Caf2 intorduction to economics and finance questionbank

2015
INTRODUCTION TO
ECONOMICS AND FINANCE
QUESTION BANK
CAF-02

Question
Bank
ICAP
P
Introduction to
economics and finance

© Emile Woolf International ii The Institute of Chartered Accountants of Pakistan
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© Emile Woolf International iii The Institute of Chartered Accountants of Pakistan
Certificate in Accounting and Finance
Introduction to economics and finance
C
Contents
Page
Question and Answers Index v
Questions
Section A Multiple choice questions 1
Section B Objective test and long-form questions 25
Answers
Section C Multiple choice answers 55
Section B Objective test and long-form answers 65

© Emile Woolf International v The Institute of Chartered Accountants of Pakistan
I
Index to Objective test and
long-form questions and
answers
QUESTION
PAGE
ANSWER
PAGE
CHAPTER 1 – ECONOMIC CONCEPTS
1.1 FACTORS OF DEMAND 25 66
1.2 PRODUCTION POSSIBILITY CURVE 25 67
1.3 ECONOMIC GROWTH 25 67
1.4 ISLAMIC ECONOMIC SYSTEM 27 68
CHAPTER 2 - MICROECONOMICS
2.1 TYPES OF GOODS 27 69
2.2 QUANTUM OF SUPPLY OF A PRODUCT 27 69
2.3 MOVEMENT 27 70
2.4 A MARKET ECONOMY 27 71
CHAPTER 3 – DEMAND AND SUPPLY: ELASTICITIES
3.1 ELASTICITY OF DEMAND 27 73
3.2 ELASTICITY OF DEMAND 2 27 74
3.3 ELASTICITY OF DEMAND 3 28 75
3.4 CALCULATE PEDS 28 76
3.5 CONCEPTS OF DEMAND 28 76

© Emile Woolf International vi The Institute of Chartered Accountants of Pakistan
QUESTION
PAGE
ANSWER
PAGE
3.6 COFFEE MARKET 28 78
3.7
COMPETITIVE GOODS AND
COMPLEMENTARY GOODS
29 79
3.8 PRICE ELASTICITY OF SUPPLY 29 81
3.9 CROSS ELASTICITY OF DEMAND 29 81
3.10 PRICE ELASTICITY OF DEMAND 29 82
3.11 TOTAL EXPENDITURE METHOD 29 82
3.12
PROPORTIONATE OR PERCENTAGE
METHOD
29 82
3.13 GEOMETRICAL METHOD 29 83
3.14
NUMERICAL EXERCISE: PRICE
ELASTICITY OF DEMAND
29 85
3.15
IMPORTANCE OF PRICE ELASTICITY OF
DEMAND
30 85
CHAPTER 4 – UTILITY ANALYSIS
4.1 CONSUMER’S EQUILIBRIUM 30 87
4.2 INDIFFERENCE CURVES 30 88
4.3 CONCEPTS 30 89
4.4 PRICE EFFECT 31 90
4.5 INCOME EFFECT 31 91
4.6 SUBSTITUTION EFFECT 31 92
4.7 LAW OF DIMINISHING UTILITY 31 92
4.8 INDIFFERENCE CURVES 1 31 93
4.9 INDIFFERENCE CURVES 2 31 94
4.10 MARGINAL RATE OF SUBSTITUTION 31 96
CHAPTER 5 – COSTS, REVENUES AND FIRMS
5.1 MONOPOLIST PROFIT 32 98
5.2 PERFECT COMPETITION 32 99
5.3 INCREASING RETURNS 32 100

Index to questions and answers
© Emile Woolf International vii The Institute of Chartered Accountants of Pakistan
QUESTION
PAGE
ANSWER
PAGE
5.4 LARGE FIRMS 32 100
5.5 THE SCALE OF PRODUCTION 32 102
5.6 MONOPOLY AND COMPETITION 34 103
5.7 PROFIT MAXIMISATION AND DEMAND
ANALYSIS
35 104
5.8 REVENUES AND COSTS 36 105
5.9 COSTS AND REVENUES 36 106
5.10 TYPES OF COSTS 36 107
5.11 MONOPOLY SETUP 36 108
5.12 CONSUMPTION GOODS 36 108
5.13 EQUILIBRIUM OF THE FIRM 37 109
5.14 MARKET FUNCTIONING 37 110
5.15 FREE FORCES 37 111
5.16 PRICE OUTPUT DETERMINATION 37 112
5.17
OLIGOPOLY AND DUOPOLY:
DIFFERENCE
37 113
5.18 PRICE CARTELS AND COLLUSION 37 113
5.19 PRICE LEADERSHIP 37 114
5.20 KINKED DEMAND CURVE 37 114
5.21 NON-PRICE COMPETITION 37 114
CHAPTER 6 – MACROECONOMICS INTRODUCTION
6.1 NATIONAL INCOME 38 114
6.2 MEASURING NATIONAL INCOME 38 115
6.3 CIRCULAR FLOW OF INCOME 38 117
6.4 INJECTIONS AND WITHDRAWALS 38 118
6.5 AGGREGATE SUPPLY: SHORT RUN 38 119
6.6 AGGREGATE SUPPLY: LONG RUN 38 120
6.7 AGGREGATE DEMAND 39 120

© Emile Woolf International viii The Institute of Chartered Accountants of Pakistan
QUESTION
PAGE
ANSWER
PAGE
6.8
MACROECONOMIC EQUILIBRIUM:
RECESSION - KEYNESIAN
39 122
6.9
MACROECONOMIC EQUILIBRIUM:
INFLATIONARY GAP
39 123
6.10 DEFLATIONARY GAP 39 124
6.11 CALCULATION OF GDP 1 39 126
CHAPTER 7 – CONSUMPTION, SAVINGS AND INVESTMENT
7.1 CIRCULAR FLOW OF INCOME 41 130
7.2 INVESTMENT AND MEC 42 131
7.3 CONSUMPTION FUNCTION 42 132
7.4 PRIVATE INVESTMENT 42 133
CHAPTER 8 – MULTIPLIER AND ACCELERATOR
8.1 MULTIPLIER 43 134
8.2 MULTIPLIER 1 43 134
8.3 MULTIPLIER 2 43 135
8.4 ACCELERATOR QUESTION 44 136
CHAPTER 9 – MONEY
9.1 THE MONEY SUPPLY 45 138
9.2
MONEY SUPPLY AND QUANTITY
THEORY
45 139
9.3 IMPORTANT FUNCTIONS 46 141
9.4 UNEMPLOYMENT 46 142
9.5 PHILLIPS CURVE 46 143
9.6 LIQUID FORM 46 144
9.7 MONEY FUNCTIONS 46 145

Index to questions and answers
© Emile Woolf International ix The Institute of Chartered Accountants of Pakistan
QUESTION
PAGE
ANSWER
PAGE
CHAPTER 10 – GROWTH AND TAXES
10.1 INDIRECT TAXES 46 146
10.2 MACROECONOMIC POLICY 46 146
10.3 DIRECT AND INDIRECT TAXATION 47 147
10.4 TRADE CYCLE 47 150
10.5 MIXED ECONOMY 48 151
10.6 GROWTH RECESSION INDICATORS 48 152
10.7 ECONOMIC POLICY OBJECTIVES 48 153
10.8
AGGREGATE DEMAND AND AGGREGATE
SUPPLY
48 154
CHAPTER 11 – MONETARY POLICY
11.1 FINANCIAL INTERMEDIATION 48 155
11.2 THE CENTRAL BANK 48 155
11.3 MONEY MARKETS 48 157
11.4 INTEREST RATE RISE 49 157
11.5 TYPES OF BANKS 49 157
11.6 CENTRAL BANKS 49 158
11.7 MONETARY POLICY 1 49 159
11.8 MONETARY POLICY 2 49 160
11.9 MONETARY AND FISCAL POLICY 49 161
CHAPTER 12 – CREDIT
12.1 CREDIT 50 161
12.2 BANKS 50 162
12.3
COMMERCIAL BANKS AND CREDIT
CREATION
50 163
CHAPTER 13 – BALANCE OF PAYMENTS AND TRADE
13.1 A BALANCE OF PAYMENTS DEFICIT 51 165
13.2
BALANCE OF PAYMENT AND BALANCE
OF TRADE
51 166

© Emile Woolf International x The Institute of Chartered Accountants of Pakistan
QUESTION
PAGE
ANSWER
PAGE
13.3 BALANCE OF PAYMENTS 51 167
13.4 DISEQUILIBRIUM 51 167
13.5 BALANCE OF PAYMENTS: COMPONENTS 51 168
13.6 CURRENT ACCOUNT DEFICIT CAUSES 51 169
13.7
CURRENT ACCOUNT DEFICIT
NONMONETARY MEASURES
52 169
13.8
CURRENT ACCOUNT DEFICIT
MONETARY MEASURES
52 170
13.9 OPEN MARKET OPERATIONS 52 171
13.10 CHANGE IN EXCHANGE RATES 52 171
CHAPTER 14 – FINANCIAL MARKETS
14.1 USE OF MONEY AND CAPITAL MARKETS 52 171
14.2 DERIVATIVES 52 172
14.3 CAPITAL MARKET 53 173
14.4 CAPITAL MARKET INSTRUMENTS 53 174

© Emile Woolf International 1 The Institute of Chartered Accountants of Pakistan
SECTION
A
Multiple choice questions
1 Which of the following is not a factor of production?
A Land
B Labour
C Money
D Entrepreneurship
2 Which of the following is not an economic resource?
A Air
B Water
C Sulphuric acid
C Books
3 Which of the following concepts is NOT illustrated by the Production Possibility
Curve?
A Efficiency
B Opportunity cost
C Equity
D Trade-off
4 Which of the following are regarded as withdrawals from the circular flow of income?
A Saving and taxation
B Export and import
C Investment and saving

5 The curvature of the Production Possibility Curve is due to:
A change in opportunity cost
B increase in resources
C decrease in demand
D decrease in supply
6 Which one of the following is a basic economic problem?
A Unlimited wants and scarce resources
B Lower incomes and higher indirect taxes
C Unemployment and inflation
D Recession
7 All of the following are determinants of supply except:
A price
B income level
C level of technology
D objectives of the firms
8 The demand curve slopes downward because of:
A consumer indifference
B elasticity of demand
C inelastic demand
D law of diminishing marginal utility
9 The supply curve of a factor for a firm that is in perfect competition in the input market
is:
A elastic
B inelastic
C perfectly elastic
D perfectly inelastic
10 Which ONE of the following will cause the demand curve for a good to move to the
right (outwards from the origin)?
A A decrease in the costs of producing the good
B A fall in the price of the good
C An increase in the price of a complementary good
D An increase in the price of a close substitute good

Question bank: Multiple choice questions
11 When only a small proportion of a consumer's income is spent on a good,
A the demand for the good will be highly price elastic
B the good is described as 'inferior'
C a rise in the price of the good will strongly encourage a search for substitutes
D the demand for the good will be price inelastic
12 When the price of a good is held above the equilibrium price, the result will be
A excess demand
B a shortage of the good
C a surplus of the good
D an increase in demand
13 The demand for and supply of a good are in equilibrium. An indirect tax is levied on
the good. Which one of the following will show the new equilibrium?
A A shift in the supply curve to the right
B A shift in the demand curve to the right
C A shift in the supply curve to the left
D A shift in the demand curve to the left
14 A shift to the right in the supply curve of a good, the demand remaining unchanged,
will reduce its price to a greater degree
A the more elastic the demand curve
B the less elastic the demand curve
C the nearer the elasticity of demand to unity
D the more elastic the supply curve
15 Which of the following products is likely to have the lowest price elasticity of demand?
A Salt
B Cars
C Houses
D Apples
16 Which statement is true of a curve with a constant slope?
A It is a straight line
B It is non linear
C It runs parallel to Y-axis
D It runs parallel to X-axis

17 Production and employment in which of the following industries would be least
affected by recession?
A Sugar
B Steel
C Garments
D Vehicles
18 If the market price of a product increases from Rs. 35 to Rs. 40 and in response, the
quantity demanded decreases from 1400 units to 1200 units, the value of its price
elasticity of demand is:
A 0.9
B 1
C 1.1
D 1.2
19 Which of the following is NOT a method for the measurement of price elasticity of
demand?
A Total outlay
B Total savings
C Point method
D Arc method
20 If the price of a good fell by 10% and, as a result, total expenditure on the good FELL
by 10%, the demand for the good would be described as
A perfectly inelastic
B perfectly elastic
C unitary elastic
D elastic
21 Which one of the following statements about the elasticity of supply is not true?
A It tends to vary with time.
B It is a measure of the responsiveness of supply to changes in price.
C It is a measure of changes in supply due to greater efficiency.
D It tends to be higher for manufactured goods than for primary products.
22 If the demand for a good is price inelastic, which ONE of the following statements is
correct?
A If the price of the good rises, the total revenue earned by the producer
increases.
B If the price of the good rises, the total revenue earned by the producer falls.
C If the price of the good falls, the total revenue earned by the producer increases.
D If the price of the good falls, the total revenue earned by the producer is
unaffected.

23 An inferior good is one which has an income elasticity of demand that is
A positive but less than unity
B negative
C unitary
D zero
24 A business, currently selling 10,000 units of its product per month, plans to reduce
the retail price from £1 to £0.90. It knows from previous experience that the price
elasticity of demand for this product is -1.5.
Assuming no other changes, the sales which the business can now expect will be
A 8,500 units
B 9,000 units
C 11,000 units
D 11,500 units
25 If the demand for a good is price elastic, a fall in price will lead to
(i) a rise in sales
(ii) a fall in sales
(iii) a rise in total expenditure on the good
(iv) a fall in total expenditure on the good
Which of the above are correct?
A (i) and (iii) only
B (i) and (iv) only
C (ii) and (iii) only
D (ii) and (iv) only
26 The price elasticity of supply means the
A change in supply divided by price
B responsiveness of the quantity supplied to a change in price
C responsiveness of the quantity supplied to a change in demand
D time taken for supply to adjust to a change in price
27 Price elasticity coefficient of 0.2 implies that the %age change in quantity for a 5%
change in price will be:
A 0.2
B 2.5
C 5
D 1

28 Assume that a fall in price of a commodity form Rs10 to Rs.9 per unit results in an
increase in weekly sales from 100 units to 110 units. Price elasticity of demand would
be:
A 1.9
B Unity
C 2
D Zero
E 0.9
F 0.1
29 Very small or zero Co-efficient of price elasticity of demand means that the good is:
A a necessity
B a comfort
C a luxury
D any of the above
E none of the above.
30 The standard measure for measuring demand and supply elasticity is
A Zero
B Unity
C Infinity
D Two
31 The income elasticity of demand for an income inferior good has an arithmetic sign.
A Positive
B Zero
C Negative
D No sign
32 From the demand schedule below, the price elasticity of demand following a fall in
price from Rs 25 to Rs. 20 is:
Price (Rs.) Quantity (units)
30 15
25 20
20 25
15 30
A -1
B -1.25
C -1.50
D -1.75

33 If the price of a good fell by 20% but total expenditure on the good remained the
same, the demand curve could be described as
A Perfectly elastic
B Elastic
C Perfectly inelastic
D Unitary elasticity
34 Prices are most volatile when:
A supply is elastic, demand is elastic
B supply is inelastic, demand is inelastic
C supply is elastic, demand is inelastic
D supply is inelastic, demand is elastic
35 Which statement is true, in respect of every point on an indifference curve?
A The price of each good is the same.
B The level of satisfaction is the same.
C All of these statements are true.
D None of these statements is true.
36 Which of the following best defines marginal utility?
A The satisfaction of a want that results from consuming a good or service.
B The change in total utility as a result of consuming an additional unit of a
product.
C The ability to buy more of a product or service when real income increases.
D The decrease in satisfaction that results from consuming an additional unit of a
product.
37 With the principle of diminishing marginal utility in effect, increasing consumption will:
A lower total utility
B produce negative total utility
C lower marginal utility, and therefore total utility
D lower marginal utility, but may increase total utility
38 If a consumer’s marginal rate of substitution equals 2 apples for 1 carrot
A the consumer’s indifference curve will be positively sloped
B the consumer’s indifference curve will be convex to the origin
C the ratio of marginal utility of 1 apple must be ½ of 1 carrot
D all of the above

39 If all prices remain constant, an increase in income results in
A an increase in the slope of the budget line
B a decrease in the slope of the budget line
C an increase in the intercept of the budget line
D a decrease in the intercept of the budget line
E Both a and c
40 Indifference curve for the consumer is always:
A Concave
B Straight
C Convex to Origin
D Upward Sloping
41 Shift in consumer equilibrium due to change in price is called:
A Price effect
B Income effect
C Substitution effect
D None of the above
42 Marginal rate of substitution of X for Y along an ordinary indifference curve is:
A Diminishing
B Increasing
C Constant
D All of the above
E None of the above
43 The budget line of a consumer explains various combinations of two commodities
that:
A are actually purchased at market prices
B can be purchased at market prices
C equate consumers’ expenditure to his money income
D b and c above
E None of the above.
44 Under perfect market conditions, the supply curve of a firm is the same as:
A MC curve
B MR curve
C AR curve
D AC curve

45 In a perfectly competitive market ___________ is/are the price maker(s):
A the individual firm
B the industry
C a large number of consumers
D the trade association
46 Which of the following is NOT included in the explicit costs of a firm?
A Wages paid to labour
B Interest paid for borrowed capital
C Payments for purchases of materials
D Normal profit
47 Monopoly power may be based on:
A economies of large scale production
B patents
C control of key natural resources
D all of the above
48 Which of these is NOT a component of cost function of a product?
A Market price of the product
B Operating technology of the plant
C Operating capacity
D All of the above
49 The demand for a Factor of Production is called:
A quantity demand
B derived demand
C factor price
D cost of production
50 As its output increases, a firm’s short-run marginal cost will eventually increase
because of:
A diseconomies of scale
B a lower product price
C the firm’s need to break even
D diminishing returns

51 A firm that breaks even after all the economic costs are paid, is earning:
A economic profit
B no profit
C normal profit
D super normal profit
52 When diminishing returns begin to operate, the total variable cost curve will start to
A fall at an increasing rate
B rise at a decreasing rate
C fall at a decreasing rate
D rise at an increasing rate
53 Marginal cost is best defined as
A the difference between total fixed costs and total variable costs.
B costs which are too small to influence prices.
C the change in total costs when output rises by one unit.
D fixed costs per unit of output.
54 The 'law of diminishing returns' can apply to a business only when
A all factors of production can be varied.
B at least one factor of production is fixed.
C all factors of production are fixed.
D capital used in production is fixed.
55 Which of the following always rise when a manufacturing business increases its
output?
(i) fixed costs
(ii) marginal cost
(iii) average variable cost
(iv) total costs
A (i) and (ii) only
B (ii) and (iii) only
C (iii) and (iv) only
D (iv) only
56 The minimum price needed for a firm to remain in production in the short run is equal
to
A average fixed cost
B average variable cost
C average total cost
D marginal cost

57 A business employs 11 workers at a wage of £24 per day. To attract one more worker
it raises the wages to £25 per day.
The marginal cost of employing the extra worker is
A £1
B £12
C £25
D £36
58 The long-run average cost curve for a business will eventually rise because of
A the law of diminishing returns
B increasing competition in the industry
C limits to the size of the market for the good
D diseconomies of scale
59 Economies of scale
A can be gained only by monopoly firms
B are possible only if there is a sufficient demand for the product
C do not necessarily reduce unit costs of production
D depend on the efficiency of management
60 If the total cost curve is plotted, marginal cost curve can be illustrated by:
A U shapes curve cutting the total cost curve from its minimum point.
B a straight line cutting the curve at its lowest point.
C a straight line cutting the curve at its lowest point
D the slope of a tangent to the curve at any given output.
61 A firm, in the short run, would stop production if:
A marginal cost was equal to marginal revenue
B total costs were equal to total revenue
C total revenue were less than total variable cost
D total revenue were less than total fixed cost
E variable cost were to rise above fixed costs
62 The long term shape of the average cost curve is due to:
A economies of scale
B variable proportions
C change in technology
D imperfect competition
E diseconomies of the scale
F a and e
G b and d
H none of the above

63 In a diminishing cost industry, an increase in industry output causes the Average total
cost curve of a typical firm to shift:
A Upward
B Downward
C To the right
D To the left
64 In an increasing cost industry, an increase in output causes the Average total cost
curve of a typical firm to shift.
A To the left
B To the right
C Downward
D Upward
65 What does it mean to say that firms in an oligopoly are interdependent?
A The firms must charge identical prices for the products
B The firms economic profits must equal zero in the long run
C Barriers block the entry of new firms into the industry
D The output price decisions of one firm affect the output price decisions of
other firms in the industry
66 Marginal cost curve intersects Average total cost curve at:
A the minimum point of ATC
B the minimum point of MC
C the minimum points of both the MC and ATC
D all of the above
E none of the above.
67 Duopoly is a special case of which of the following:
A Perfect competition
B Monopoly
C Monopolistic competition
D Oligopoly
E None of the above
68 Oligopoly is a type of market organization in which there exists:
A a single firm
B two firms
C a large number of firms
D few firms

69 Which of the following distinguishes oligopoly market from other forms of market
organization?
A Interdependence of producers
B Differentiated products
C Many firms in a small market
D Firms are price takers
E Price discrimination
70 Which of the following describes the dominant firm model?
(I) The dominant firm produces at the intersection of market demand by its MC
curve.
(II) The small firms are price takers.
(III) The dominant firm’s demand curve is derived by subtracting output supplied
by small firms from total market demand.
A II only
B III only
C I only
D II and II
E None of the above
71 All members of a cartel:
A produce at the same average cost
B produce where their MC equals price
C adopt independent price and output policy
D share the market equally
E None of the above
72 A cartel is a collusive agreement:
A among largest firms in an industry
B among smallest firms in an industry
C sanctioned by the government
D among firms to increase profit by reducing output
73 Duoplists producing homogeneous products will in the long run charge:
A uniform price
B different prices
C any of the above
D none of the above

74 Which of the following is a measure of income earned by a factor of production?
A Indirect taxes
B Depreciation
C Rent
D Corporate taxes
75 In the long-run, price is determined by:
(a) cost of production
(b) number of consumers
(c) influence of tastes and fashion
(d) competitive forces
76 The aggregate demand curve would shift to the right if:
A government taxes increase
B net exports increase
C government spending decreases
D the nominal money supply decreases
77 Which of the following topics are studied in Macro Economics?
A Theory of Demand
B Aggregate Demand and Aggregate Supply
C Equilibrium of Industry
D None of the above
78 Which of the following would decrease aggregate demand?
A Increased investment
B Increase in export revenue
C Increased taxation
D Increased consumption
79 A prolonged and deep recession is called:
A Hyperinflation
B Depression
C Stagflation
D Great depression
80 The aggregate supply curve:
A is the sum of the individual supply curves in the economy
B is a market supply curve
C embodies the same logic that lies behind an individual firm’s supply curve
D none of the above

81 Which of the following represent withdrawals from the circular flow of national
income?
(i) Distributed profits
(ii) Interest paid on bank loans
(iii) Income tax payments
(iv) Imports
A (i) and (ii) only
B (ii) and (iii) only
C (i) and (iii) only
D (iii) and (iv) only
82 An isolated island community produces only one good, fish. In a typical week the
island's fishermen manage to earn £800 selling their catch to the island's fish
wholesaler. She, in turn, sells the catch to the island's two fish shops for a total of
£1,200. To make a profit and pay wages to their employees the two shopkeepers sell
the fish to the island's population for £1,500.
What will be the value of the island's output over the course of a year (52 weeks)?
A £140,400
B £182,000
C £78,000
D £36,400
83 An inflationary gap exists in an economy when
A the government has a budget deficit
B aggregate demand is greater than the full employment level of income
C withdrawals exceed injections at the full employment level of income
D the money supply rises faster than national income
84 Which ONE of the following would cause a fall in the level of aggregate demand in an
economy?
A A decrease in the level of imports
B A fall in the propensity to save
C A decrease in government expenditure
D A decrease in the level of income tax
85 When will savings increase in a country?
A When interest rate rises
B When inflation increases
C When more credit cards are issued by the banks
D When production of consumer goods decreases

86 An inflationary gap exists in an economy when
A the government has a budget deficit
B aggregate demand is greater than the full employment level of income
C withdrawals exceed injections at the full employment level of income
D the money supply rises faster than national income
87 Which of the following is likely to shift the marginal efficiency of capital (MEC)
schedule to the right?
(1) An increase in the supply of funds available
(2) Introduction of cost reducing technology
(3) A reduction of government subsidies on investment
A l only
B 2 only
C 3 only
D l and 2 only
88 Which of the following statements does not reflect the Keynesian view of the
economy?
A The economy will naturally settle at a level of output that ensures full
employment
B Government can move the economy towards full employment by managing
aggregate demand
C Measures to stimulate private consumption will raise the level of income
D The level of aggregate monetary demand will affect the level of income
89 Which of the following describes the effect of improved technology on the marginal
efficiency of capital curve?
A It will shift it to the left
B It will shift to the right
C The curve will be unaffected
D The curve will become more inelastic
90 Which of the following factor is not used in the multiplier formula for the open
economy?
A Marginal propensity to save
B Marginal propensity to import
C Marginal propensity to tax
D Marginal propensity to export

91 The concept of the Multiplier discusses:
A Savings and investments
B Income and investments
C Income and expenditure
D Income and savings
92 In an economy where, out of every extra £100 of national income, £25 is paid in tax,
£10 is spent on imports and £15 is saved, the value of the multiplier will be
A 2
B 2.5
C 5
D 10
93 Which of the following is the basic concept which underlies the accelerator theory of
investment?
A Investment depends on the level of savings
B Investment is inversely related to the rate of interest
C Investment is determined by the volume of commercial bank lending
D Investment rises when there is an increase in the rate of growth of demand in
the economy
94 In a given economy, of each additional £1 of income, 30% is taken in taxes, 10% is
spent on imports and 40% is spent on domestically produced goods.
The multiplier is:
A 2.5
B 1.67
C 1.25
D 0.6
CHAPTER 9 – MONEY
95 Money does NOT function as a:
A medium of exchange
B hedge against inflation
C store of value
D measure of value
96 Which of the following is not a function of money?
A Store of value
B Unit of account
C Standard of deferred payment
D Payment of interest

97 The term “Precautionary motive” has been discussed in:
A Quantity theory of money
B Theory of consumer behaviour
C Liquidity preference theory
D Multiplier accelerator theory
98 Which of the following is not one a Keynesian motive for holding money?
A Investment motive
B Precautionary motive
C Speculative motive
D Transaction motive
99 On a short-run Phillips Curve, high rates of inflation coincide with:
A low interest rates
B high unemployment rates
C low unemployment rates
D low discount rates
100 Which of the following would reduce inflation?
A An increase in direct taxes
B An increase in indirect taxes
C Increase in government spending
D Increase in income
101 In the Keynesian theory of demand for money, the transactions demand for money is
determined by:
A the rate of interest
B the level of consumers’ income
C expected changes in consumer prices
D the amount of money in circulation
102 Which of the following is NOT a method of holding wealth?
A Bonds and equities
B Human wealth
C Consumer durables
D Commodities
103 According to the theory underlying the Phillips Curve:
(i) the rate of change in money 0wages is positively correlated with the level of
unemployment.
(ii) there is a natural rate of unemployment in the economy.
(iii) money wage stability is only possible at full employment.
(iv) the rate of change in money wages is negatively correlated with the level of
unemployment.

Which of the above statements is correct?
A (ii) and (iv)
B (i), (ii) and (iii)
C (i), (iii) and (iv)
D (iv) only
104 Which of the following is most likely to lead to a fall in the money supply?
A A fall in interest rates
B Purchases of government securities by the central bank
C Sales of government securities by the central bank
D A rise in the amount of cash held by commercial banks
105 According to Keynesian liquidity preference theory, an increase in the money supply
will
(i) raise the price of financial assets
(ii) reduce the price of financial assets
(iii) lower the rate of interest
(iv) increase the quantity of money people are willing to hold
Which of the above are correct?
A (i), (iii) and (iv) only
B (ii), (iii) and (iv) only
C (i) and (iii) only
D (ii) and (iii) only
106 Fiscal deficit can be controlled by reducing:
A Taxes
B Imports
C Unemployment
D Public expenditure
107 Which of the following is a direct tax?
A Sales tax
B Capital gains tax
C Federal excise duty
D Value added tax

108 Which of the following is an example of indirect tax?
A Income tax
B Sales tax
C Capital gains tax
D Property tax
109 The four main phases of a business cycle does NOT include:
A Depression
B Inflation
C Boom
D Recession
110 Which one of the following is NOT a feature of a good tax system?
A It should be equitable
B It should be economical
C The rate should be same for everybody
D It should be certain
111 Economic growth in an industrial society results from:
A Technological change
B Innovation
C Capital production
D All of the above
112 Which of the following is a financial intermediary?
A Pension fund
B International Monetary Fund
C State Bank of Pakistan
D Stock exchange
113 Which of the following is NOT considered to be a credit instrument?
A IOU
B Draft
C Bond
D Stock

114 Which one of the following is NOT an asset of a commercial bank?
A Balances at the central bank
B Money at call
C Customers' deposits
D Advances to customers
115 Which of these appears as a liability on a bank’s balance sheet?
A Reserves
B Checking accounts
C Loans
D Investments and securities
116 If the Reserve Ratio is 40%, and Rs.10,000 is deposited in a commercial bank, what
is the final outcome for the economy?
A Rs. 4,000
B Rs. 10,000
C Rs. 25,000
D Rs. 40,000
117 Which of the following is NOT the function of a central bank?
A Lender of the last resort
B Monetary policy
C Fiscal policy
D Credit creation
118 Which of the following is a central bank unable to do?
A Influence banks to tighten or loosen their credit policies
B Create a climate of monetary ease or restraint
C Directly set market interest rates
D Influence the interest rate on new treasury bonds
119 To counteract a recession, the Central Bank should:
A raise the reserve requirement and the discount rate
B sell securities on the open market and lower the discount rate
C buy securities on the open market and raise the discount rate
D buy securities on the open market and lower the discount rate
120 An increase in the Cash Reserve Ratio would:
A decrease prices
B reduce inflation
C control lending
D all the above

121 Which of the following is most likely to be affected by a change in interest rates?
A Consumer spending
B Investment spending
C Government spending
D Exports
122 A stimulative fiscal policy combined with a restrictive monetary policy will necessarily
cause:
A gross domestic product to increase
B gross domestic product to decrease
C interest rate to fall
D interest rates to rise
123 The government makes a new issue of bonds and sells them on the open market,
where they are bought by private investors using cheques drawn on their banks.
Which of the following describes the effect this has on the commercial banks?
A They can raise lending because their cash base will rise.
B There is no effect on bank lending.
C They must cut lending to maintain an appropriate ratio of cash to loans.
D They will only be able to increase long term loans.
124 If the American dollar is overvalued relative to the Pakistan rupee:
A Pakistani goods are cheaper than US goods.
B the Pakistan rupee is undervalued relative to the dollar.
C the rupee price of the dollar must rise.
D the cost of Pakistani goods in the United states must be increasing.
125 Index price of exports ÷ Index price of imports is equal to:
A Balance of trade
B Balance of payment
C Terms of trade
D Inflation

126 Which of the following measures would immediately increase the cost of imports?
A Tariff
B Quota
C Embargo
D Subsidies
127 Currency is usually devalued to:
A increase exports
B increase imports
C decrease inflation
D increase prices
128 Which ONE of the following would appear as a DEBIT item on the current account of
the balance of payments?
A Payment of interest on debts owed to overseas commercial banks
B Expenditure by tourists visiting the country
C Overseas capital investment by domestic companies
D Repayment of debts to overseas central banks
129 Which of the following is most likely to cause a country's balance of payments to
move towards a deficit?
A A devaluation of that country's currency
B An expansionary fiscal policy
C A contractionary fiscal policy
D A rise in the rate of domestic saving
130 The 'current account' of the balance of payments includes all the following items
EXCEPT which ONE?
A The inflow of capital investment by multinational companies
B Exports of manufactured goods
C Interest payments on overseas debts
D Expenditure in the country by overseas visitors
131 Which of the following might cause a country's exports to decrease?
A A fall in the exchange rate for that country's currency
B A reduction in other countries' tariff barriers
C A decrease in the marginal propensity to import in other countries
D A rise in that country's imports

132 Which of the following instruments are NOT traded in the capital market?
A Corporate bonds
B Treasury bills
C Mortgages
D Shares
133 Other things being equal, all of the following would lead to a rise in share prices
EXCEPT which ONE?
A A rise in interest rates
B A reduction in corporation tax
C A rise in company profits
D A decline in the number of new share issues
134 Which of the following does not engage in the buying and selling of shares in other
companies?
A Investment trusts
B Stock exchanges
C Insurance companies
D Pension funds
135 An investor who buys a call option is:
A buying the right to buy shares at a particular price
B buying the right to sell shares at a particular price
C selling the right to buy shares at a particular price
D selling the right to sell shares at a particular price
136 Which of the following occurs within a traditional money market?
A the issue of sterling certificates of deposit
B interbank lending in the sterling inter-bank market
C discount houses buying short term government debt in the discount market
D local authority borrowing in the euro-currency market

Audit and Assurance
SECTION
B
Objective test and
long-form questions
1.1 FACTORS OF DEMAND
(a) Explain any four factors on account of which the demand of a product may
change even when its price remains the same. (06)
(b) Explain the role of State in a mixed economy. (05)
(11)
1.2 PRODUCTION POSSIBILITY CURVE
Draw and briefly explain the “Production Possibility Curve”. (07)
1.3 ECONOMIC GROWTH
The achievement of economic growth has been a major objective of most governments
throughout the second half of the twentieth century. That period of time has seen a
significant rise in living standards in the western world. One way to measure growth is
by measuring the annual rate of growth of ‘real’ GDP per capita. This statistic is
commonly used as an index of improvements in living standards. Although growth is
highly desirable, and should lead to a rise in economic welfare, in recent years concern
has grown about the extent to which economic growth can continue. Economists have
begun to consider not just the opportunity cost of resource allocation decisions, but
also the extent to which current rates of economic growth in the world are sustainable.
Required:
(a) Use your knowledge of economic principles to complete the following statements
relating to economic growth:
(i) The phrase, ‘rate of growth of real GDP per capita’ means…..
Your answer must not exceed 30 words (02)
(ii) Economic growth will lead to a rise in the economic of
society. (01)

(b) The diagram below can be used to illustrate the idea of economic growth.
Complete the following statements about it:
(i) The curves in the diagram are referred to as curves. (02)
(ii) The shift from curve 1 to curve 2 indicates that has
occurred. (01)
(iii) Point X suggests an economy where there is either……..
(iv) Point Y is currently (01)
(v) Assuming that all resources are currently employed, the opportunity cost of
increasing food production from 12 million units to 22 million units is……
Your answer should not exceed 5 words (01)
(c) State one factor which will encourage economic growth to occur:
(d) State whether each of the following statements about economic growth is true or
false:
(i) A rise in output, occurring as an economy recovers from a deep recession
with high unemployment, is usually regarded as an example of economic
growth.
True or False (01)
(ii) A high level of growth is possibly unsustainable because there is a limit to
the increases in output that can be achieved through technological
advances.
True or False (01)
(iii) High levels of economic growth may be unsustainable without a degree of
environmental pollution.
True or False (01)
(iv) Sustainable economic growth means increasing output in the present
without compromising the ability of future generations to meet their own
needs.
True or False (01)
(16)

Question bank: Objective test and long-form questions
1.4 ISLAMIC ECONOMIC SYSTEM
(a) Explain how the Islamic religion has impacted upon its economic system. (10)
(b) What are its similarities and differences with the free market economic system?
(06)
(16)
2.1 TYPES OF GOODS
Differentiate between substitute goods, complimentary goods and independent goods.
Give two examples of each. (06)
2.2 QUANTUM OF SUPPLY OF A PRODUCT
According to the law of demand, supply of a product increases when the price
increases.
Briefly describe the other factors that affect the quantum of supply of a product. (09)
2.3 MOVEMENT
Explain what is Movement along the Demand Curve and Shift in the Demand Curve
highlighting the difference between these two concepts. Also illustrate the difference by
means of diagrams. (09)
2.4 A MARKET ECONOMY
(a) Explain how the price system works to allocate resources in a market economy.
(10)
(b) Describe the main reasons why markets do not always allocate resources in an
efficient manner. (10)
(20)
3.1 ELASTICITY OF DEMAND
(a) What is meant by Elasticity of Demand? List and explain briefly the factors which
determine the Elasticity of Demand of a product. (07)
(b) Briefly describe when Demand for a product is considered to be:
 Highly Elastic
 Unit Elastic
 Relatively Inelastic (03)
(10)
3.2 ELASTICITY OF DEMAND 2
(a) Explain the concepts of price elasticity of demand and income elasticity of
demand and the factors which determine their values for different goods. (12)
(b) Explain the usefulness to a business of information on price and income elasticity
of demand for its product. (08)
(20)

3.3 ELASTICITY OF DEMAND 3
(a) Define Arc elasticity of demand and provide the formula to measure it. (05)
(b) Differentiate between point elasticity and Arc elasticity of demand. (03)
(08)
3.4 CALCULATE PEDS
For each of the following diagrams calculate the following information;
(a) The price elasticity of demand (assume the change comes about from a fall in
price). (09)
(b) The total sales revenue earned at the old and new price. (03)
(12)
3.5 CONCEPTS OF DEMAND
Explain briefly by means of diagrams, the concepts of Unitary Elastic Demand,
Relatively Elastic Demand, and Relatively Inelastic Demand. Also, state the impact of a
decrease in price on total expenditure in each of the different types of elasticities of
demand. (12)
3.6 COFFEE MARKET
The following passage is based on newspaper articles and refers to the market for
coffee.
Supermarkets recently ended ten years of cheap coffee when some raised the price of
their own brands of instant coffee by up to 12%. Major producers of ground coffee said
that their prices would also increase, but probably not for some weeks.
Reports of severe frost damage to Brazilian coffee plantations sent the open market
price of coffee beans for September delivery up from $3,100 a ton to $4,000 a ton – the
highest level since 1986. The price has risen five-fold since 1993. Even before the frost
damage, the price had been rising because some coffee farmers, discouraged by the
previous low price of coffee, had moved to other, more profitable crops. The depressed
price of coffee before 1993 was partly due to the collapse of the International Coffee
Agreement. This Agreement, effectively a cartel, had kept prices artificially high. When
the Agreement broke down, supplies flooded into the market and the price of coffee
fell.
The current price increases will end a golden age of cheap coffee for consumers. From
1986 to 1993, the retail price had fallen by more than 15%; given that these years were
ones of rapid inflation, the real price of coffee fell even more steeply. This caused a
boom in coffee drinking and the sales of coffee in the UK exceeded those of tea. Now it
looks as if there may be a switch back to tea. This may be similar to the switch to tea
which happened in the 1970s – the last time when coffee prices rose sharply. During
that period, many coffee drinkers, especially young people, switched their consumption
to tea.

Requirements:
Using BOTH your knowledge of economic theory AND information in the passage:
(a) (i) identify and explain TWO reasons why the price of coffee has risen
recently, using an appropriate diagram (04)
(ii) explain the concept of 'price elasticity' and 'demand' AND show how it is
important in determining the size of the rise in coffee prices (04)
(iii) explain the meaning of the statement 'the real price of coffee fell even
more steeply'. (02)
(b) Explain the concept of 'cross elasticity of demand' AND use it to explain the
relationship between the level of coffee prices and the demand for tea. (07)
(17)
3.7 COMPETITIVE GOODS AND COMPLEMENTARY GOODS
(a) What is meant by “Competitive goods” and “Complementary goods”? Give two
examples of each. (04)
(b) Explain briefly the factors which determine the Price Elasticity of Demand. (06)
(c) Illustrate the relationship between the price and quantity demanded with the
help of a diagram when the price elasticity of demand is Elastic, Unitary Elastic
and Inelastic.
(Explanation is not required) (06)
(16)
3.8 PRICE ELASTICITY OF SUPPLY
Describe briefly the factors influencing price elasticity of supply. (05)
3.9 CROSS ELASTICITY OF DEMAND
Write a comprehensive note on Cross elasticity of Demand. (05)
3.10 PRICE ELASTICITY OF DEMAND
Write a note on the relationship between Price elasticity of Demand and Revenue.
(05)
3.11 TOTAL EXPENDITURE METHOD
Describe briefly the Total Outlay or Total Expenditure Method. (05)
3.12 PROPORTIONATE OR PERCENTAGE METHOD
Write a note on Proportionate or Percentage method giving numerical illustration. (05)
3.13 GEOMETRICAL METHOD
Explain Geometrical measure of point elasticity of demand. (08)
3.14 NUMERICAL EXERCISE: PRICE ELASTICITY OF DEMAND
Product A, currently sells at Rs. 40/- per unit and its demand at this price was 500
units. If price fell to Rs. 35/- P.U, its demand extends to 525 units. Product B,
currently sells at Rs. 70 per unit and its demand at this price was 300 units, it price
fell to Rs. 60/- per unit, its demand extends to 400 units.

Required:
(i) Calculate price elasticity of demand for both the products. (05)
(ii) Calculate changes in total revenue if demand is met in full before and after the
change in price. (05)
(10)
3.15 IMPORTANCE OF PRICE ELASTICITY OF DEMAND
Elaborate the usefulness of the concept of Price elasticity of demand. (08)
4.1 CONSUMER’S EQUILIBRIUM
Demonstrate your familiarity with the indifference curve approach to the problem of
consumer’s equilibrium. Support your description by drawing a suitable diagram. (12)
4.2 INDIFFERENCE CURVES
a) Explain why on an indifference map, the curve is convex? What concept does
this represent? (08)
b) Explain why this indifference map doesn’t fit with economic theory.
(08)
(16)
4.3 CONCEPTS
Explain the following concepts with reference to consumer behaviour, using
appropriate diagrams:
 Price effect
 Substitution effect
 Income effect (12)

4.4 PRICE EFFECT
Define price effect and display price effect using diagrams for.
 Substitute goods
 Independent goods
 Complementary goods. (06)
4.5 INCOME EFFECT
Define Income effect using diagrams for.
 Normal goods
 When product X, is inferior
 When product Y, is inferior (06)
4.6 SUBSTITUTION EFFECT
Sliding over the same IC is called Substitution effect. Explain with the help of a
diagram. (05)
4.7 LAW OF DIMINISHING MARGINAL UTILITY
(a) Describe the Law of Diminishing Marginal Utility. (03)
(b) When is a consumer in an Equilibrium position? (02)
(c) Narrate the assumptions applicable to the indifference curve approach. (03)
(d) With the help of Indifference Curves show how consumers maximize their levels
of satisfaction. Support your decision by drawing a suitable diagram. (07)
(15)
4.8 INDIFFERENCE CURVES 1
(a) Narrate the basic assumptions applicable to the Indifference Curve Approach.
(03)
(b) Explain consumer’s equilibrium with the help of a diagram using indifference
curves. (09)
(12)
4.9 INDIFFERENCE CURVES 2
(a) Define Indifference Curve. (03)
(b) Prove that indifference curves are always convex to origin. (06)
(c) Prove that indifference curves do not intersect each other. (04)
(13)
4.10 MARGINAL RATE OF SUBSTITUTION
Write a detailed note on Marginal Rate of Substitution. (05)

5.1 MONOPOLIST PROFIT
Explain the process of profit-maximization by a monopolist with the help of an
appropriate diagram. (08)
5.2 PERFECT COMPETITION
(a) Briefly describe the important characteristics of a market under perfect
competition. (05)
(b) Explain the equilibrium of a firm under perfect competition, with the help of an
appropriate diagram. (05)
(10)
5.3 INCREASING RETURNS
Explain the law of increasing returns. How does the law apply in the case of a
manufacturing industry? (05)
5.4 LARGE FIRMS
Although the average factory size has not changed greatly over the past fifty years, the
growth of firms has been significant. This can be explained to some extent by
economies of scale and how the growth of the firm has been achieved. One of the
main consequences of firms of very large size is that competition has declined and the
consumer is the loser.
Using both your knowledge of economic theory and the passage above:
(a) explain how economies of scale may be achieved (05)
(b) using a diagram to illustrate your answer, what determines the optimum scale of
the firm in the long run? (05)
(c) explain the different economies of scale that may occur, if a firm grows by merger
or take-over (04)
(d) why might firms of very large size be justified? (02)
(16)
5.5 THE SCALE OF PRODUCTION
The twentieth century has seen a fairly significant rise in the size of the firm. In the UK,
for example, in 1909, the 100 biggest manufacturing firms produced 16% of
manufactured goods. By 1980, this figure had risen to more than 40%.
Many motives have been identified for this growth trend, including the desire to achieve
economies of scale, market domination, and greater security for the firm.
Some of this growth has been internal or organic, but a significant amount has been
achieved through merger activity.
Required:
Use your knowledge of economic concepts to answer the following questions relating
to the above passage:
(a) The diagram below illustrates the cost structures for different sizes of firm in a
particular industry. Study it and then complete the statements that follow:

(i) SRAC stands for….
(ii) LRAC stands for….
(iii) The significance of output level Q1 is that at this level the firm achieves the
scale of production usually referred to as the…
(iv) Between Q1 and Q2 the firm is experiencing….
(v) The shape of the SRAC curves in the diagram is based on the law of
diminishing returns (also known as the law of variable proportions).
The law states that……
(vi) The behaviour of LRAC beyond output level Q2 is due to what economists
call….
(vii) State two specific examples of the phenomenon you identified in (vi) above:
(13)

5.6 MONOPOLY AND COMPETITION
The traditional view in economics is that the perfectly competitive market will provide
benefits for society which are unlikely to occur under conditions of monopoly. Indeed,
the introduction of the Monopolies Commission in 1948, and the ongoing development
since then of controls on the activities of large dominant firms, suggest that monopoly
presents considerable problems for society. However, there is an argument that
monopoly is not necessarily always inferior to competition.
Required:
Using your knowledge of economic theory, answer the following questions relating to
the above passage:
(a) (i) Complete the diagram below to illustrate the profit maximising:
position for a firm in a monopolistic situation
(ii) Assume that, at the profit maximising level of output, the profit earned is
£20,000, average cost is £15 and average revenue is £25. Calculate the
profit maximising level of output: (02)
(b) State whether each of the following statements about monopoly is true or false:
In a monopolistic market:
(i) normal profits are likely in the long run
True or False (01)
(ii) although the firm in perfect competition will, in the long run, produce at the
lowest possible average cost, it will not necessarily produce more cheaply
than a monopolistic firm
True or False (01)
(iii) output in a market is likely to be lower if the market is monopolistic rather
than perfectly competitive
True or False (01)
(iv) economies of scale may allow a monopolist to produce a larger output at
lower cost than would be possible if the market is perfectly competitive
True or False (01)

(c) Complete the diagram below to show the long run position for a firm in a perfectly
competitive market:
(04)
(d) Complete the following statement:
A firm in a perfectly competitive market is said to be technically efficient because
it will produce the level of output at which…..
Your answer must not exceed 10 words. (02)
(16)
5.7 PROFIT MAXIMISATION AND DEMAND ANALYSIS
The following data refer to the costs of a firm and the demand for its product.
Quantity sold Price Total cost
£ £
1 34 12
2 30 20
3 27 34
4 25 53
5 23 75
6 21 102
7 19 131
Requirements:
Using BOTH your knowledge of economic theory AND the data above,
(a) Calculate for each level of output
(i) the marginal cost (02)
(ii) the marginal revenue. (02)
(b) Calculate the level of profit at EACH level of output AND identify the profit-
maximising level of output. (02)
(c) Calculate the price elasticity of demand for the good for a price fall from £25 to
£23. (04)
(d) Identify the factors which might explain the value of the elasticity of demand for
this good. (05)
(e) Explain how you would expect the demand curve for this firm to vary if the
number of firms in the industry were to rise. (05)
(20)

5.8 REVENUES AND COSTS
The following data refer to the revenue and costs of a firm.
Output Total revenue Total costs
0 - 110
1 50 140
2 100 162
3 150 175
4 200 180
5 250 185
6 300 194
7 350 219
8 400 269
9 450 325
10 500 425
(a) Calculate the marginal revenue for the firm and state which sort of market it is
operating in. (04)
(b) Calculate the firm's fixed costs and the marginal cost at each level of output.(04)
(c) What level of output will the firm aim to produce and what amount of profit will it
make at this level? (04)
(d) Describe and explain the effect on the firm's output and profits of the entry of
new producers into the industry. (08)
(20)
5.9 COSTS AND REVENUES
Consider a monopolistically competitive firm.
(a) State the effect of a rise in the firm's costs at all levels of output on:
(i) the equilibrium price and output; (01)
(ii) total profits. (1)
(b) State what would happen to the firm's average and marginal revenue curves
and its equilibrium price and output if:
(i) consumer incomes rose; (2)
(ii) new firms entered the industry. (2)
(c) Explain the ways in which the firm might attempt to discourage the entry of new
firms into its industry. (8)
(14)
5.10 TYPES OF COSTS
Explain the relationship between different types of costs using a table. (10)
5.11 MONOPOLY SETUP
Briefly describe the disadvantages of having a monopoly setup. (08)
5.12 CONSUMPTION GOODS
(a) Describe consumption goods and state the main determinants of demand for
these goods. (02)

(b) Define Price Elasticity of Demand. Compute the price elasticity of a product if
a decline in the price of the product from Rs. 12 per unit to Rs. 11 per unit
increases its demand from 48,000 units to 60,000 units. (04)
(06)
5.13 EQUILIBRIUM OF THE FIRM
(a) Explain the term Equilibrium of the Firm. (02)
(b) State the conditions which are essential for the existence of Perfect
Competition in a market. (05)
(c) Explain by means of a diagram how price and output are determined in the
long-run for a firm operating under conditions of Perfect Competition. (08)
(15)
5.14 MARKET FUNCTIONING
Explain six different features which distinguish a market functioning in an
environment of perfect competition from a market which operates as a monopoly.
(09)
5.15 FREE FORCES
(a) How do free forces of demand and supply determine equilibrium price and
equilibrium quantity? Support your answer with the help of a diagram. (07)
(b) Explain briefly why the short-run average cost curve is “U” shaped. (06)
(13)
5.16 PRICE OUTPUT DETERMINATION
Explain with the help of an appropriate diagram, the price output determination
under monopolistic competition in the short-run. (10)
5.17 OLIGOPOLY AND DUOPOLY: DIFFERENCE
Define and differentiate duopoly market and oligopoly market. (04)
5.18 PRICE CARTEL AND COLLUSION
Define price cartel or price ring and collusion. (04)
5.19 PRICE LEADERSHIP
When price leadership occurs? (03)
5.20 KINKED DEMAND CURVE
What is kinked demand curve? (04)
5.21 NON-PRICE COMPETITION
Write a note on Non-Price Competition. (06)

6.1 NATIONAL INCOME
(a) Briefly describe three different approaches of measuring National Income. (06)
(b) What difficulties are usually faced in measuring National Income? (06)
(12)
6.2 MEASURING NATIONAL INCOME
(a) Explain the income, output and expenditure methods of measuring national
income. (6)
(b) Describe some of the difficulties involved in their calculation. (14)
(20)
6.3 CIRCULAR FLOW OF INCOME
(a) Draw a Diagram of Circular Flow of Income. (04)
(b) Identify and explain briefly the three different types of Withdrawals and
Injections from the Circular Flow of Income. (06)
(10)
6.4 INJECTIONS AND WITHDRAWALS
(a) Explain what is meant by 'injections' and 'withdrawals' in the circular flow of
income model AND show their role in determining the level of national income.
(12)
(b) How might the business sector be affected if there were a rise in the savings
rate in households? (8)
(20)
6.5 AGGREGATE SUPPLY: SHORT RUN
(a) The neo-classical branch of economists believe that there is a short run
aggregate supply curve (SRAS) and a long run aggregate supply curve (LRAS).
Draw a SRAS curve. (02)
(b) Draw a shift in the supply curve as a result of a decrease in the cost of labour
throughout an economy. (04)
(c) What are 6 reasons for a backward shift in a SRAS? (06)
(15)
6.6 AGGREGATE SUPPLY: LONG RUN
(a) Delete/ insert where appropriate:
Going from the short run to the long run, the aggregate supply curve gets
<steeper/ flatter>. This is because in the <short run/ long run> resources are
used at their most efficient point. The long run aggregate supply curve (LRAS)
is a <horizontal/vertical> line as it is completely <dependent/ independent> of
the price level. (04)
(b) Is the LRAS more, or less likely to fluctuate than the SRAS? Explain your
answer. (04)
(08)

6.7 AGGREGATE DEMAND
(a) What are the 5 components of aggregate demand (AD), and what is the
equation? (04)
(b) Draw a shift in the AD curve as a result of consumers having less disposable
income. Give two other examples that could cause this shift. (06)
(c) Define what Keynes meant by “effective demand”. (02)
(12)
6.8 MACROECONOMIC EQUILIBRIUM: RECESSION - KEYNESIAN
(a) Draw a graph using a Keynesian aggregate supply curve where the economy is
in a deep recession. (04)
(b) The government increases spending in the economy. Show how this will change
the equilibrium in the economy. Make particular reference to:
(i) the general price level
(ii) the level of output in the economy (04)
(c) How would a neo-classical model of the economy interpret an increase of
government spending in a recession? Show with a diagram. (06)
(14)
6.9 MACROECONOMIC EQUILIBRIUM: INFLATIONARY GAP
(a) Define an output gap. What are positive and negative output gaps known as? (03)
(b) Draw a positive output gap on a graph. (04)
(c) Explain how a positive gap is possible within an economy. (09)
(16)
6.10 DEFLATIONARY GAP
Explain, using a diagram, the concept of deflationary gap in the economy. (06)
6.11 CALCULATION OF GDP 1
Given the following data of a firm in an economy during a certain period of time.
Calculate GDP according to
(a) Income approach
(b) Expenditure approach
(c) Value added approach. Rupees
(i) Raw material imports 400,000
(ii) Wages and salaries paid 900,000
(iii) Output sold 2,000,000
(iv) Profits 700,000
(v) Pays its post-tax profits to Shareholders as dividend 400,000
(vi) Taxes on labor are 200,000 and on the company 300,000
(vii) Domestic consumer's expenditure 1,100,000
(1,100,000 = 700,000 wages + 400,000 (profits) dividends)
(viii) Government expenditures
(500,000 = 200,000 tax on labor + 300,000 tax on company) 500,000
(ix) Exports 400.000
(12)

The following data relates to the economy of a country over one year period.
Rs. in million
Consumers expenditures 20,000
Federal government expenditures 4,500
Capital formation 5,100
Physical decrease in stocks (100)
Exports receipts 7,000
Imports payments 6,500
Taxes on expenditures 6,000
Subsidy 500
Net property income from abroad 500
Depreciation (Capital consumption Expenditures) 2,000
Required
(i) GDP at market prices
(ii) GDP at factor cost
(iii) GNP at market prices
(iv) GNP at factor cost
(v) National income at factor cost
(vi) NNP at Market price
(12)
The Economic Survey of the government of Pakistan discloses the following
Rupees in millions
Government expenditure 7,500
Sales value of output of firms 30,000
Imports 6,000
Profit before tax of firms 10,500
Consumers’ expenditure 16,500
Wages etc. received by employees 12,000
Tax deducted out of wages 1,500
Exports 6,000
Cost of goods and services purchased from outside country firms 6,000
You are required to compute Gross Domestic Product (GDP) by using:
(i) expenditure approach
(ii) income approach
(iii) value added approach

Following data relates to the economy of a country over a year period.
Capital consumption 2,625
Subsidies 450
Exports 9,675
Imports (9,360)
Consumers’ expenditure 27,600
Taxes on expenditure (4,140)
Net property income from abroad 315
Value of physical decrease in stocks (30)
Gross domestic fixed capital formation 7,380
General government final consumption 6,810
Required:
You are required to compute the following, showing necessary workings
a. Gross Domestic Product (GDP) at market prices and at factor cost
b. Gross National Product (GNP) at market prices and at factor cost
c. National Income at factor cost and at Market price
7.1 CIRCULAR FLOW OF INCOME
The following diagram shows the circular flow of income for an economy.
Requirements:
(a) State which of the lettered flows in the diagram refer to:
(i) a government purchase of computer equipment from a UK producer;
(ii) households' transfer incomes;
(iii) corporation tax;
(iv) reinvestment of business profits to finance capital investment;
(v) a UK firm's sales of goods to a firm in Japan. (5)
Firms
Banking system Rest of the world
Households
Government
A
J
G
ID
H
C
F
EB

(b) For an open economy, state:
(i) the three injections into the circular flow;
(ii) the three withdrawals (leakages) out of the circular flow. (3)
(c) Explain the effect on the business sector of an economy of an increase in the
household savings rate. (4)
(12)
7.2 INVESTMENT AND MEC
(a) Explain (with a diagram) how a fall in interest rates will affect the level of
investment. (4)
(b) How might the motives for an investment by a government and a private sector
firm differ? And give examples of the projects that they might undertake. (6)
(c) Complete the following sentence: if the _____ generated from investment is
greater than the ______, then profit maximising firms will invest. (2)
(d) What might cause a shift in the Marginal Efficiency of Capital curve? (4)
(16)
7.3 CONSUMPTION FUNCTION
(a) Briefly explain the relationship between consumption, income and savings. (02)
(b) How does an increase of income affect the level of consumption in an economy?
How does Keynes explain the difference based on household income, and what
are the implications of this? (10)
(c) How stable is the consumption function? (04)
(16)
7.4 PRIVATE INVESTMENT
State briefly how a government can influence the level of private investment in the
country. (10)

8.1 MULTIPLIER
(a) Explain what you understand by the term Multiplier. (03)
(b) What are the limitations of the Multiplier? (06)
(09)
8.2 MULTIPLIER 1
Output determination occurs when the savings of all of the households in an economy
are equal to the desired investment opportunities.
The diagram shows an economy in equilibrium.
(a) Explain how savings become investment in an economy. Which type of
organisation usually facilitates it? (04)
(b) Are the levels of savings and investment planned, or actual levels? Comment on
the significance. (02)
(c) Explain how if output was greater than M (i.e. in disequilibrium), the economy
would revert to equilibrium. (04)
(10)
8.3 MULTIPLIER 2
(a) Fill in this description of the multiplier: “the consumption of one person becomes
the ___ ___ ___” (02)
(b) Explain, with the help of separate diagrams, why Keynes believed it was
necessary to boost AD during a Depression, and not AS. (06)
(c) Explain three limitations to the effectiveness of the multiplier. (06)
(18)
S = Savings, I = Investment, Q* = maximum GNP output, E = Equilibrium,
M = current level of output, B = zero savings level of output

8.4 ACCELERATOR QUESTION
(a) Define gross investment, and explain its importance in the accelerator principle.
(04)
(b) Complete the following example to calculate gross investment: (04)
Example:
Year Y
(=Output)
Stock of
capital
[1]
Net
investment
[2]
Depreciation
[3]
Gross
investment
[4]
(0) (200) (600)
1 200
2 220
3 240
4 250
5 250
[1]: Capital : output ratio = 3:1
[2]: Net investment = 3*change in output compared to previous year
[3]: Depreciation = 0.1*Stock of previous year’s capital
[4]: Gross investment = Net investment + depreciation
(c) Using your answer from part (b), determine the rate of change of Gross
investment. (04)
Example:
Year Y
(=Output)
% change in Y Gross
investment
% change in
gross
investment
(0) (200)
1 200 from (b)
2 220 from (b)
3 240 from (b)
4 250 from (b)
5 250 from (b)
The shows the disparity in the rates of change of output and gross investment.
(d) Comment on the relationship between %change in output and % change in gross
investment. (03)
(15)

CHAPTER 9 - MONEY
9.1 THE MONEY SUPPLY
(a) Explain what is meant by the term 'the money supply'. (04)
(b) Why do governments believe that it is important to control the growth of the
money supply? (08)
(c) Describe the methods by which the government can attempt to control the money
supply. (08)
(20)
9.2 MONEY SUPPLY AND QUANTITY THEORY
The following data for the UK refer to the rate of inflation, as measured by the retail
price index (RPI), and the growth of the money supply (M0).
Growth of Rate of
money supply inflation
(% rise in M0) (% rise in RPI)
1976 11.2 12.9
1977 13.1 17.6
1978 13.7 7.8
1979 11.9 15.6
1980 5.8 16.9
1981 2.4 10.9
1982 3.2 8.7
1983 6.0 4.2
1984 5.4 4.5
1985 3.8 6.9
1986 5.3 2.4
1987 4.3 4.4
1988 7.7 4.8
1989 5.7 8.2
1990 2.7 9.8
1991 3.1 5.5
1992 2.8 3.7
1993 6.0 1.4
1994 6.9 2.3
1995 6.1 3.5
(Source: Economic Trends, HMSO)
Requirements:
Using BOTH your knowledge of economic theory AND material contained in the table,
(a) Describe the apparent relationship between the money supply (M0) and the rate
of inflation. (04)
(b) Explain the quantity theory of money. (06)
(c) Describe the extent to which the data given are in line with the predictions of the
quantity theory of money. (06)
(d) Explain how the effects of a change in the money supply might differ between the
short run and the long run. (04)
(20)

9.3 IMPORTANT FUNCTIONS
(a) Identify the four important functions of money and highlight their significance. (08)
(b) Keynes has identified three different motives on account of which a person refers
to keep his money in liquid form. Identify these motives and describe their
influence on the liquidity preference of an individual. (06)
(14)
9.4 UNEMPLOYMENT
(a) Explain the relationship between Inflation and Unemployment with the help of a
Phillips Curve. (06)
(b) Full Employment is achieved when the rate of Unemployment reaches zero.
Discuss. (04)
(c) Identify and briefly describe various types of Unemployment. (08)
(18)
9.5 PHILLIPS CURVE
(a) Explain the trade-off between inflation and unemployment in an economy. Why,
at low unemployment is inflation likely to be higher, and vice versa? (3)
(b) Draw this relationship, in the style of a Phillips Curve. (3)
(c) Economist Milton Friedman agreed that such a relationship existed, however
argued that in the long run, no trade-off between inflation and unemployment
existed. Explain this with the aid of a diagram. (10)
(16)
9.6 LIQUID FORM
According to Keynes, individuals have various motives for retaining their money in
liquid form.
Identify these motives and explain their influence on the liquidity preference of an
individual. (06)
9.7 MONEY FUNCTIONS
Explain what is meant by the term "money" AND explain the functions it performs.
(14)
10.1 INDIRECT TAXES
(a) What is meant by Indirect Taxes? Give three examples of Indirect Taxes. (02)
(b) Briefly explain the disadvantages of Indirect Taxes. (09)
(11)
10.2 MACROECONOMIC POLICY
(a) In your opinion what are the three most important primary goals of a well-
conceived Macroeconomic policy?
Briefly discuss the significance of each of these macroeconomic goals. (06)
(b) Explain briefly the concepts of Demand-pull inflation and Cost-push inflation.
(04)
(10)

10.3 DIRECT AND INDIRECT TAXATION
Following decades of relatively high levels of direct taxation, the 1980s and 1990s
have seen a consistent movement towards lower direct taxation, accompanied by
higher rates of indirect taxation and a widening of the scope of indirect taxes.
Clearly, this change has a significant influence on business costs and prices, and
may represent a considerable burden for consumers and producers alike.
Requirements:
Using your knowledge of economic ideas, answer the following questions relating to
the above passage:
(a) Distinguish between direct and indirect taxation and explain the principles
underlying a good taxation system. (06)
(b) Assess the effects on businesses of a major shift from direct to indirect
taxation, and explain how the elasticities of demand and supply affect the
burden of indirect taxes. (10)
(16)
10.4 TRADE CYCLE
The following data refer to the UK economy:
Change in Gross
Domestic
Product from
previous year
Change in business
investment
(excluding
dwellings)
from previous year
Level of interest
rates
(London Inter-Bank
Rate)
1978 + 3.5% +10.1% 9%
1979 + 2.8% + 3.4% 13%
1980 - 2.0% - 3.9% 17%
1981 - 1.1% - 4.8% 13%
1982 + 1.7% + 8.4% 12%
1983 + 3.7% - 2.0% 10%
1984 + 2.0% + 4.9% 10%
1985 + 4.0% + 4.1% 12%
1986 + 4.0% + 0.5% 10%
1987 + 4.6% + 17.3% 9%
1988 + 4.9% + 17.8% 9%
1989 + 2.2% + 6.1 % 14%
1990 + 0.6% - 3.1 % 15%
1991 - 2.3% - 9.5% 11%
1992 - 0.5% - 5.1 % 10%
1993 + 2.0% - 0.7% 6%
1994 + 3.0% + 4.6% 5%
(source: HMSO "Economic Trends")
Requirements:
Using BOTH your knowledge of economic theory AND the data above,
(a) explain what is meant by the "trade cycle" AND show the recovery and
recession phases of the trade cycle between 1978 and 1994. (04)
(b) explain briefly what is meant by the accelerator principle AND assess the
extent to which the data show the presence of an accelerator effect. (08)
(12)

10.5 MIXED ECONOMY
(a) Describe the main objectives of macroeconomic policy in a mixed economy.
(12)
(b) Explain how fiscal policy can be used to achieve these objectives. (08)
(20)
10.6 GROWTH RECESSION INDICATORS
(a) Explain the features of an economy in a recession, and what might cause a
subsequent recovery. (06)
(b) What are some of the leading, coincident and lagging indicators which might
confirm these phases? (10)
(16)
10.7 ECONOMIC POLICY OBJECTIVES
To achieve economic policy objectives, the government has a vital economic role in
building the necessary infrastructure, ensuring the availability of adequate financing
facilities, moulding the social structure and adapting the legal framework to the tasks
of development.
(a) List down the main objectives of the economic policies of a government. (06)
(b) Briefly discuss the policy tools usually adopted by the government to achieve
these objectives. (06)
(12)
10.8 AGGREGATE DEMAND AND AGGREGATE SUPPLY
Explain with the help of a diagram using the concepts of Aggregate Demand and
Aggregate Supply, how equilibrium level of national income is achieved. (12)
11.1 FINANCIAL INTERMEDIATION
(a) What is meant by Financial Intermediation? (02)
(b) Give reasons why commercial banks strive hard to maintain adequate liquidity
at all times. (02)
(04)
11.2 THE CENTRAL BANK
(a) Describe the role of a central bank when it acts as 'banker to the banks and
banker to the government'. (10)
(b) Describe the main features of the 'supervision of the banking system'
undertaken by a central bank or by a regulatory authority. (10)
(20)
11.3 MONEY MARKETS
Explain what is meant by the "money market" AND describe the role played by the
major institutions in that market. (06)

11.4 INTEREST RATE RISE
Explain three ways how a manufacturer of computer games might be affected by a
0.5% rise in interest rates by the central bank. (06)
11.5 TYPES OF BANKS
a) What are the two main categories of banks? What are their features? Name
three ways in which they differ. (08)
b) What are the drawbacks of a bank increasing its line of credit to customers?
What might affect its ability to do so? (08)
(16)
11.6 CENTRAL BANKS
(a) What are the main objectives of a Central Bank? (06)
(b) Is it possible for a Central Bank to meet all of these objectives? Explain your
answer. (10)
(16)
11.7 MONETARY POLICY 1
Suppose a central bank is looking to reign in the level of aggregate demand in an
economy through tightening the money supply. There are a number of options
available to them. Talk through how the following policies would look to achieve this:
(a) Reducing the level of reserves of commercial banks. (10)
(b) Moral suasion. (04)
(14)
11.8 MONETARY POLICY 2
Suppose a central bank is looking to increase the level of aggregate demand in an
economy through expanding the money supply. Talk through how the following
policies would look to achieve this:
(a) Open-Market Operations. (10)
(b) Discount-rate policy. (08)
(18)
11.9 MONETARY AND FISCAL POLICY
(a) Complete the following sentence: In general, monetary policy is undertaken by
“government/ the central bank/ commercial banks/ industrial bodies” and fiscal
policy is undertaken by “government/ the central bank/ commercial banks/
industrial bodies”. (02)
(b) Show, with the aid of a neo-classical aggregate supply diagram, how
monetary and fiscal policy can work together to increase the level of output in
an economy during a recession without increasing the price level. (10)
(12)

12.1 CREDIT
All businesses rely to some extent on credit, in at least a few of its forms. Short
term, as well as medium and long term credit, provide sources of finance to enable a
business to expand or survive the problems of economic recession. The length of
the credit term chosen depends on the life of the asset or project for which the
funding is to be used. Credit also has an effect on the economy as it contributes to
money supply, which can be inflationary, and so the government has a responsibility
to keep it under control.
(a) give two examples of short term credit, medium term credit and long term
credit, available to business. (03)
(b) give two examples of consumer credit and explain how this may be of benefit
to a firm. (03)
(c) explain why a firm may choose to use long term credit rather than issue
shares. (04)
(d) explain how credit can contribute to the money supply and the ways in which
the government may try to control its growth. (06)
(16)
12.2 BANKS
Commercial banks are an essential part of the business infrastructure. They act as
financial intermediaries, providers of all forms of finance and enable the payment of
debts but at the same time are in business to make profits for their shareholders.
Their position is so strong that they are unlikely to fail to make a profit.
(a) explain the term 'financial intermediary'. (04)
(b) explain how banks can create credit and the limitations of this ability. (06)
(c) explain how and why banks can combine the aims of liquidity, profitability and
security when advancing money to customers. (06)
(16)
12.3 COMMERCIAL BANKS AND CREDIT CREATION
(a) Describe the functions of commercial banks AND show how these meet the
needs of business customers. (06)
(b) With reference to the process of credit creation, explain briefly
(i) how commercial banks can 'create credit'. (04)
(ii) how the central bank can restrict the ability of commercial banks to
create credit. (04)
(14)

13.1 A BALANCE OF PAYMENTS DEFICIT
(a) Explain what is meant by the term 'a balance of payments deficit'. (05)
(b) Describe the main factors that might lead a country to experience a deficit on
the current account of its balance of payments. (10)
(c) Explain the difference between 'financing' a balance of payments deficit and
'correcting' that deficit. (05)
(20)
13.2 BALANCE OF PAYMENT AND BALANCE OF TRADE
What do you understand by balance of payment and balance of trade? Describe the
steps that may be taken if there is an adverse balance of payment. (09)
13.3 BALANCE OF PAYMENTS
Describe the measures a country may take to correct disequilibrium in the Balance
of Payments. (07)
13.4 DISEQUILIBRIUM
(a) Briefly describe the main causes of disequilibrium in the balance of payments.
(07)
(b) State the measures for rectifying disequilibrium in the balance of payments.
(07)
(14)
13.5 BALANCE OF PAYMENTS: COMPONENTS
(a) What are the four components of the current account? Place the following in
each of the categories:
(i) Finished goods
(ii) Tourism
(iii) Dividends from shares in foreign firms
(iv) Overseas aid (08)
(b) The capital and financial accounts record the flow of capital and finances
between domestic country and the rest of the world. Describe three of these
flows. (03)
(c) Net errors and omissions compensate for discrepancies in current and capital
accounts. If a government had a balance of payments deficit, how could they
balance. (02)
(13)
13.6 CURRENT ACCOUNT DEFICIT CAUSES
(a) Explain a current account deficit with reference to the income and outflow of a
country. (03)
(b) Name and explain three causes of a current account deficit in a country. (06)
(09)

13.7 CURRENT ACCOUNT DEFICIT NONMONETARY MEASURES
(a) What is a tariff? (02)
(b) Explain, with a diagram, how tariffs can help correct a current account deficit.
(10)
(c) What other non-monetary measures could a government take to reduce a
current account deficit? (06)
(18)
13.8 CURRENT ACCOUNT DEFICIT MONETARY MEASURES
(a) If a country experiences exchange rate depreciation in relation to a trading
partner, will its exports become more, or less attractive to the other country?
(01)
(b) If the exchange rate was Rs.6: US$1, and the rupee depreciates by 50%, what
will the new exchange rate be? (02)
(c) Why might this strategy not be immediately effective at correcting a current
account deficit? Explain with reference to a J-curve. (09)
(12)
13.9 OPEN MARKET OPERATIONS
What do we mean by ‘Open Market Operations’? Why does the Central Bank
undertake such operations? (05)
13.10 CHANGE IN EXCHANGE RATES
Explain the effect on the business sector of an economy of (5)
14.1 USE OF MONEY AND CAPITAL MARKETS
(a) Distinguish between the 'money market' and the 'capital market', and identify
the main institutions which operate in each market. (08)
(b) Using examples, show how a business might need to use both the money and
capital markets. (10)
(c) Explain the circumstances under which the government might need to use the
capital market. (06)
(24)
14.2 DERIVATIVES
(a) Briefly explain what differentiates a derivative instrument from other financial
instruments. For example a share, and a call option based upon a share price.
(08)
(b) What are the two ways that an investor can buy a derivative product? Explain
how they differ, and what the benefits and drawbacks of each are. (08)
(16)

14.3 CAPITAL MARKET
(a) What is the main distinction between capital markets and money markets? (02)
(b) Who are the typical participants in the capital market? (04)
(c) How might an individual investor have access to the capital market? Describe
in detail. (06)
(12)
14.4 CAPITAL MARKET INSTRUMENTS
(a) Explain briefly the two categories of instruments traded on the capital
markets? (04)
(b) Describe the difference between ‘common stock’ and ‘preference shares’. (06)
(c) Suppose a government wishes to raise money through capital markets for a
long term investment. Explain the choices that they have, and what factors are
likely to affect their choice? (06)
(16)

SECTION
C
Multiple choice answers

1 C
2 A
3 C
4 A
5 A
6 A
7 B
8 D
9 C
10 D
A is not relevant as this affects the supply curve for the good. A fall in the price of the
good will result in a movement along the curve not a shift of the whole curve, hence B
is not correct. An increase in the price of a complementary good is likely to shift the
whole demand curve to the left i.e., inwards towards the origin, hence C is not correct.
11 D
A consumer will not change the amount normally demanded of a good even if its price
changes provided that it does not affect significantly his or her overall spending pattern.
12 C
When the price of a good is held above the equilibrium price supply will exceed
demand which will cause a surplus of the good, therefore C.
13 C
Indirect taxes such as VAT shift a producer's supply curve to the left. At each price the
producers supply less because part of sales income goes in tax to the government.
14 B
15 A
16 A
17 A
18 B
19 B
20 A
Elasticity of demand measures how responsive consumers are to changes in price.
Demand is elastic when a fall in price brings about an increase in total expenditure. If
expenditure fell by the same amount as the price fall then demand must be perfectly
inelastic to A.

Answer bank: Multiple choice answers
21 C
A, B and D are all true statements about the elasticity of supply. C is to do with
productivity.
22 A
If a good is price inelastic then the ratio of the percentage change in quantity
demanded to the percentage change in price is less than one. In other words the
proportionate change in quantity demanded is less than the proportionate change in
price so an increase in price will increase total revenue and a fall in price will reduce
total revenue. Hence only A is correct.
23 B
B is the correct answer since the definition of an inferior good is one where less is
purchased as income increases.
A is incorrect as this would imply that as incomes rose so would the consumption of the
good, although to a lower extent than the increase in income.
C is incorrect as this implies that more is purchased in line with the rise in income.
D is incorrect as in this case any change in income would have no effect on the amount
purchased.
24 D
Price elasticity of demand =
priceinchangePercentage
demandedquantityinchangePercentage
1.5 =
%10
x

(Price has dropped by 10% from £1 to
£0.90)
 x = 15%
As x is positive it means the quantity demanded has risen by 15%. Hence 10,000 units
plus 15% = 11,500.
25 A
If a good is price elastic then its sensitivity to price changes is high, hence a certain
change in price will give rise to a greater percentage change in quantity demanded.
The correct response is therefore A.
26 B
27 D
28 B
29 B
30 B
31 C
32 B
33 D
34 D

35 B
36 B
37 D
38 C
39 C
40 C
41 A
42 A
43 A
44 A
45 B
46 D
47 D
48 D
49 B
50 D
51 C
52 D
When diminishing returns set in, employing more units of a variable resource with a
fixed amount of other resources will lead to increasingly small increments in output as
total variable costs rise.
53 C
54 B
55 D
Fixed costs may remain the same, marginal costs and average variable cost may even
fall if gains from large scale production become available.
56 B
Note we are talking about the short run situation, obviously in the long-run all costs
must be covered.
57 D
The full wage of the extra worker = 25
The extra £1 per worker for all workers already employed (Note: It is not just the new
worker who gets £25 but all workers)
11  £1 = 11
£36

58 A
The traditional theory of the firm is based on the premise that the objective of a firm is
to maximise profits and will thus strive to achieve this situation by producing at the
equilibrium position where marginal cost equals marginal revenue.
59 B
A is not true, any firm can benefit from economies of scale providing they are of
sufficient size to obtain such economies. C is not true by definition. D is not true,
management can generally be inefficient and still make some good decisions.
60 D
61 C
62 F
63 B
64 D
65 D
66 A
67 D
68 D
69 A
70 D
71 A
72 A
73 A
74 C
75 A
76 B
77 B
78 C
79 B
80 D
81 D
Withdrawals from the circular flow of income are those amounts not passed on from
firms to households or vice versa. There are three categories of withdrawals - savings,
taxation and imports. The correct response is D because it includes tax payments and
imports - distributed profits and interest paid on bank loans are both types of income
which are passed on from firms to households and are thus not withdrawals.
82 C
The answer is found by adding the value added at each stage of production and
multiplying by 52.
£(800 + 400 + 300)  52 = £78,000

Answer B is wrong because output has been double counted. Answer A ignores the
contribution of the fishermen and double counts the remainder. Answer D ignores the
contribution of the fishermen.
83 B
The inflationary gap is a Keynesian concept which describes a situation where demand
exceeds the level required to bring about full employment.
84 C
A decrease in the level of imports, a fall in the propensity to save and a decrease in the
level of income tax are all injections into the circular flow of funds and will thus tend to
increase the level of aggregate demand in an economy.
85 A
86 D
The inflationary gap is a Keynesian concept which describes a situation where demand
exceeds the level required to bring about full employment.
87 B
Regarding 1, the MEC schedule is essentially the demand curve for investment,
showing the relationship between capital invested and the return on that capital. An
increase in the supply of funds available will reduce the price of capital i.e., the rate of
interest and cause a movement to the right along the same curve. Hence (1) is
incorrect.
Regarding 2, the introduction of cost reducing technology will increase the demand for
investment, i.e., the MEC schedule will shift to the right, hence (2) is correct.
Regarding 3, a reduction of government subsidies will reduce rather than increase the
demand for investment, i.e., (3) is incorrect.
88 A
Keynes argued that it is highly unlikely that the economy will automatically produce that
level of output which employs all resources. The other three answers all reflect the
Keynesian notion that demand management can influence income, output and
employment.
89 B
Improved technology will raise the rate of return at all levels of capital stock. Therefore
the downward sloping (left to right) MEC curve shifts to the right.
90 D
91 B
92 A
An injection into an economy (in this case an increase in income) can be expected to
increase activity not merely by the amount injected but by some multiplying factor -
essentially as a result of money passing from hand to hand. The recipients of the
increase in income cannot each spend more than the increase but they can spend less.

A proportion is bound to be saved. Thus the multiplier is defined as 1 over MPS, the
marginal propensity to save. But other leakages can occur which will make the
multiplier smaller. In the example given these are taxation defined as the marginal
propensity to taxation (MPT) and imports defined as the marginal propensity to import
(MPM). Thus we have :
2
111
MPS+MPM+MPT
1
2
1
20
10
20
3
10
1
4
1



93 D
The accelerator theory emphasises the importance of changes in consumer demand or
National Income in investment decisions. A, B and C are thus incorrect as the theory
has nothing directly to say about the level of savings, rates of interest or volumes of
commercial bank lending.
94 B
The multiplier is calculated as:
leakageofrate
1
The rate of leakage is made up of:
Taxes 30%
Imports 10%
Saving 20% as this represents the balance after deducting taxes, import
spending and domestic consumption.
Hence the multiplier is
2.01.03.0
1

= 1 3
2
CHAPTER 9 – MONEY
95 B
96 D
97 C
98 A
99 C
100 A
101 B
102 B
103 A
104 C
Only C takes money out of the economy since balances have to be drawn down to pay
for the securities. A reduced quantity of money, other things remaining equal, will lead
to a reduction in the money supply. It should be noted that a sale of government
securities will only have this effect if they are sold to the non-bank public and the
question should perhaps have made this clear, although it would have also made the
answer more obvious.

105 B
According to Keynesian liquidity preference theory if the government wishes to
increase the money supply it must purchase bonds and hence their price rises (not falls
as in (ii)) and because of the inverse relationship with the rate of interest, the rate of
interest falls. In such circumstances, the theory suggests, people are less willing to
hold bonds and prefer to hold cash.
106 D
107 B
108 B
109 B
110 C
111 D
112 A
113 D
114 C
Customer's deposits are a liability of a commercial bank.
115 B
116 C
117 C
118 C
119 D
120 D
CHAPTER 12 - CREDIT
121 B
122 D
123 C
As private investors pay for the bonds, using funds in their bank accounts, the cash
position of the commercial banks will be squeezed. As a result they may be forced to
cut their lending portfolio to maintain an adequate relationship between cash and loans.
124 B
125 C
126 A
127 A

Caf2 intorduction to economics and finance questionbank

Caf2 intorduction to economics and finance questionbank

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