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Economics multiple choice questions

A level

Government Macro Policy Aim

Multiple Choice Questions and Answers

Why might a reduction in domestic interest rates improve the current account of a country’s balance of payments?

A It will cause an appreciation in the exchange rate.
B It will reduce the amount of interest paid to foreign holders of the country’s financial assets.
C The resulting higher level of economic activity is likely to increase imports.
D There will be an outflow of capital from the country. [J08/P3/Q30]

➡Answer B

A reduction in domestic interest rates results in an increase in capital outflow and depreciation in the exchange rate. Lowering rates makes borrowing money cheaper. This encourages consumer and business spending and investment and can boost asset prices. Imports will decrease.

In 2004 China’s ability to exploit its comparative advantage in cotton production increased. What could explain this change?

A a fall in the value of the currency of India, a major cotton producer
B a reduction of the import quota on Chinese cotton into the European Union
C a rise in the wages of Brazilian cotton workers matched by an increase in their productivity
D the removal of the United States of America’s subsidy to its cotton growers [J09/P3/Q29]

➡Answer D

Comparative advantage is an economy's ability to produce a particular good or service at a lower opportunity cost than its trading partners. Subsidy to local producers create an artificial cost advantage to US producers. Removal of subsidy to US cotton grower will erode this cost advantage.

Which policy is most likely to help to correct an adverse balance on the current account of the balance of payments?

A abolishing tariffs
B devaluing the currency
C reducing direct taxes
D reducing indirect taxes [N09/P3/Q28]

➡Answer B

Devaluation of currency is expected to increase exports and decrease imports hence improves current account of the BOP. Other options are likely to have an adverse effect on current account

What could explain why the terms of trade of most developing economies tend to worsen over time?

A Their currencies are over-valued in foreign exchange markets.
B They impose lower barriers on imports than developed economies.
C They produce a narrower range of goods than developed economies.
D They produce goods with a low income elasticity of demand. [J10/P3/Q23]

➡Answer D

Goods that are considered essential have a low elasticity of demand. Electricity, gas, oil, and water are all relatively inelastic because consumers rely on these as necessities rather than luxuries. Low income elasticity of demand suggests stable demand and minimum variation in prices. Over-valued currency would improve TOT hence A is incorrect.

Which policy is most likely to reduce a balance of payments deficit without causing inflation?

A a devaluation of the exchange rate
B an increase in import tariffs
C an increase in indirect taxes
D an increase in direct taxes [J10/P3/Q26]

➡Answer D

An increase in direct taxes would reduce disposable income and imports. To reduce inflation, the government can increase indirect taxes. Devaluation of exchange rate, import tariffs and indirect taxes all can reduce BOP deficit but at the expense inflation.

An economy has underemployed resources. Which method of financing an increase in government expenditure is likely to have the greatest expansionary effect?

A borrowing from the central bank
B borrowing from the non-bank private sector
C increased direct taxation
D increased indirect taxation [J10/P3/Q28]

➡Answer A

Expansionary policies increase the availability of funds, which, in turn, leads to increased consumption and greater economic growth. Borrowing from the central bank will increase money supply in the economy and hence is likely to have the greatest expansionary effect. Borrowing from private sector and increased taxation would have less expansionary effect because these measures do not increase money supply in the economy.

Why might a reduction in domestic interest rates have an adverse effect on a country’s balance of payment on current account?

A It will cause a rise in the exchange rate.
B It will make the country’s industry less competitive. a
C The resulting higher level of economic activity is likely to increase imports.
D There will be an outflow of capital from the country. [J11/P3/Q26]

➡Answer C

lower interest rates encourage consumer spending; therefore there will be a rise in spending on imports leading to a worsening of current account.

What would be classified as a supply side policy measure?

A additional legislation to restrict the power of trade unions
B a reduction in the government’s fiscal deficit
C an open market sale of securities
D the imposition of a tariff on imported goods [JII/P3/Q27J

➡Answer A

The supply-side theory is an economic concept whereby increasing the supply of goods leads to economic growth. Restrictions on the powers of trade unions would increase supply — a supply-side measure. Option B suggests fiscal policy white C refers to monetary policy and D refers to foreign trade policy.

What would be an economic benefit to a major economy of imposing a tariff on imported goods?

A It would increase labour productivity.
B It would increase pressure on foreign suppliers to reduce their prices.
C It would make the country’s exports more competitive.
D It would reduce the prices paid by consumers for imported goods. [JH/P3/Q29]

➡Answer B

A tariff is a tax imposed by the government of a country or by a supranational union on imports or exports of goods. Tariffs increase the prices of imported goods. In order to retain their market share the foreign sellers would reduce their selling prices. A tariff will result in both inefficient use of resources and prices of imported goods to rise thus A & D are incorrect while C is irrelevant in this context.

An economist wishes to judge whether an economy’s budget deficit is excessive. What would be the most appropriate way to measure the budget deficit when making this judgement?

A as a percentage of foreign currency reserves
B as a percentage of GDP
C in inflation adjusted terms
D in purchasing power parity terms [N12/P3/Q17}

➡Answer B

A budget deficit occurs when expenses exceed revenue and can indicate the financial health of a country. Gross domestic product is a monetary measure of the market value of all the final goods and services produced in a specific time period by countries. Budget deficit as a percentage of GDP is considered an appropriate measure to assess its size.

In 2009 the US central bank, the Federal Reserve, increased the money supply. Which policy measure taken by the Federal Reserve would have achieved this outcome?

A a purchase of government securities in the open market
B a reduction in the issue of shortterm government debt
C a requirement for commercial banks to increase their liquidity ratios
D an increase in the bank rate [N12/P3/Q20]

➡Answer A

By buying or selling government securities (usually bonds), a central bank affects the money supply and interest rates.
When the central bank buys government securities it makes payments to the private sellers thus causes money supply to increase

Why is it more effective to increase regressive taxes rather than progressive taxes when pursuing a deflationary fiscal policy?

A Changes in VAT have minimal effect on consumers’ spending.
B It is much more unfair to increase progressive taxes.
C Many workers reduce the hours they work when income taxes arc raised.
D Low income households spend a larger proportion of their incomes. [N12/P37Q29]

➡Answer D

A progressive tax is a tax that takes a larger percentage of income from high-income groups than from low-income groups. A regressive tax is a tax that takes a larger percentage of income from low-income groups than from high-income groups. Regressive taxes are likely to reduce spending on goods in general.

What is the main objective of supply side policies?

A to bring a country’s potential output up to the level of its actual output
B to ensure a budget surplus
C to ensure that the composition of output matches the pattern of demand
D to increase potential output by increasing efficiency [J13/P3/Q28]

➡Answer D

Supply-side policies are government attempts to increase productivity and increase efficiency in the economy. Supply side policies primarily target efficient use of resources in order to increase potential growth

What is most likely to result from a devaluation of the £ sterling?

A an increase in foreign direct investment in the UK by global manufacturing firms
B an increase in the number of UK residents taking holidays abroad
C an increase in the number of UK students applying for places in North American universities
D an increase in the supply of foreign workers seeking temporary employment over the summer in the UK [J14/P3/Q29J

➡Answer A

It will cause the value of assets in U.K to fall in foreign currency. However, it will be expensive for UK citizens to travel abroad therefore B and C are incorrect.

A government’s budget is balanced at a time when the economy is fully employed, but an aggregate demand shock causes a decline in national income. What will be the result if the government keeps its tax rates and level of spending unchanged?

A a cyclical budget deficit
B a cyclical budget surplus
C a structural budget deficit
D a structural budget surplus [J15/P3/Q30]

➡Answer A

The term demand shock suggests cyclical charges while a decrease in national income will result in a decrease in tax revenue leading to a budget deficit.

In the absence of offsetting changes, what will result in an increase in a government’s fiscal deficit?

A a decrease in household saving
B a decrease in interest rates on government bonds
C a decrease in private sector investment
D a decrease in the country’s trade deficit

➡Answer C

Government will be required to lower tax rates and increase its spending in order to offset the decrease in aggregate demand caused by a fall in private sector investment

When would an economic recession result in an increase in a government’s budget deficit?

A The government increases tariffs on imports with inelastic demand and keeps the total amount it spends on unemployment benefit unchanged.
B The government keeps the unemployment benefit rate and direct and indirect tax rates unchanged.
C The government reduces foreign aid and widens the tax base.
D The government reduces the unemployment benefit rate and decreases the tax free allowance on income tax. [J16/P3/Q27]

➡Answer B

No change in tax rate will reduce tax revenue in recession and with the same level of expenditure the government will have to run a budget deficit.

What will be most likely to rise if unemployment is increasing in an economy?

A the human capital of unemployed workers
B the living standards of all workers
C the nominal money wage rate of employed workers
D the tax burden on employed workers [J16/P3/Q28]

➡➡Answer D

In order to pay unemployment benefit to an increasing number of unemployed the government will have to increase tax burden of those who are employed

Which policy pursued by a central bank represents a contractionary monetary policy?

A a reduction in the interest rate at which it will lend to banks
B a reduction in the minimum cash to deposit ratios of banks
C the purchase of foreign currency to influence the country’s exchange rate
D the sale of government bonds in the open market [N16/P3/Q29]

➡Answer D

Contractionary monetary policy is driven by increases in the various base interest rates controlled by modern central banks or other means producing growth in the money supply. When the central bank purchases bonds on the open market it will result in an increase in the money supply. If it sells bonds on the open market, it will result in a decrease in the money supply.

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