
(d) is incorrect because the average propensity to
consume would be calculated by dividing the new
consumption by the new income ($2,800/$3,500 = .8).
14. (c) The requirement is to describe market conditions
in a competitive market when both demand and supply
increase. In a competitive market, the market will
always clear at the equilibrium price. If there is an equal
increase in both demand and supply, the equilibrium
price may increase, decrease, or remain the same.
However, there will be more units sold and, therefore,
answer (c) is correct. Answers (a), (b), and (d) are
incorrect because the equilibrium price may increase,
decrease, or remain the same.
15. (d) The requirement is to calculate the marginal
propensity to consume. Answer (d) is correct because
the marginal propensity to consume is calculated by
dividing the change in consumption by the change in
disposable income. Therefore, the marginal propensity
to consume would be .75 [($44,000 –
$38,000)/($48,000 – $40,000)].
16. (b) The requirement is to determine the item that
will cause a shift in the supply curve. A shift in the
supply curve may result from (1) changes in production
technology, (2) changes or expected changes in
resource prices, (3) changes in the prices of other
goods, (4) changes in taxes or subsidies, (5) changes in
the number of sellers in the market, and (6)
expectations about the future price of the product.
Answer (b) is correct because it identifies changes in
production taxes, which will alter the supply curve.
Answer (a) is incorrect because a change in the price of
the product involves movement along the existing
supply curve, not a shift in the supply curve. Answers
(c) and (d) are incorrect because they identify changes
that result in a shift in the demand curve.
17. (d) The requirement is to identify the effects of
government regulation on a product. Government
regulation increases the cost of the product and
therefore will most likely 180 Module 42: Economics,
Strategy, and Globalizationresult in higher prices. Thus
answer (d) is correct. Answer (a) is incorrect because
the regulation has no relationship to consumption.
Answer (b) is incorrect because an increase in cost is
not likely to result in a decrease in price. Answer (c) is
incorrect because tax revenue will likely decline due to
the added production costs and reduced sales.
18. (a) The requirement is to identify which of the
situations indicate inelastic demand. Elasticity of
demand is measured by the percentage change in the
quantity demanded divided by the percentage change in
price. If the quotient is greater than one, demand for
product is price elastic, and if it less than one, demand
for the product is price inelastic. A quotient of exactly
one indicates unitary elasticity. Answer (a) is correct
because the price elasticity quotient is equal to 0.6
(3%/5%). Answer (b) is incorrect because the quotient
is 1.5 (6%/4%). Answer (c) is incorrect because the
quotient is 1 (4%/4%). Answer (d) is incorrect because
the quotient is equal to 1.67 (5%/3%).19. (a) The
requirement is to describe the effect of an
increase in wages on demand for labor. Answer (a) is
correct because, like any other good or service, if price
is increased for labor, the demand will fall and
employment will fall. Answer (b) is incorrect because
setting a maximum wage will not allow workers to
increase wages. Answer (c) is incorrect because firms
may or may not change in size. Answer (d) is incorrect
because supply will only decrease if the price of the
product decreases.
20. (a) The requirement is to identify the market effects
of a polluting manufacturer’s actions. Answer (a) is
correct because a polluting firm calculates its profits
without considering the costs of environmental damage
and, as a result, prices its products too low. Answer (b)
is incorrect because the polluting manufacturer is
producing too much, not too little output. Answer (c) is
incorrect because the manufacturer reports too much,
not too little profitability. Answer (d) is incorrect
because there is no direct relationship between the use
of equity versus debt financing and the externalities
involved in the production activities of the firm.
21. (b) The requirement is to describe the effects of a
government-mandated maximum price. If the
government mandates a maximum price below the
equilibrium price, the product will be selling at an
artificially low price resulting in shortages. Thus the
correct answer is (b). Answer (a) is incorrect because
price floors result in surpluses. Answer (c) is incorrect
because price ceilings would probably result in more
demand. Answer (d) is incorrect because the market
would be affected.
22. (b) The requirement is to identify a valid reason for
government intervention in a wholesale market. Answer
(b) is correct because a valid reason for government
intervention is the lack of a competitive market.
Answers (a), (c), and (d) are incorrect because they
provide no indication that the market is not competitive.
23. (a) The requirement is to identify the type of good
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that is likely to have an income elasticity coefficient of
3.00. Answer (a) is correct because an income elasticity
coefficient of 3.00 indicates that demand for the good is
very sensitive to income levels. This is a characteristic of
a luxury good. Answer (b) is incorrect because while the
good may be complementary, it would have to be
complementary to a luxury good. Answer (c) is incorrect
because an inferior good’s coefficient will be negative.
Answer (d) is incorrect because demand for a necessity
is not sensitive to income levels.24. (c) The requirement
is to calculate the price elasticity of demand for golf. The
price elasticity of demand is calculated as the
percentage change in quantity divided by the
percentage change in price. If the result is greater than
one, demand is elastic; if it is less than one, it is
inelastic; and if it is equal to one, it is unitary elastic.
The regular weekday demand is elastic as calculated
below.(80 – 70) ÷ [(80 + 70) ÷ 2]= 1.4
($11 – $10) ÷ [($11 + $10) ÷ 2]
The weekend demand is inelastic as calculated below.
(223 – 221) ÷ [(223 + 221) ÷ 2]
= .03
($20 – $15) ÷ [($20 + $15) ÷ 2]
The senior citizen demand is elastic as calculated below.
(150 – 82) ÷ [(150 + 82) ÷ 2]= 2.05
($8 – $6) ÷ [($8 + $6) ÷ 2]
The only statement that correctly defines these
relationships is answer (c).
25. (c) The requirement is to identify the factor that
would cause the demand curve for a product to shift to
the left. Answer (c) is correct because a shift in the
demand curve to the left would be indicative of a
decrease in demand for the product, and an increase in
the price of a complementary commodity would cause
such a shift. Answers (a), (b), and (d) are incorrect
because they would all potentially cause an increase in
demand, causing the demand curve to shift to the
right.
26. (c) The requirement is to describe the effect of price
ceilings. Price ceilings cause the price of a product to be
artificially low resulting in decreased supply. The price is
below the equilibrium price as indicated by answer (c).
Answer (a) is incorrect because government price
support is an example of a price floor. Answer (b) is
incorrect because price ceilings create prices less than
equilibrium prices. Answer (d) is incorrect because price
ceilings create shortages, not surpluses.
27. (b) The requirement is to determine the immediate
effect upon one product of an increase in the price of a
substitute good. The demand and price of substitute
products are directly related. If the price of a good
increases, the demand for its substitute will also
increase. Answer (b) is correct because it depicts this
relationship. Answer (a) is incorrect because the price of
a product will not increase due to an increase in a
substitute product’s price. Answer (c) is incorrect
because the quantity supplied will not be impacted by an
increase in price of a substitute product. Answer (d) is
incorrect because even though the quantity demanded
will increase with an increase in price of a substitute
product, the price and supply will not be directly
affected.
28. (d) The requirement is to calculate the effect a
decrease in the price of a substitute good has on
demand for a good. Answer (d) is correct because if the
coefficient of crosselasticity is 2.00, a 5% decrease in
price will result in a 10% (5% × 2.00) decrease in the
demand for Wilson’s product. Answers (a), (b), and (c)
are incorrect because they misstate the relationship.
29. (d) The requirement is to calculate the price
elasticity of demand for a product. Price elasticity using
the arc method is calculated by dividing the percentage
change in quantity demanded by the percentage change
in price, using the average changes. In this case, price
elasticity is calculated below.
(150 – 100) ÷ [(150 + 100) ÷ 2]= 3.8
($50 – $45) ÷ [($50 + $45) ÷ 2]
Therefore answer (d) is correct.
30. (b) The requirement is to calculate the price
elasticity of demand. Answer (b) is correct because the
formula for price elasticity is equal to the percentage
change in quantity demanded divided by the percentage
change in price. In this case, the percentage change in
price is 0.88 as calculated below.
(225 – 200) ÷ [(225 + 200) ÷ 2]= .088
($40 – $35) ÷ [($40 + $35) ÷ 2]
31. (b) The requirement is to identify the effect of a
boycott on demand for a good. Answer (b) is correct
because a boycott means less people are purchasing the
good. Therefore, demand is decreased. Answer (a)
would not occur because, if anything, a decrease in
demand would lead to a decrease in price. Answer (c) is
incorrect because demand does not affect supply.
Answer (d) is incorrect because the elasticity of demand
for a good is determined by its nature.
32. (c) The requirement is to identify the factor that is
not likely to affect the supply of a good. Answer (c) is
correct because changes in consumer income could
affect the demand for the good, but not its supply.
Answer (a) is incorrect because government subsidies
reduce the cost of producing a good, and therefore,
affect supply. Answer (b) is incorrect because changes
in technology can alter production costs, and therefore,
affect supply. Answer (d) is incorrect because changes
in production costs affect the supply of a good.
33. (d) The requirement is to identify the effect on total
revenue of a decrease in price of a price-elastic product.
Answer (d) is correct because if a product’s demand is
price-elastic, a decrease in price will lead to an even
larger percentage increase in quantity demanded.
Therefore, total revenue will increase. Answers (a), (b),
and (c) are incorrect because they do not describe the
appropriate effect.
34. (a) The requirement is to identify the goods that are
notcomplementary goods. Complementary goods are
those that are used together because they enhance each
other’s use. Margarine and butter are substitute goods,
not complementary goods. Therefore, (a) is correct.
Answers (b), (c), and (d) all are pairs of complementary
goods.
35. (a) The requirement is to describe the law of
diminishing
marginal utility. The law states that marginal utility
declines
as consumers acquire more of a good. Therefore,
answer (a) is correct. Answer (b) is incorrect because
total utility will not decline as more of a good is
acquired. Answer (c) is incorrect because the demand
curve slopes downward.
36. (b) The requirement is to identify the price elasticity
of an essential product with no substitutes. The correct
answer is (b). Demand for the product is perfectly
inelastic because the diabetic will purchase the product
regardless of the price.37. (c) The requirement is to
define the implications of economies of scale. In the
long run firms may experience increasing returns
because they operate more efficiently. With growth
comes specialization of labor and related production
efficiencies related to the law of diminishing returns.
This phenomenon is called economies of scale. Answer
(c) is correct because it accurately describes this
concept. Answers (a) and (b) are incorrect because they
describe inefficiencies. Answer (d) is incorrect because
total costs do not decline but average costs do.38. (d)
The requirement is to identify the reason for
increasing returns. In the long run firms may experience
increasing returns because they operate more
efficiently. With growth comes specialization of labor
and related production efficiencies. This phenomenon is
called economies of scale and, therefore, answer (d) is
correct. Answer (a) is incorrect because the law of
diminishing returns states that at some point firms get
too large and diminishing returns occur. Answer (b) is
incorrect because opportunity cost is the benefit forgone
by the use of a particular resource. Answer (c) is
incorrect because comparative advantage deals with the
production choices of countries.
39. (b) The requirement is to identify the term used to
3
describe the benefit lost by using resources for a given
purpose. The correct answer is (b) because opportunity
cost is the benefit given up from not using the resource
for another purpose. Answer (a) is incorrect because
economic efficiency is a comparison among uses of
resources. Answers (c) and (d) are incorrect because
they involve comparisons across countries.
40. (c) The requirement is to calculate the total cost of
producing seven units. Total cost is equal to average
total cost multiplied by the number of units produced.
Therefore, the correct answer is (c) because 7 × $36.86
= $258.02.
41. (c) The requirement is to calculate marginal cost.
Marginal cost is the additional cost of producing one
additional item. To calculate the marginal cost of
producing the ninth unit we take the total cost of
producing nine units and deduct the total cost of
producing eight units. Thus, the correct
answer is (c) because (9 × $33.75) – (8 × $34.75) =
$25.75.
182 Module 42: Economics, Strategy, and Globalization
42. (a) The requirement is to calculate the average total
cost at an output level of 11 units. Answer (a) is correct
because the average total cost is calculated by dividing
total cost by the number of units: [($1,000 fixed cost +
$250 variable cost)/11] = $113.64.
43. (c) The requirement is to calculate the marginal
physical product. The marginal physical product is the
additional output obtained by adding one additional
worker. When one worker is added to a team of 10, five
(25 – 20) additional units are produced. Therefore, the
correct answer is (c).44. (c) The requirement is to
calculate the marginal revenue per unit. The total
revenue of adding one additional worker to a team of 11
is equal to the difference between total revenue
at 12 workers and total revenue at 11 workers, or $105
[(25 × $49) – (28 × $47.50)]. Answer (c) is correct
because the marginal revenue per unit is $35 = $105/3.
Answer (d) is incorrect because it is the average selling
price for one unit.45. (c) The requirement is to calculate
the marginal revenue product when one worker is
added. The marginal revenue product is the increase in
total revenue received by the addition of one worker.
The total revenue from adding one additional worker to
a team of 11 is equal to the difference between total
revenue at 12 workers and total revenue at 11 workers,
or $105 [(25 × $49) – (28 × $47.50)]. Therefore
answer (c) is correct.46. (d) The requirement is to
define marginal revenue. The correct answer is (d)
because marginal revenue is the change in total revenue
associated with the sale of one more unit of output.
Answer (a) is incorrect because in a monopolistic
competitive market, price is greater than marginal cost.
Answer (b) is incorrect because marginal revenue is the
increase in revenue associated with the sale of one
additional product. Answer (c) is incorrect because in a
purely competitive market, marginal revenue is equal to
price.
47. (d) The requirement is to identify the distinguishing
characteristic of long-run supply. Answer (d) is correct
because the distinguishing characteristic of the long-run
production function is that all costs are variable.
Answers (a) and (b) are incorrect because price and
output are determined by demand and supply. Answer
(c) is incorrect because firms can enter or exit the
industry.
48. (d) The requirement is to identify the main factor
that differentiates the short-run cost function from the
long-runcost function. Answer (d) is correct because in
the short run firms have fixed and variable costs,
whereas in the long run all costs are variable. Answer
(a) is incorrect because all costs are variable in the long
run. Answer (b) is incorrect because the level of
technology will affect short-run and long-run cost
functions in a similar manner. Answer (c) is incorrect
because changes in government subsidies will not affect
an industry’s cost functions.
49. (a) The requirement is to describe how a large
required capital outlay affects a market. The correct
answer is (a) because a large capital outlay constitutes
a barrier to entry into the market. Answer (b) is
incorrect because minimum efficient scale indicates that
a company must be of sufficient size to compete. This is
not indicated by the scenario. Answer (c) is incorrect
because a created barrier is one created by the
competing firms. Answer (d) is incorrect becausethe
production possibility boundary shows the maximum
combination of outputs that can be achieved with a
given number of inputs.
50. (c) The requirement is to identify the type of
economic market. The correct answer is (c) because an
oligopoly is characterized by a few firms in the industry.
Answer (a) is incorrect because a natural monopoly has
only one firm. Answer (b) is incorrect because a cartel is
a group of firms that have joined together to fix prices.
Answer (d) is incorrect because monopolistic
competition is characterized by a large number of firms
selling similar but differentiated products.
51. (d) The requirement is to identify the distinguishing
characteristics of oligopolistic markets. The correct
answer is (d) because of the small number of suppliers
in an oligopolistic market, the actions of one affect the
others; there is mutual interdependence with regard to
pricing and output in an oligopolistic market. Answers
(a) and (b) are incorrect because they describe
monopolies. Answer (c) is incorrect because oligopolistic
markets typically have barriers to entry.
52. (a) The requirement is to identify the characteristic
that is not representative of monopolistic competition.
The correct answer is (a) because monopolistic
competition is a market that has numerous sellers of
similar but differentiated products. Answers (b), (c), and
(d) are incorrect because they are all characteristic of
monopolistic competition.
53. (b) The requirement is to identify the market that is
characterized by a few large sellers. Answer (b) is
correct because it is the definition of an oligopoly.
Answer (a) is incorrect because a monopoly has a single
seller of a product or service for which there are no
close substitutes. Answer (c) is incorrect because perfect
competition is characterized by many firms selling an
identical product or service. Answer (d) is incorrect
because monopolistic competition is characterized by
many firms selling a differentiated product or service.
54. (c) The requirement is to identify the different types
of economic markets. Answer (c) is correct because it is
the definition of perfect competition. Answer (a) is
incorrect because a monopoly has a single seller of a
product or service for which there are no close
substitutes. Answer (b) is incorrect because an oligopoly
is a form of market in which there are few large sellers
of the product. Answer (d) is incorrect because
monopolistic competition is characterized by many firms
selling a differentiated product or service.
55. (c) The requirement is to identify the definition of a
natural monopoly. The correct answer is (c) because a
natural monopoly exists when, because of economic or
technical conditions, only one firm can efficiently supply
the product. Answer (a) is incorrect because while
owning natural resources may contribute to the
establishment of a natural monopoly, the firm would still
have to be the best possible producer of the product.
Answer (b) is incorrect because a patent establishes a
government-created monopoly. Answer (d) is incorrect
because if the government is the only provider, the
market is a government-created monopoly.Module 42:
Economics, Strategy, and Globalization 183
56. (c) The requirement is to identify the market
described as one with low barriers to entry and product
differentiation. The correct answer is (c) because
monopolistic competition is a market that is
characterized by a large number of small producers of a
differentiated product. Answer (a) is incorrect because a
monopoly has only one producer. Answer (b) is incorrect
because a natural monopoly is an industry in which
4
there is only one producer based on the economics of
the industry. Answer (d) is incorrect because an
oligopoly is an industry that has a few large producers
with barriers to entry.
57. (d) The requirement is to identify the item that is
not characteristic of perfect competition. In a perfectly
competitive market there are a large number of small
producers selling a standard product. Answer (d) is
correct because all sellers must sell at the industry
price. Answers (a), (b), and (c) are all characteristics of
perfect competition.
58. (a) The requirement is to describe the reason for the
kinked demand curve in an oligopolist market. An
oligopolist faces a kinked demand curve because
competitors will often match price decreases but are
hesitant to match price increases.Therefore, answer (a)
is correct. Answer (b) is incorrect because an oligopolist
does not face a nonlinear demand for its product.
Answer (c) is incorrect because an oligopolist cannot
sell its product for any price. Answer (d) is incorrect
because consumer demand determines the demand
curve in all markets.
59. (a) The requirement is to identify the impact of
consumer confidence upon the economy. Answer (a) is
correct because if consumer confidence falls then
consumers will delay spending until the uncertainty is
resolved. The end result is a downturn in the economy.
Answers (b), (c), and (d) are incorrect because they do
not properly state the relationship between consumer
confidence and the economy.
60. (a) The requirement is to determine the marginal
propensity to consume given the multiplier. The
multiplier refers to the fact that an increase in spending
has a multiplied effect on GDP. The effect of the
multiplier can be estimated using the economy’s
marginal propensity to consume, or vice versa. In this
case, the multiplier is 4 ($80/$20) and the marginal
propensity to save is 25% (1.00/4). Therefore, answer
(a) is correct because the marginal propensity to
consume is one minus the marginal propensity to save,
or 75% (100% – 25%).61. (c) The requirement is to
identify a characteristic of the trough of a business
cycle. In the trough of a business cycle, actual output
and income are below potential output and income.
Therefore, the correct answer is (c). Answer (a) is
incorrect because purchasing power is not directly
related to business cycles. Answer (b) is incorrect
because in a recession it is cyclical unemployment that
is high, not natural unemployment. Answer (d) is
incorrect because potential income will exceed actual
income.62. (c) The requirement is to describe the effect
of a decrease in government spending on the economy.
The government represents one segment of the
economy that demands goods and services. If
government spending decreases, aggregate demand
decreases. Thus, answer (c) is correct. Answer (a) is
incorrect because a decrease in government spending
will result in a decrease in aggregate demand. Answers
(b) and (d) are incorrect because a decrease in
government spending will not immediately affect supply.
63. (d) The requirement is to define aggregate demand.
The correct answer is (d) because aggregate demand is
the total amount of expenditures for consumer goods
and investment for a period of time. It includes
purchases by consumers, businesses, government, and
foreign entities.
64. (d) The requirement is to identify an item that would
be included in GDP. Gross domestic product is the value
of all final goods and services produced by the country
by both domestic and foreign-owned sources. Answer
(d) is correct because common stock is not a good or
service; it is an ownership interest in a company.
Answers (a), (b), and (c) are all incorrect because they
all represent the value of goods or services produced.
65. (d) The requirement is to identify the indicator of an
upturn in economic activity. Answer (d) is correct
because a reduction in the amount of luxury purchases
is an indicator of a downturn in economic activity.
Answers (a), (b), and (c) are all indicators of positive
economic changes.
66. (d) The requirement is to identify a leading indicator
of economic expansion. Answer (d) is correct because
an increase in weekly hours worked by production
workers is a favorable leading indicator. Answer (a) is
incorrect because a falling money supply is an indicator
associated with falling GDP. Answer (b) is incorrect
because a decline in the issuance of building permits
signals lower expected building activity and a falling
GDP. Answer (c) is incorrect because an increase in the
timeliness of delivery by vendors indicates slacking
business demand and potentially falling GDP.
67. (d) The requirement is to identify the definition of
disposable income. Answer (d) is correct because
disposable income equals personal income minus
personal taxes. It is the portion of income that can be
spent by the consumer. Answer (a) is incorrect because
gross domestic product less the capital cost allowance is
net domestic product. Answer (b) is incorrect because
net domestic product minus indirect business taxes plus
net income earned abroad is national income. Answer
(c) is incorrect because disposable income is not
measured by deducting transfer payments from personal
income.
68. (c) The requirement is to identify the primary reason
for allowing legal immigration into industrial nations.
Answer (c) is correct because immigration will increase
the supply of labor and lower its equilibrium price. This
results in greater domestic and world output and
increases income in the country to which workers
migrate. Answer (a) is incorrect because the impact on
trade deficit is less than that on growth. Answers (b)
and (d) are incorrect because trade agreements and
political agreements are not primary reasons.
69. (a) The requirement is to identify a lagging
economic indicator. Lagging indicators include (1)
average duration of unemployment in weeks, (2) the
change in the index of labor cost per unit of output, (3)
the average prime rate charged by banks, (4) the ratio
of manufacturing and trade inventories to sales, (5)
commercial and industrial loans outstanding, (6) the
ratio of consumer installment credit outstanding to
personal income, and (7) the change in the CPI for
services. Answer (a) is correct because chronic
unemployment is a lagging indicator. Answers (b), (c),
and (d) are incorrect because they are all leading
indicators.
70. (d) The requirement is to identify the true statement
about government borrowing to finance large deficits.
The correct answer is (d) because increased borrowing
by the government increases the demand for money,
which puts upward pressure on interest rates. Answer
(a) is incorrect because government borrowing reduces
the amount of lendable funds; it does not increases
them. Answer (b) is incorrect because government
borrowing exerts upward pressure on interest rates not
downward pressure. Answer (c) is incorrect because
government borrowing puts upward pressure on
interest rates.
71. (d) The requirement is to describe the effects of
rising inflation. Answer (d) is correct because rising
inflation increases the price level of goods, which means
that individuals can purchase less. Answer (a) is
incorrect because individuals that receive specific
amounts of money lose purchasing power. Answer (b) is
incorrect because there is an inverse relationship
between price level and purchasing power. Answer (c) is
incorrect because if the contracts have indexing
provisions, the prices will increase.
72. (d) The requirement is to describe the mosteffective
fiscal policy for reducing demand-pull inflation.
Demandpull inflation is caused by excess demand that
bids up the cost of labor and other resources. The
correct answer is (d) because the most effective
government policy would involve reducing demand that
could be done by taxation and reduced government
spending. Answer (a) is incorrect because it involves
monetary policy. Answers (b) and (c) are incorrect
because increasing government spending would feed
demandpull inflation.
73. (c) The requirement is to identify an action that will
5
cause a decrease in money supply. The correct answer
is (c) because an increase in the reserve requirement
will leave financial institutions with less money to lend
and therefore decrease the money supply. Answers (a),
(b), and (d) are incorrect because they would all result
in an increase in the money supply.
74. (c) The requirement is to identify how the Federal
Reserve Board mostdirectly influences the decision of
whether or not to issue debt or equity financing. Answer
(c) is correct because the Board sets the discount rate
at which the Federal Reserve Bank lends money to
member banks, which directly influences the rates that
commercial banks charge their customers. Answer (a) is
incorrect because the Board does not affect the income
tax rate. Answers (b) and (d) are incorrect because the
Federal Reserve Bank charges member banks the
discount rate.
75. (d) The requirement is to identify the effects of a tax
increase. Answer (d) is correct because a tax increase
reduces household income and, therefore, reduces
spending and decreases aggregate demand.
76. (b) The requirement is to describe an expansionary
monetary policy. The correct answer is (b) because
purchasing US securities would increase the amount of
money in the economy. Answer (a) is incorrect because
raising the reserve requirement would decrease the
amount of money in the economy. Answer (c) is
incorrect because raising the discount rate would
discourage borrowing by banks and therefore reduce the
amount of money in the economy. Answer (d) is
incorrect because both of the actions would tend to
reduce the money supply.
77. (a) The requirement is to define the reserve ratio.
The reserve ratio is the percentage of total checking
deposits that a financial institution must hold on reserve
in the central bank. Thus, the correct answer is (a).
Answer (b) is incorrect because it is the description of
the discount rate.
78. (b) The requirement is to identify the most
important way that the money supply is controlled. The
correct answer is (b). The purchase and sale of
government securities (open-market operations) is the
most important way that the government controls the
money supply. Answers (a) and (d) are incorrect
because, while they are instruments of monetary
policy, they are not the most important ways of
controlling money supply. Answer (c) is incorrect
because it describes an instrument of fiscal policy.
79. (d) The requirement is to define how the
government uses fiscal policy to stimulate the economy.
To stimulate the economy with fiscal policy, the
government would lower taxes and/or increase
spending. Therefore, the correct answer is (d). Answer
(a) is incorrect because raising taxes does not stimulate
the economy. Answer (b) is incorrect because
decreasing government spending does not stimulate the
economy. Answer (c) is incorrect because increasing the
money supply involves monetary policy.
80. (c) The requirement is to define the federal budget
deficit. The federal budget deficit is the amount by
which the government’s expenditures exceed its
revenues in a given year. Thus, answer (c) is correct.
Answer (a) is incorrect because it defines the
government debt. Answer (b) is incorrect because state
and local government amounts are not included in the
federal budget deficit. Answer (d) is incorrect because
the deficit does not deal with assets and liabilities of the
government.
81. (a) The requirement is to identify the tool that would
serve to control inflation. Answer (a) is correct because
selling government securities serves to reduce capital
available for other investments and, therefore, serves to
contract the economy. Answer (b) is incorrect because
lowering reserve requirements serves to increase the
amount of funds available for investment. Answer (c) is
incorrect because lowering the discount rate serves to
decrease the cost of funds and increase investment.
Answer (d) is incorrect because encouraging higher tax
rates is a fiscal policy.
82. (a) The requirement is to determine the reason for
the importance of the multiplier. The multiplier provides
an indication of the impact of an increase in
consumption or investment in GDP. An increase in
spending ripples through the economy because
individuals and business save only a portion of the
increase in income. Therefore, the correct answer is (a).
83. (a) The requirement is to identify the purpose of a
tax rebate. Answer (a) is correct because increasing the
amount of funds available to the consumer increases
disposable income that should stimulate economic
activity. Consumers will spend the additional funds and
correspondingly expand the economy. Answers (b), (c),
and (d) are erroneous statements about the effects of
the rebate.
84. (c) The requirement is to identify the definition of
structural unemployment. Answer (c) is correct because
structural unemployment exists when aggregate
demand is sufficient to provide full employment, but the
distribution of the demand does not correspond
precisely to the composition of the labor force. This form
of unemployment arises when the required job skills or
the geographic distribution of jobs changes. Answer (a)
is incorrect because frictional unemployment results
from imperfections in the labor market. It occurs when
both jobs and workers to fill them are available. Answer
(b) is incorrect because cyclical unemployment is caused
by contractions of the economy. Answer (d) is incorrect
because the full-employment unemployment rate is the
sum of frictional and structural unemployment.
85. (a) The requirement is to identify the nature of the
producer price index. Answer (a) is correct because the
price index measures the combined price of a selected
group of goods and services for a specified period in
comparison with the combined price of the same or
similar goods for a base period. The US government’s
producer price index (PPI) is an example. It measures
the price of a basket of 3,200 commodities at the point
of their first sale by producers. Answer (b) is incorrect
because the export price index measures price changes
for all products sold by domestic producers to
foreigners. Answer (c) is incorrect because the import
price index measures price changes of goods purchased
from other countries. Answer (d) is incorrect because
the consumer price index measures the price of a fixed
market basket of goods purchased by a typical urban
consumer.
86. (a) The requirement is to identify the formula for
calculating a price index. Answer (a) is correct because
the 2013 price index using 2008 as a reference period is
the price of the 2013 market basket in 2013 relative to
the price of the same basket of goods in 2008. The
correct formula is Price of market basket in a given year
× 100Price of same market basket in base year
Answer (b) is incorrect because the 2008 market basket
is used. Answer (c) is incorrect because it uses two
different market baskets. Answer (d) is incorrect
because it uses the 2008 prices in the numerator and
the denominator and different market baskets.
87. (d) The requirement is to describe the discount rate.
The correct answer is (d) because the discount rate is
the rate the central bank charges commercial banks for
loans. Answer (a) is not correct because it describes the
reserve requirement.
88. (c) The requirement is to identify which of the
statements is true about deflation. Answer (c) is correct
because deflation results in very low interest rates. They
could even turn negative. Answer (a) is incorrect
because consumers are not motivated to borrow money
because they will be paying back the debt with money
that has greater purchasing power. Answer (b) is
incorrect because businesses are hesitant to make
investments because prices for capital goods are
declining. Answer (d) is incorrect because deflation
typically stalls the economy.
89. (a) The requirement is to identify the characteristics
6
of a deflationary economy. The correct answer is (a)
because businesses are hesitant to make investments
when the prices of assets are declining. Answer (b) is
incorrect because consumers are hesitant to make
major purchases when prices are declining. Answer (c)
is incorrect because interest rates are very low in
periods of deflation. Answer (d) is incorrect because
when actual GDP exceeds potential GDP inflation will
exist.
90. (a) The requirement is to identify the factor that
explains the difference between real and nominal
interest rates. Real interest rates are in terms of goods;
they are adjusted for inflation. The difference between
real and nominal rates is the inflation premium. Thus,
answer (a) is correct. Answers (b) and (c) are incorrect
because credit risk and default risk explain the
difference between the nominal rate and the rate a
particular borrower receives. Answer (d) is incorrect
because market risk explains the difference between the
nominal rate and the rate paid in a particular market.
91. (c) The requirement is to identify the statement that
isnottrue regarding international trade. Answer (c) is
correct because absolute advantage is the ability to
produce a product for less than other nations.
Comparative advantage is the ability of one nation to
produce at a relatively lower opportunity cost than
another nation. Answers (a), (b), and (d) are all
incorrect because they are true.
92. (a) The requirement is to describe the effect of an
increase in the interest rate on a currency’s value. The
correct answer is (a) because if the interest rate is
increased investors will be able to get a larger return on
investment in the country. Therefore, demand for the
currency will increase for investment purposes, and the
relative value of the currency will increase.
93. (b) The requirement is to identify the group that
would most benefit from a tariff. The correct answer is
(b) because a tariff restricts the amount of imports of a
specific good, and the group most benefiting would be
the domestic producers of that good. Answers (a), (c),
and (d) are incorrect because these groups would not
benefit from the tariff.
94. (a) The requirement is to identify the description of
comparative advantage. Answer (a) is correct because
the respective opportunity costs determine which
country will produce which product. Answer (b) is
incorrect because profit margins do not enter into the
decision. Answer (c) is incorrect because economic order
quantity determines optimum inventory levels. Answer
(d) is incorrect because tariffs would 186 Module 42:
Economics, Strategy, and Globalizationonly come into
play after each country produced its respective
products.
95. (c) The requirement is to identify the scenario that
would result in appreciation in the value of a country’s
currency. The correct answer is (c) because the lag in
imports in relation to exports means that there will be
more demand for the currency from other countries to
pay for the country’s exported goods. Answer (a) is
incorrect because if the country is importing goods this
will increase demand for other currencies and cause the
country’s currency to decline in relative value. Answer
(b) is incorrect because a higher rate of inflation
depresses a country’s currency. Answer (d) is incorrect
because lower interest rates means there will be less
demand for the currency for investment.96. (c) The
requirement is to identify the effect of a decline in the
US dollar. The correct answer is (c) because US goods
will be cheaper in foreign countries and, therefore, US
exports will increase. Answer (a) is incorrect because
foreign currencies will appreciate if the dollar
depreciates. Answer (b) is incorrect because the US
balance of payments should improve due to the increase
in exports. Answer (d) is incorrect because US imports
will decline because of the increase in cost of foreign
goods in dollars.
97. (c) The requirement is to describe how exchange
rates are determined. The correct answer is (c) because
exchange rates are determined in the same way price is
determined for other goods, based on demand and
supply. Answers (a), (b), and (d) are incorrect because
while they can have a temporary influence on exchange
rates, supply and demand is the major determining
factor.
98. (b) The requirement is to determine the effect of
changes in exchange rates. Answer (b) is correct
because the dollar’s value has declined against the mark
and therefore German goods become more expensive.
Answer (a) is incorrect because the German mark has
appreciated against the dollar. Answer (c) is incorrect
because the dollar will buy less in Germany. Answer (d)
is incorrect because US exports to Germany should
increase because they are less expensive in German
marks.
99. (c) The requirement is to identify the most
restrictive barrier to an exporting country. The correct
answer is (c) because an embargo is a total ban on
certain types of imports. Answer (a) is incorrect because
a tariff is merely a tax on imports. Answer (b) is
incorrect because quotas are merely restrictions on the
amounts of imports. Answer (d) is incorrect because
exchange controls are limits of the amount of foreign
exchange that can be transacted or exchange rates.
100. (d)The requirement is to identify the item that does
notdescribe a foreign exchange control. Answer (d) is
correct because requiring a market-driven (floating)
exchange rate involves no controls on the market. All
others describe ways of controlling foreign exchange.
101. (b)The requirement is to identify the item that
describes a dumping pricing policy. Answer (b) is correct
because a dumping pricing policy involves sales of goods
by a company of one country in another country at a
price that is lower than its cost or significantly lower
than the price charged in the company’s country.
102. (a)The requirement is to identify the item that
describes an appropriate response by importing country
to export subsidies. Answer (a) is correct because
countervailing subsidies is an appropriate response, as
they serve to offset the export subsidies.
103. (c) The requirement is to identify the item that
describes a pegged exchange rate. Answer (c) is correct
because a pegged exchange rate is one that is kept from
deviating far from a range or value by the central bank.
104. (a)The requirement is to calculate the forward
premium or discount on the euro. Answer (a) is correct
because the premium or discount is calculated as
follows:PremiumorDiscount=Forward rate –
Spot rate
× equilibrium price for the market. Answers (a), (b), and
Months (or days) in
year
Spot rate Months (or days) in
forward period
= because the ultimate purpose of competitor analysis is
$1.367 – $1.364
× competitor. Answer (a) is not a part of competitor
12
$1.364 3
= 0.88% premium
105. (a)The requirement is to identify the effect of
negative net exports. Answer (a) is correct because
when a country has negative net exports, it imports
more than it exports. Therefore, it results in a net flow
of goods from firms in foreign countries to the domestic
country.106. (d)The requirement is to identify the factor
that is leastlikely to affect a country’s currency foreign
exchange rate. Answer (d) is correct because the
country’s tax rate is least likely to affect the country’s
currency exchange rate. Answers
(a), (b), and (c) are incorrect because they are all
factors that affect the value of the country’s currency.
7
107. (c) The requirement is to compute the foreign
exchange loss or gain. The correct answer is (c) because
before the decline in value, the receivable had a value of
$18,000 (10,000 × $1.80), and after the decline in
value, the receivable had a value of $17,500 (10,000 ×
$1.75). Therefore, the loss is equal to $500. Answers
(a), (b), and (d) are incorrect because they inaccurately
calculate the loss.
108. (c) The requirement is to identify the appropriate
hedging strategy. The correct answer is (c) because by
selling euros in the futures market, the firm has locked
in the exchange rate today. Answer (a) is incorrect
because lending euros puts the company at greater risk
for changes in value of the euro. It would need to
borrow euros to lock in the exchange rate. Answer (b) is
incorrect because it involves the purchase of euros; the
appropriate strategy would involve the sale of euros.
Answer (d) is incorrect because the purchase of euros
on the spot market would put the firm more at risk to
losses from decline in the value of the euro.
109. (b)The requirement is to identify hedging
strategies that are notappropriate for political risk.
Political risk is the risk related to actions by a foreign
government, such as enacting legislation that prevents
the repatriation of a foreign subsidiary’s profits or
seizing a firm’s assets. Answer (b) is correct because
purchasing or selling futures contracts is designed to
hedge transaction risks relating to foreign exchange
rates. Answer (a) is incorrect because a firm can
purchase insurance to mitigate political risk. Answer (c)
is incorrect because if the firm finances the investment
with local-country capital, it may not be forced to repay
the loans if assets are seized by the government.
Answer (d) is incorrect because by entering into joint
ventures with local-countryfirms, the firm can reduce
the risk of seizure of the investment by the government.
110. (c) The requirement is to describe how patents
affect markets. The correct answer is (c) because a
patent prevents another firm from coming into a market
and selling the same or a very similar product.
Therefore, it is a barrier to entry into the market.
Answer (a) is incorrect because vertical integration
refers to expansion into another phase of producing the
same product. Answer (b) is incorrect because market
concentration refers to how many firms compete in the
market. Answer (d) is incorrect because collusion refers
to firms acting collectively to control the market.
111. (c) The requirement is to estimate the short-term
and long-term effects of an increase in demand in a
perfectly competitive market. Answer (c) is correct
because in the short term the price of the product will
increase but in the long term it will return to the
(d) are incorrect because the long-term price will not
likely increase.
112. (d) The requirement is to identify the ultimate
purpose of competitor analysis. Answer (d) is correct
to understand and predict the behavior of a major
analysis. Answers (b) and (c) are part of competitor
analysis but not the ultimate purpose.
113. (c) The requirement is to identify the item that
is not an important aspect of supply chain management.
Supply chain management is primarily designed to
manage the firm’s relationships with suppliers by
sharing key information all along the supply chain. The
correct answer is (c) because the area of customer
relations is not a primary focus of supply chain
management. Answer (a) is incorrect because
information technology is used extensively to share
information electronically. Answer (b) is incorrect
because accurate forecasts are essential to effective
supply chain management. Answer (d) is incorrect
because communication is the basis for supply chain
management.
114. (d) The requirement is to identify the type of
organization that would mostlikely engage in public because objective setting involves establishing short-
relationstype advertising. Firms that have monopolies termgoals.
are more likely to engage in public relations-type 124. (c) The requirement is to identify the least
advertising to forestall additional regulation. Therefore, important measure of unemployment in predicting the
the correct answer is (d).115. (b) The requirement is to future state of the economy. Answer (c) is the correct
identify target market analysis. The correct answer is answer because frictional unemployment measures the
(b) because target market analysis involves obtaining a temporary unemployment that always exists as workers
thorough understanding of the market in which the firm change jobs or new workers enter the workforce.
sells or plans to sell its product or services. Answer (a) is incorrect because structural
116. (c) The requirement is to identify an unlikely unemployment measures the workforce that is
market unemployed due to a mismatch in job skills. Significant
segmentation dimension for business customers. Answer amounts of structural unemployment can drag down the
(c) economy. Answer (b) is incorrect because cyclical
is correct because lifestyle is a possible individual unemployment measures the workforce that is
customer market segmentation dimension for unemployed due to economic conditions. Answer (d) is
individuals, not businesses. Answers (a), (b), and (d) incorrect because overall unemployment includes the
are incorrect because they all represent possible workforce that is unemployed for all reasons.
dimensions for business customer segmentation. 125. (a) The requirement is to identify the steps
117. (b) The requirement is to identify the percentage of involved in performing competitor analysis. Answer (a)
variance in quantity demanded explained by price. is correct because competitor analysis is designed to
Answer (b) is correct because the adjusted R squared predict the behavior of major competitors. Answers (b)
(.72458) measures the percent of the variance in the and (c) are incorrect because they describe aspects of
dependent variable explained by the independent industry analysis. Answer (d) is incorrect because it
variable. Answer (a) is incorrect because it is the describes aspects of general environment and industry
Multiple R that is the coefficient of correlation. Answer analyses.
(c) is incorrect because it is the intercept that is used in 126. (d) The requirement is to identify the item that is
the equation to predict quantity. Answer (d) is incorrect not a way in which companies in developed countries
because it is the standard error that measures the can generally compete with companies in developing
standard deviation of the estimate of quantity. countries. Answer (d) is correct because developing
118. (a) The requirement is to calculate the predicted countries typically have low-costresources. Answers (a),
quantity demanded. The correct answer is (a) because (b) and (c) are incorrect because they all represent
the ways that a company in a developed country may
formula is compete with companies from developing countries.
Quantity demanded =a+ bx
= 56,400.50 + (7.00 x– 4,598.2)
= 24,213.
119. (d) The requirement is to identify the item that is
notone of the forces in Porter’s model for industry
analysis. The correct answer is (d) because
consideration of general economic conditions is not part
of industry analysis. Answers (a), (b), and (c) are
incorrect because the five forces include the threat of
new entrants, the bargaining power of customers,
the bargaining power of suppliers, the threat of
substitute products or services, and the rivalry of the
firms in the market.
120. (a) The requirement is to identify the defining
characteristic of supply chain management. The correct
answer is (a) because a key aspect of supply chain
management is the sharing of key information from the
point of sale to the consumer back to the manufacturer,
the manufacturer’s suppliers, and the supplier’s
suppliers. Answer (b) is incorrect because it is the focus
of process reengineering. Answer (c) is incorrect
because it is the focus of total quality management.
Answer (d) is incorrect because strategic alliances
involve joint ventures and partnerships.
121. (d) The requirement is to identify an unlikely
strategy for a firm in a purely competitive market. The
correct answer is (d) because in a purely competitive
market firms compete based on price, and developing a
brand name is a product differentiation strategy.
Answers (a), (b), and (c) are all cost leadership
strategies and appropriate for a firm in a purely
competitive market.
122. (c) The requirement is to identify the purpose of a
response profile. The correct answer is (c) because a
response profile is a description of possible actions that
may be taken by a competitor in varying circumstances.
Answers (a), (b), and (d) all involve aspects of industry
analysis.
123. (b) The requirement is to define the process of
dividing all potential consumers into smaller groups of
buyers with distinct needs, characteristics, or behaviors.
Answer (b) is correct because this describes market
segmentation. Answer (a) is incorrect because strategic
planning involves deciding on the appropriate strategic
initiatives for a period. Answer (c) is incorrect because
product positioning involves deciding on a strategy for a
particular product. Answer (d) is incorrect