1. C Both oligopoly and monopolistic competition are consistent with firms that produce slightly differentiated products. However, with few significant barriers to entry and little interdependence among competitors, the industry does not fit the definition of an oligopoly and would be best characterized as monopolistic competition. (Study Session 4, Module 15.4, LOS 15.h)
2. B A firm that is producing more than the quantity where its marginal revenue (the market price in perfect competition) is equal to its marginal cost is losing money on sales of additional units. A firm producing where marginal cost is less than price is foregoing additional profit by not increasing production. The other responses accurately describe characteristics of firms in perfectly competitive markets. (Study Session 4, Module 15.1, LOS 15.e)
3. B The advantage of an economic union is that its members establish common economic policies and institutions. A common currency is a characteristic of a monetary union. All regional trading agreements remove barriers to imports and exports among their members. (Study Session 5, Module 19.2, LOS 19.f)
4. B The components listed indicate that the capital and financial accounts are in surplus. This indicates that the current account must be in deficit. (Study Session 5, Module 19.2, LOS 19.h)
5. C It does not necessarily follow from the information given in the question that products Y and Z are complements.
The increase in the price of Product X caused the quantity demanded of Product Y to increase (positive cross-price elasticity) and caused the quantity demanded of Product Z to decrease (negative cross-price elasticity). This suggests that Product Y is a substitute for Product X, and Product Z is a complement to Product X.
But this does not mean Product Y is a complement to Product Z. For example, gasoline is a complement to automobiles; bicycles are a substitute for
automobiles; but gasoline is not a complement to bicycles. (Study Session 4, Module 14.1, LOS 14.a)
6. B 0.70145 × 1.03 / 1.02 = 0.7083; 1 / 0.7083 = 1.4118. (Study Session 5, Module 20.2, LOS 20.h)
7. B The elasticities approach to evaluating the effect of exchange rates on the trade balance suggests that the more elastic both import demand and export demand are, the more likely currency depreciation is to narrow a trade deficit. A country with a trade deficit imports more than it exports by definition. An increase in investment relative to savings would tend to increase the trade deficit (net exports equal private and government savings minus investment). (Study Session 5, Module 20.3, LOS 20.j)
8. A Real business cycle theory holds that economic cycles are driven by utility- maximizing individuals and firms responding to changes in real economic factors, such as changes in technology. Keynesian cycle theory attributes the business cycle to changes in business confidence. Monetarist theory attributes the business cycle to inappropriate changes in the rate of money supply growth. (Study Session 4, Module 17.1, LOS 17.c)
9. A Changes in the U.S. federal funds rate and changes in long-term interest rates are unlikely to be proportionate. Long-term rates are the sum of short-term rates and a premium for the expected rate of inflation. If a decrease (increase) in the target federal funds rate by the Fed causes economic agents to increase (decrease) their inflation expectations, the change in long-term rates will be less than the change in the federal funds rate. Increases in spending on consumer durables and a decrease in the foreign exchange value of the U.S. dollar are among the
expected results of a decrease in the target U.S. federal funds rate. (Study Session 5, Module 18.2, LOS 18.k)
10. A An increase in aggregate demand will cause short-run equilibrium to move along the short-run aggregate supply curve. This will tend to increase both real GDP and the price level in the short run. (Study Session 4, Module 16.3, LOS 16.l)
11. B An increase in the money wage rate would not increase long-run aggregate supply (potential real GDP), but instead would decrease the short-run aggregate supply curve. An improvement in technology would tend to increase potential real GDP. An increase in the participation ratio increases the full-employment quantity of labor supplied and potential real GDP. (Study Session 4, Module 16.2, LOS 16.h)
12. C Structural and frictional unemployment are always present. The natural rate of unemployment is the lowest rate consistent with non-accelerating inflation. (Study Session 4, Module 17.2, LOS 17.d)
FORMULAS
breakeven points:
perfect competition: AR = ATC imperfect competition: TR = TC short-run shutdown points:
perfect competition: AR < AVC imperfect competition: TR < TVC
GDP, expenditure approach:
GDP = C + I + G + (X − M) where:
C = consumption spending
I = business investment (capital equipment, inventories) G = government purchases
X = exports M = imports
GDP, income approach:
GDP = national income + capital consumption allowance + statistical discrepancy national
income = compensation of employees (wages and benefits)
+ corporate and government enterprise profits before taxes + interest income
+ unincorporated business net income (business owners’ incomes) + rent
+ indirect business taxes − subsidies (taxes and subsidies that are included in final prices)
personal income = national income
+ transfer payments to households
− indirect business taxes
− corporate income taxes
− undistributed corporate profits
personal disposable income = personal income − personal taxes
growth in potential GDP = growth in technology + WL(growth in labor) + WC(growth in capital)
where:
WL = labor’s percentage share of national income WC = capital’s percentage share of national income
growth in per-capita potential GDP = growth in technology + WC(growth in the capital- to-labor ratio)
where:
WC = capital’s percentage share of national income
equation of exchange: money supply × velocity = price × real output (MV = PY) Fisher effect: nominal interest rate = real interest rate + expected inflation rate neutral interest rate = real trend rate of economic growth + inflation target
fiscal multiplier:
where:
t = tax rate
MPC = marginal propensity to consume
forward premium (+) or discount (−) for the base currency:
interest rate parity:
Marshall-Lerner condition:
WX εX + WM (εM − 1) > 0 where:
WM = proportion of trade that is imports WX = proportion of trade that is exports εM = elasticity of demand for imports εX = elasticity of demand for exports