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CFA Level 1 Practice Questions for Economics
CFA Level 1 Practice questions for Economics
1. If mangoes cost India Rupees (INR) 10 each, a consumer spends his budget on fruits that he values
more highly than mangoes. However, at a price of INR 4 per mango the consumer buys 20 mangoes. The
total consumer surplus (in INR) is closest to:
A. 26.
B. 60.
C. 120.
Answer: B
The consumer surplus is the value of the good minus the price paid for it (10-4) = 6, summed over the
quantity bought. The total consumer surplus is the consumer surplus on each mango that the consumer
buys and added together. It is the area of the right triangle = (base x height) / 2 as in Fig.2 on p. 40, with
base equal to 20 mangoes a week and the height equal to 6, the consumer surplus on each mango. Thus
the total consumer surplus = (20 x 6) / 2 = INR 60 (see example on p.40).
2. The best characterization of a firm that is operating on its long-run average cost curve is when it:
A. experiences constant returns to scale.
B. produces a given output at the least possible cost.
C. chooses a plant size that minimizes the average fixed cost.
Answer: B
The long-run average cost curve tells the firm the plant size and the quantity of labor to use at each
output to minimize cost. Once the plant size is chosen, the firm operates on the short-run cost curves
that apply to that plant size. Therefore, the firm is said to be operating on its long-run average cost
curve when it is producing a given output at the least possible cost.
3. As the quantity of labor increases, which of the following is the most likely outcome with respect to
the marginal revenue product (MRP) of labor?
A. MRP increases for a monopoly.
B. MRP decreases for a firm in perfect competition.
C. MRP increases for both monopoly and a firm in perfect competition.
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Answer: B
MRP decreases for a firm in perfect competition, due to a decline in marginal product.
4. The cross elasticity of demand for a complementary product would most likely be:
A. zero.
B. positive.
C. negative.
Answer: C
The cross elasticity of demand is negative for a complement and positive for a substitute.
5. The return to entrepreneurial ability in a firm that makes a positive economic profit is most likely:
A. normal.
B. less than normal.
C. greater than normal.
Answer: C
The return to entrepreneurial ability is greater than normal in a firm that makes a positive economic
profit.
6. The belief that money wage rates are sticky is least likely to be associated with:
A. classical macroeconomics.
B. monetarist macroeconomics.
C. Keynesian macroeconomics.
Answer: A
Both Keynesians and monetarists believe that money wage rates are sticky. Classical macroeconomics
does not.
7. For a firm in perfect competition, as output increases the marginal revenue will most likely:
A. increase.
B. decrease.
C. remain constant.
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Answer: C
When output increases for a firm in perfect competition, marginal revenue remains constant while
marginal cost changes.
8. Price discrimination is most likely an attempt by a monopoly to:
A. resell a product.
B. capture a producer surplus.
C. capture a consumer surplus.
Answer: C
A monopoly employs price discrimination to capture consumer surplus and to convert a consumer
surplus to an economic profit.
9. Which of the following will most likely lead to cost-push inflation?
A. A decrease in the cost of financing.
B. An increase in the money prices of raw materials.
C. A technology change that lowers production costs.
Answer: B
Increased material costs cause firms to manufacture less. Less manufacturing decreases short-run
supply making prices rise (see page 388).
10. Which of the following is least likely to be a tool available to central banks for implementing
monetary policy?
A. Inflation targeting.
B. Adjusting taxation.
C. Managing interest rates.
Answer: B
Adjusting taxation is not a tool available to central banks. Only the government can adjust taxation as it
is a fiscal policy tool.
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11. The monetary policy tools available to the Federal Reserve are least likely to include:
A. open market operations.
B. the ability to determine the required reserve ratios of its member banks.
C. adjustments to the amount of gold held as reserves against Federal Reserve notes.
Answer: C
The Fed uses three main policy tools to achieve its objectives: required reserve ratios, discount rate, and
open market operations. Making adjustments to gold reserves is not one of the fed policy tools.
12. Suppose the CPI basket contains only two goods and services: oranges and haircuts. In the base
period, consumers bought 15 oranges at $2 each and 5 haircuts at $10 each. In the current period,
consumers buy 15 oranges at $1.75 each and 5 haircuts at $12 each. The CPI for the current period is
closest to:
A. 107.81.
B. 114.58.
C. 117.97.
Answer: A
CPI equals 100 times the cost of the CPI basket at current-period prices divided by the cost of the CPI
basket at base-period prices. In this problem the current period cost is (15 1.75 + 5 12) = 86.25. The
base period cost is (15 2 + 5 10) = 80. The CPI is (86.25 / 80) 100 = 107.81.
13. Demand for guest rooms in a resort hotel increases from 100 to 150 rooms per night when the
nightly room rate increases from $150 to $200. The elasticity of supply of guest rooms in the resort
hotel is closest to:
A. 0.72.
B. 1.40.
C. 1.50.
Answer: B
The elasticity of supply equals the percent change in quantity relative to the average quantity divided by
the percent change in demand relative to the average demand: The average quantity = (100 + 150)/2 =
125, the % change in quantity = 50/125 = 40%; The average price = (150 + 200)/2 = 175, the % change in
price = 50/175 = 28.6% Elasticity of supply = 40%/28.6% = 1.40
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14. A recessionary gap is more likely to be observed when:
A. real GDP is above potential GDP.
B. real GDP is below potential GDP.
C. employment is above full-employment equilibrium.
Answer: B
A below full-employment equilibrium is a macro-economic equilibrium in which potential GDP exceeds

real GDP. The amount by which potential GDP exceeds real GDP is called the recessionary gap.
15. Which of the following statements is most accurate in regard to the tax division between buyers and
sellers of products with perfectly elastic demand?
A. Sellers pay the entire tax.
B. Buyers bear the entire tax burden.
C. Buyers and sellers share the tax burden.
Answer: A
Under perfectly elastic demand sellers pay the entire tax.
16. A company compiles the following information:
The companys economic profit is closest to:
A. $90,000.
B. $110,000.
C. $130,000.
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Answer: A
Economic profit is equal to total revenue minus total costs, both explicit and implicit costs (including
normal profit) Total costs = 100,000 + 50,000 + 40,000 + (300,000 280,000) = 210,000 Economic profit
= Total revenue Total costs = 300,000 - 210,000 = 90,000
17. In the short run, an increase in output at low levels of production will most likely cause:
A. an increase in the marginal cost due to the rising total fixed cost.
B. an increase in the marginal cost due to the law of diminishing returns.
C. a decrease in the marginal cost due to economies from greater specialization.
Answer: C
The marginal cost decreases at low levels of output due to economies from greater specialization.
However, at higher levels of production, it eventually increases because of the law of diminishing
returns.
18. In regulating a natural monopoly, the most commonly adopted compromise pricing rule by a
regulator is the:
A. total cost pricing rule.
B. average cost pricing rule.
C. marginal cost pricing rule.
Answer: B
The average cost pricing rule allows the natural monopoly to cover its costs and to break even (make
zero economic profit).
19. Which of the following statements provides the best description of Nash equilibrium of two firms in
the game of prisoners dilemma?
A. One firm complies and the other cheats.
B. Both firms cheat and each firm makes zero economic profit.
C. Both firms comply and each firm makes a positive economic profit.
Answer: B
Both firms realize that compliance results in an economic loss whereas cheating results in zero economic
profit (p. 236). Since zero economic profit is better than an economic loss, both firms cheat.
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20. The best characterization of the natural resources market is that:
A. supply of a nonrenewable natural resource is perfectly inelastic and firms are price takers.
B. price is determined by market demand in a renewable resources market and by supply in a

nonrenewable resource market.
C. supply of a renewable natural resource is perfectly elastic and the price is equal to the present
value of the next period's expected price.
Answer: B
With the supply of a renewable natural resource being fixed, the price is determined on the basis of
market demand. In a nonrenewable natural resource market, the flow supply of a nonrenewable natural
resource is perfectly elastic but the price is determined on the basis of supply.
21. Based on supply-side effects, an increase in income tax will most likely:
A. shift the demand curve for labor.
B. decrease the full-employment quantity of labor.
C. increase potential Gross Domestic Product (GDP).
Answer: B
An income tax increase makes the difference between after-tax pay and before-tax pay larger. This
situation weakens the incentive to work and lowers the full-employment quantity of labor (see page
419).
22. A change in the natural rate of unemployment will most likely shift:
A. the short-run but not the long-run Phillips curves.
B. both the short-run and the long-run Phillips curves.
C. neither the short-run nor the long-run Phillips curves.
Answer: B
A change in the natural rate of unemployment shifts both short-run and long-run Phillips curves.
Suppose the natural rate of unemployment increases from 6 to 9 percent, but the inflation remains
constant at 10 percent. As a result, both short-run and long-run Phillips curves move outward adjusting
to the new, higher level of natural unemployment rate. The new point of intersection between the two
lines would be at 9 percent unemployment rate and 10 percent inflation rate (Figure 9, p. 395)
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23. Which of the following goals of monetary policy is best described to be the key goal?
A. Price stability.
B. Full employment.
C. Moderating long-term interest rates.
Answer: A
Price stability is considered to be the key goal of monetary policy in that it is the source for the other
two monetary policy goals.
24. The least likely reason why a firm in perfect competition is a price taker is because:
A. buyers are well informed about prices of other firms.
B. it can set its products price at or above the market price.
C. it produces a very small portion of the total output of a particular good.
Answer: B
A price taker is a firm that cannot influence the market price and consequently sets its own price at the
market place price, not above it. The key reason why a firm in perfect competition is a price taker is
because buyers are well informed about prices of other firms and it produces a tiny portion of the total
market output.
25. For a firm in perfect competition, as the quantity of labor increases, the marginal revenue product
most likely diminishes because of a decline in:
A. marginal product only.
B. marginal revenue only.
C. both marginal product and marginal revenue.
Answer: A
For a firm in perfect competition, as quantity of labor increases, marginal revenue product diminishes
because marginal product diminishes.
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26. If a price cut of a product increases total revenue, demand is best described as:
A. elastic.
B. inelastic.
C. unit elastic.
Answer: A
A products demand is elastic if demand increases by a greater percentage than the percentage price cut
when prices are cut. For example, if a 1 percent price cut increases the quantity sold by more than 1
percent, total revenue increases and demand is said to be elastic.
27. Which of the following types of unemployment is most likely to be associated with an economy in
which many workers have been made obsolete by changing technology?
A. Cyclical
B. Frictional
C. Structural
Answer: C
Structural unemployment arises when changes in technology or international competition change the
skills needed to perform jobs or change the locations of jobs.
28. The free-rider problem, an obstacle to efficiency, is most likely associated with:
A. monopolies.
B. public goods.
C. subsidies and quotas.
Answer: B
Public goods can be consumed simultaneously by everyone and it is in each persons interest to free
ride on everyone else and avoid paying for her or his share of a public good.
29. An expansionary fiscal policy is least likely to include an increase in:
A. tax rates.
B. government borrowing.
C. government expenditures.
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Answer: A
An expansionary fiscal policy means that government increases its purchases of goods and services
and/or cuts tax rates to increase aggregate demand. As a consequence, government borrowing is likely
to increase.
30. For markets with perfectly elastic supply, the introduction of a tax will most likely result in:
A. a price increase and the seller pays the entire tax.
B. a price increase and the buyer pays the entire tax.
C. no change in price and the seller pays the entire tax.
Answer: B
When supply is perfectly elastic (horizontal supply curve) the price increases by the amount of tax and
the seller passes on the entire tax burden to the buyer.
31. A company determines that the quantity demanded of a product increases by 5% when price is
reduced by 10%. The products price elasticity of demand is best described as:
A. elastic.
B. inelastic.
C. perfectly elastic.
Answer: B
When the price elasticity of demand is between 0 and 1, the good is said to have an inelastic demand.
In this case, the price elasticity of demand is calculated as 5% / 10% = 0.5.
32. In perfectly competitive industries what is the most likely final long-run effect of a permanent
decrease in demand?
A. Price decreases.
B. Economic profit decreases.
C. The number of firms decreases.
Answer: C
A permanent decrease in demand in a perfectly competitive industry will, in the short-run, cause the
demand curve to shift to the left causing prices to fall and creating losses for producers. As the fall in
demand is permanent, eventually firms will leave the industry due to these economic losses. As firms
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leave the industry the supply curve moves to the right thus increasing prices back to an equilibrium
where economic profit is zero.
33. If a regulatory agency sets prices equal to a monopolys long-run average cost (LRAC), the monopoly
will most likely have economic profit that is:
A. zero.
B. positive.
C. negative.
Answer: A
If regulators set the price to equal long-run average cost, the monopolist will earn zero economic profits
(Figure 11, p. 210).
34. When rent controls limit rents to prices below equilibrium prices, which of the following is most
likely to occur?
A. New housing construction expands.
B. Long-time tenants extract significant benefit from landlords.
C. Newcomers are given preferential entry into rent-controlled apartments.
Answer: B
Rent ceilings reduce construction and create a housing shortage. They lower rents for some but raise
them for others. Long-time renters are winners but mobile newcomers are losers.
35. Consider the following information regarding consumer price index (CPI) numbers for this year and
last year.
The inflation rate (in %) for the period is closest to:
A. 2.35.
B. 2.38.
C. 2.41.
Answer: C
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The inflation rate is calculated as: ((CPI this year CPI last year) / CPI last year) 100. In this question,
the inflation rate is ((267.54 261.25) / 261.25) 100 = 2.407656.
36. The quantity theory of money is best described as the proposition that, in the long run, an increase
in the quantity of money brings a percentage increase in the price level that is:
A. equal.
B. lower.
C. higher.
Answer: A
The quantity theory of money is the proposition that in the long run, an increase in the quantity of
money brings an equal percentage increase in the price level.
37. In regard to the relation between output and costs in the short-run, a decline in the marginal cost
most likely occurs at what level of production?
A. Low output
B. High output
C. Profit-maximizing output
Answer: A
Marginal cost, in the short-run, decreases at low level of outputs due to economies from greater
specialization. However, at higher levels of production, it eventually increases because of the law of
diminishing returns.
38. When the supply curve of a factor is perfectly elastic the factor income is most likely:
A. entirely economic rent.
B. entirely opportunity cost.
C. part economic rent and part opportunity cost.
Answer: B
When the supply of a factor is perfectly elastic (the supply curve is horizontal), the entire factor income
is opportunity cost (see Figure 14 in the reading).
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39. The most likely initial (short-run) effect of demand-pull inflation is an increase in:
A. the price level and a decrease in real GDP.
B. the price level and an increase in real GDP.
C. government expenditure followed by a decline in the quantity of money.
Answer: B
The initial effect of demand-pull inflation is an increase in the aggregate demand which, in turn, leads to
an increase in the real GDP (Figure 2 (a), pp. 399).
40. According to the short-run Phillips curve, when inflation is less than expected, the most likely initial
effect is that:
A. real wage rates will fall.
B. real interest rates will fall.
C. unemployment will rise above its natural rate.
Answer: C
The difference between actual and expected rates of inflation influences unemployment. When inflation
falls below its expected rate, unemployment rises above the natural rate.
41. Which of the following is the least likely outcome when a monopoly adopts perfect price
discrimination because of the customers differing demand elasticities?
A. The monopolist shares the total surplus with consumers.
B. The price for marginal unit becomes less than the price for other units.
C. The output increases to the point at which price equals the marginal cost.
Answer: A
In a monopoly, perfect price discrimination results in the total surplus being kept by the producer, the
monopolist.
42. Which of the following is least likely to resolve or reduce the principal-agent problem in
organizations?
A. Ownership
B. Long-term contracts
C. Professional management
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Answer: C
Professional management is not a mechanism to resolve the principal-agent problem in organizations. In

fact, professional managers are agents and create the agency problem by pursuing their own goals and
imposing costs on the principal.
43. The crowding-out effect suggests that government borrowing to finance higher expenditures will
most likely increase:
A. private investment.
B. the real interest rate.
C. the supply of loanable funds.
Answer: B
Discuss the sources of investment finance and the influence of fiscal policy on capital markets, including
the crowding-out effect. Government borrowing to finance budget deficits leads to a crowding-out
effect which would in turn lead to an increase in the real interest rate, a decrease in the supply of
loanable funds, and a decrease in private investment.
44. The view that the money wage rates are sticky in the short-run is least likely held by which of the
following schools of thought?
A. Classical
B. Keynesian
C. Monetarist
Answer: A
Classical economists believe the economy is self-regulating and that wage rates will correct quickly to
changes in economic conditions. Both Keynesian and monetarist economists believe that wage rates are
sticky in the short-run.
45. The Nash equilibrium for a duopoly faced with a Prisoners Dilemma set of choices is most likely to
result in:
A. both firms earn economic profits.
B. neither firm earns an economic profit.
C. one of the firms earns an economic profit but the other firm does not.
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Answer: B
The Nash equilibrium for the duopoly is that both firms cheat on their collusive agreement. Prices and
quantities produced are the same as those in perfect competition; neither firm earns an economic
profit.
46. Limited liability is most likely to be an advantage of which type of business organization?
A. Partnership
B. Corporation
C. Proprietorship
Answer: B
Owners have limited liability under the corporate form of business organization. Some partners in a
limited partnership enjoy limited liability, but even in a limited partnership at least one general partner
is exposed to unlimited liability. Proprietors are exposed to unlimited liability.
47. In a simple economy containing only two goods apples and shirts the prices and quantities in the
base period and the current period are:
Assuming the base period consumer price index (CPI) = 100, the CPI for the current period is closest to:
A. 103.57.
B. 107.00.
C. 113.75.
Answer: B
The cost of the CPI basket at base period prices is: (25 $1.00) + (5 $20.00) = $125. The cost of the CPI
basket at current period prices is: (25 $1.25) + (5 $20.50) = $133.75. The CPI for the period is
($133.75 / $125) 100 = 107.
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48. A consumer good demonstrates the following changes in price and quantity:
The elasticity of supply is closest to:
A. 0.60
B. 0.64
C. 0.67
Answer: B
The elasticity of supply is equal to the percentage change in quantity supplied divided by the percentage
change in price. It measures the percentage changes relative to the average price and average quantity.
Average quantity supplied is (30 + 25) / 2 = 27.5 and the percentage change in quantity supplied is 5 /
27.5 = 0.181818. Average price is (20 + 15) / 2 = 17.5 and the percentage change in price is 5 / 17.5 =
0.285714. The elasticity of supply is 0.181818 / 0.285714 = 0.636364.
49. If the quantity demanded of pears falls by 4% when the price of apples decreases by 3%, then apples
and pears are best described as:
A. substitutes.
B. complements.
C. inferior goods.
Answer = A
The cross elasticity of demand is defined as the percentage change in quantity demanded divided by the
percentage change in the price of a substitute or complement. If the cross elasticity of demand is
positive, the goods are substitutes. In this case, the 4 % decline in quantity of pears is divided by the 3 %
decline in the price of apples, which is a positive number, -4 / -3 = +1.333333.
50. Assume that at current production and consumption levels, a product exhibits price elasticity of
demand equal to 1.20 and elasticity of supply equal to 1.45. The true economic consequences of taxes
imposed on the seller of such a product are most likely borne:
A. by the seller.
B. by the buyer.
C. partly by the buyer and partly by the seller.
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Answer = C
As the good exhibits neither perfectly elastic nor perfectly inelastic demand or supply (see pp. 27-28),
the incidence of taxation will be shared by buyers and sellers regardless of whether the tax is placed on
buyers or on sellers.
51. Assume that a monopoly is charging a price higher than the price that would exist in pure
competition. If the monopoly decides to increase the price even more, the deadweight loss to society
will most likely:
A. increase.
B. decrease.
C. remain the same.
Answer = A
As depicted in Figure 6 on page 200 of the readings, a higher monopoly price will increase the
monopolys profit and also increase the deadweight loss.
52. Assume the U.S. Federal Reserve system (the Fed) has decided to lower interest rates in the
economy. To carry out this policy, the Fed will most likely:
A. sell securities.
B. buy securities.
C. increase required reserve ratios.
Answer = B
When the Fed purchases securities, the Fed increases the reserves held by the banking system. These
increased reserves lead to a reduction in the federal funds rate and, ultimately, to a reduction in other
interest rates in the economy.
53. Government policies to stimulate an economy suffering a recession and designed to reduce
unemployment in the short run are most likely directed towards reducing which type of unemployment?
A. Cyclical
B. Frictional
C. Structural
Answer = A
The fluctuating unemployment over the business cycle is called cyclical unemployment.
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54. Which of the following statements concerning market structure and Herfindahl-Hirschman Index
(HHI) is most accurate?
A. HHI is a useful measure of potential barriers to entry.
B. Low control over prices is characteristic of oligopolies.
C. An HHI value of 60 indicates that a market is highly competitive.
Answer = C
HHI values below 100 indicate the market is highly competitive.
55. The primary monetary policy goal of most major central banks is best characterized as:
A. containing inflation.
B. stimulating economic growth.
C. maintaining low interest rates.
Answer = A
Most major central banks primary monetary policy goal is to contain inflation.
56. Externalities, in reference to a particular good, are most likely to impact:
A. sellers.
B. buyers.
C. someone other than buyers and sellers.
Answer = C
An externality is a cost or benefit that affects someone other than the seller or the buyer of a good.
57. Generational accounting indicates the United States, as well as other developed nations, faces
severe generational imbalances regarding government programs such as Social Security. Which of the
following is most likely a possible outcome?
A. Reduction in income taxes.
B. Increase in government discretionary spending.
C. Creation of new money to pay government obligations.
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Answer = C
Because the estimated fiscal balance is so large, the possible outcome will likely involve both lower
benefits and higher taxes. One of these taxes could be the inflation tax paying bills with new money
and creating inflation.
58. The consumer price index (CPI) this year is 252. The CPI last year was 246. The inflation rate this year
is closest to:
A. 2.38%.
B. 2.44%.
C. 6.00%.
Answer = B
The inflation rate is measured as [(CPI this year CPI last year) / CPI last year] 100. In this case, [(252
246) / 246] 100 = 2.439%.
59. Land is best characterized as:
A. having perfectly inelastic supply.
B. being a nonrenewable natural resource.
C. being priced according to the Hotelling principle.
Answer = A
The supply of a given piece of land is perfectly inelastic because the quantity is fixed.
60. Which of the following is least likely to be a valid function/characteristic of money? Money:
A. acts as a unit of account.
B. provides a means of payment.
C. requires a double coincidence of wants.
Answer = C
The functions of money include being a means of payment, acting as a medium of exchange, acting as a
unit of account, and acting as a store of value. It does not require a double coincidence of wants, as
barter does.
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61. Over a given period, the price of a commodity falls by 5.0% and the quantity demanded rises by
7.5%. The price elasticity of demand for the commodity is best described as:
A. elastic.
B. inelastic.
Answer = A
If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent and total
revenue increases.
62. Regarding a companys production function, both labor costs and capital costs are best described as:
A. fixed in the long run.
B. variable in the long run.
C. variable in the short run.
Answer = B
In the short run, a company can vary the quantity of labor but the quantity of capital is fixed. In the long
run, a firm can vary both the quantity of labor and the quantity of capital.
63. Consider the following data for a firm operating in perfect competition.
The firms profit-maximizing output (in units) is most likely:
A. 21.
B. 23.
C. in excess of 24.
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Answer = B
Under perfect competition, economic profits are maximized where marginal revenue equals marginal
cost; in this case where marginal cost crosses $10 per unit. Profits are maximized at 23 units of
production.
64. Assume that two firms in a duopoly enter into a collusive agreement in an attempt to form a cartel
and restrict output, raise prices, and increase profits. Given this, the most likely outcome according to
the Nash equilibrium is that:
A. both firms cheat.
B. both firms comply.
C. one firm cheats and the other firm complies.
Answer = A
The Nash equilibrium of the prisoners dilemma game is that both firms cheat.
65. The tools used by the U.S. Federal Reserve system (the Fed) to implement monetary policy most
likely include:
A. transfer payments.
B. open market operations.
C. raising or lowering income taxes.
Answer = B
The Fed uses three main policy tools to achieve its objectives: required reserve ratios, discount rate, and
open market operations.
66. Suppose inflation increases due to increases in government spending and a reduction in taxes. Such
inflation is best described as:
A. cost-push inflation.
B. demand-pull inflation.
C. monetarist cycle theory.
Answer = B
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67. The price of a good falls from $15 to $13. Given this decline in price, the quantity demanded of the
good rises from 100 units to 120 units. The price elasticity of demand for the good is closest to:
A. 1.3.
B. 1.5.
C. 10.0.
Answer = A
Price elasticity of demand is calculated as: Price elasticity of demand = %Q/%P = (Q / Qave) / (P /
Pave) In this case, (20 / 110) / (2 / 14) = 1.27 rounded to 1.3
68. The supply curve for a particular factor of production with total income consisting solely of economic
rent is most likely:
A. vertical.
B. horizontal.
Answer = A
When the total income of a factor of production consists solely of economic rent, it indicates that the
factor has perfectly inelastic supply. For perfectly inelastic supply, the supply curve is a vertical line.
69. In competitive markets, when the efficient quantity is produced, the least likely result is to:
A. maximize total surplus.
B. generate underproduction.
C. minimize deadweight loss.
Answer = B
When the efficient quantity is produced, total surplus (the sum of consumer surplus and producer
surplus) is maximized. Deadweight loss reduces total surplus and occurs when there is either
underproduction or overproduction, i.e. when the quantity produced differs from the efficient quantity.
When the efficient quantity is produced, underproduction does not occur.
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70. A minimum wage above the equilibrium wage is best characterized as a:
A. price floor.
B. price ceiling.
C. means of minimizing unemployment.
Answer = A
When a price floor is applied to labor markets, it is called a minimum wage. Being above the equilibrium
wage is irrelevant.
71. The crowding-out effect is most likely associated with:
A. falling real interest rates.
B. government budget deficits.
C. government budget surpluses.
Answer = B
The tendency for a government budget deficit to decrease private investment is called the crowding-out
effect.
72. Successful product development, advertising, and the creation of brand names are most likely to
have a positive impact on the economic profits of the producer under:
A. a monopoly.
B. perfect competition.
C. monopolistic competition.
Answer = C
Product development, advertising, and the creation of brand names are most likely to have a positive
impact on the economic profits of the producer under monopolistic competition. Under perfect
competition, all producers (and all consumers) are price takers and economic profits do not exist. Under
monopoly, product development, advertising, and the creation of brand names are of little consequence
in determining economic profits.
Page 23 of 34
73. Consumer surplus is best described as:
A. always less than or equal to zero.
B. always greater than or equal to zero.
C. at times positive and at other times negative.
Answer = B
B is correct. Consumer surplus arises when one pays less for a good than the maximum price that she or
he was willing to pay for it. Consumer surplus is the value (or marginal benefit) of a good minus the price
paid for it, summed over the quantity bought. Because no consumer will (willingly) pay a price greater
than the marginal value or benefit, consumer surplus is always positive.
74. The diagram illustrates a consumers allocation of her budget between items X and Y. With an initial
budget (BC1) she consumes Qa units of item Y. When the price of Y drops, she consumes Qc units of
item Y. Lines BC2 and BC3 are parallel to one another.
The income effect arising from this change in the price of Y is best described as the distance between:
A. Qb and Qa.
B. Qc and Qb.
C. Qc and Qa.
Answer = B
B is correct. When the price of Y falls, the budget constraint shifts outward from BC1 to BC2, indicating
an increase in the consumption of Y. Points a and b reflect the change in consumption of Y due solely to
a decrease in price because BC3 reduces her income by a sufficient amount to return her to her original
indifference curve. Qc Qb is the income effect (which is negative here) because this is an inferior good.
Page 24 of 34
75. If the minimum efficient scale of a single producer is small relative to the demand for an
undifferentiated good, the market structure of the producer is best described as being:
A. an oligopoly.
B. perfect competition.
C. monopolistic competition.
Answer = B
B is correct. Perfect competition involves the sale of a homogeneous product by many sellers;
monopolistic competition may also involve many sellers, but its product involves differentiation.
76. In regard to the aggregate demand curve and an increase in one of its associated factors, which of
the following relationships is least accurate?
Answer = A
A is correct. If stock prices rise, the aggregate demand curve will shift to the right (increase in AD)
because of higher consumption (wealth effect), not lower investments.
77. Holding the working-age population constant, if the labor force participation ratio declines while the
number of people employed remains unchanged, the unemployment rate will most likely:
A. increase.
B. decrease.
C. remain unchanged.
Answer = B
B is correct. For a given working-age population, a decline in the labor force participation rate, often the
result of an increase in discouraged workers, reduces the labor force. If the number of people employed
remains the same while the labor force is smaller, the number of workers defined to be unemployed
must be smaller and the unemployment rate lower.
Page 25 of 34
The following example illustrates the direction of change:
Labor force participation rate = Labor force Working age population. Unemployment rate =
Unemployed Labor force.
78. Which of the following statements is most accurate? For a country to gain from trade it must have:
A. an absolute advantage.
B. a comparative advantage.
C. economies of scale or lower labor costs.
Answer = B
B is correct. A comparative advantage arises if one entity can produce an item at a lower opportunity
cost than another. An absolute advantage in producing a good (or service) arises if one entity can
produce that good at a lower cost or use fewer resources in its production than its trading partner. Even
if a country does not have an absolute advantage in producing any of its goods, it can still gain from
trade by exporting the goods in which it has a comparative advantage. The country with the lower
opportunity cost (with the comparative advantage) should specialize and produce its low opportunity
cost item, and the other country should produce the high opportunity cost item, trading the goods
between each other to make both better off.
79. The following equations have been developed for a company:
The profit maximizing output for this firm (in units) is closest to:
A. 7.
B. 8.
Page 26 of 34
C. 11.
Answer = A
A is correct. The profit-maximizing output will arise when MR = MC. MR = 150 10 Q = MC = 3 Q2 20

Q + 73. On reduction, this becomes: 3 Q2 10 Q 77 = 0. Only with Q=7 will this equation be
satisfied: 3 72 10 7 77 = 0.
80. Which of the following government interventions in market forces is most likely to cause
overproduction?
A. Price floors
B. Price ceilings
C. Imposing an additional per-unit tax of $1 on sellers
Answer = A
A is correct. Price floors lead to overproduction.
81. In an effort to influence the economy, a central bank conducted open market activities by selling
government bonds. This implies that the central bank is most likely attempting to:
A. contract the economy by reducing bank reserves.
B. expand the economy through a lower policy interest rate.
C. contract the economy through a lower policy interest rate.
Answer = A
A is correct. Selling government bonds results in a reduction of banks reserves and reduces banks
ability to lend, causing a decline in money growth through the multiplier mechanism and hence leading
to a contraction in the economy.
82. Consider two countries, A and B. Country A is a closed country with a relative abundance of labor
and holds a comparative advantage in the production of textiles. Country B has a relative abundance of
capital. When the textile trade is opened between the two countries, Country A will most likely
experience a favorable impact on:
A. labor.
B. capital.
C. both capital and labor.
Answer = A
Page 27 of 34
A is correct. As a country opens up to trade, the benefit accrues to the abundant factor, which is labor in
Country A.
83. Four countries operate within a customs union. One country proposes moving to a common market
structure. What additional level of economic integration between the countries would most likely arise
if this change took place? They would:
A. establish common trade barriers against non-members.
B. begin to allow free movement of the factors of production.
C. establish common economic institutions and coordination of economic policies.
Answer = B
B is correct. A common market structure incorporates all aspects of the customs union and extends it by
allowing free movement of factors of production among members.
84. The current spot rate for the USD/EUR is 0.7500. The forward rate for the EUR/Australian dollar
(AUD) is 1.4300, which represents a 400 point forward premium to the spot rate (scaled up by four
decimal places). The USD/AUD spot rate is closest to:
A. 1.0296.
B. 1.0425.
C. 1.1154.
Answer = B
Convert forward quotations expressed on a points basis or in percentage terms into an outright forward
quotation.
85. Demand for a good is most likely to be more elastic when:
A. the good is a necessity.
B. a lesser proportion of income is spent on the good.
C. the adjustment to a price change takes a longer time.
Answer = C
C is correct. The longer the time that has elapsed since a price change, the more elastic demand is. For
example, if gas prices rise, consumers cannot quickly change their mode of transportation but will likely
do so in the longer run.
Page 28 of 34
86. A local laundry and dry cleaner collects the following data on its workforce productivity. Workers
always work in teams of two, and the laundry earns $3.00 of revenue for each shirt laundered.
The marginal revenue product ($ per worker) for hiring the fifth and sixth workers is closest to:
A. 14.
B. 21.
C. 42.
Answer = B
B is correct. The marginal product (MP) is the amount of additional output resulting from using one
more unit of input: TP/L, where TP is the change in total product and L is the change in total labor.
The marginal revenue product (MRP) is the marginal product of an input times the price of the product:
MP Price = TP/L Price. In this problem, the marginal product of hiring the 5th and 6th workers (L
= 2) is 14 shirts per hour/2 workers = 7 shirts per hour/worker. With each shirt resulting in $3 of
revenue, the MRP is 7 shirts per hour/worker $3/shirt = $21 per worker.
87. First degree price discrimination is best described as pricing that allows producers to increase their
economic profit while consumer surplus:
A. increases.
B. decreases.
C. is eliminated.
Answer = C
C is correct. In the first degree price discrimination, the entire consumer surplus is captured by the
producer: The consumer surplus falls to zero.
Page 29 of 34
88. Which of the following actions on the part of a central bank is most consistent with increasing the
quantity of money?
A. Increasing reserve requirements
B. Selling securities on the open market
C. Purchasing securities on the open market
Answer = C
C is correct. When a central bank purchases securities, bank reserves increase. The banks thus have
excess reserves and are able to increase their lending, increasing the money supply.
89. If a government increases its spending on domestically produced goods by an amount that is
financed by the same increase in taxes, the aggregate demand will most likely:
A. increase.
B. decrease.
C. remain unchanged.
Answer = A
A is correct. Aggregate demand rises when the government increases spending by the same amount as it
raises taxes because the marginal propensity to spend out of disposable income is less than 1, and
hence for every dollar less in disposable income, spending only falls by c (where c is the marginal
propensity to consume in dollars). Aggregate spending will fall less than the tax rise by a factor c. This
additional output will, in turn, lead to further increases in income and output through the multiplier
effect.
Page 30 of 34
90. In early 2011, a New Zealand traveler returned from Singapore with SGD7,500 (Singapore dollars). A
foreign exchange dealer provided the traveler with the following quotes:
The amount of New Zealand dollars (NZD) that the traveler would receive for his Singapore dollars is
closest to:
A. 4,565.
B. 7,248.
C. 7,761.
Answer = B
B is correct. The NZD/SGD cross-rate is NZD/USD USD/SGD = 0.7670 1.26 = 0.9664. The traveler will
receive 0.9664 NZD per SGD; 0.9664 NZD/SGD 7,500 SGD = 7,248 NZD.
91. In a simple economy with no foreign sector, the following equations apply:
If the real interest rate is 3% and government spending increases to 2,000, the increase in aggregate
income will be closest to:
A. 1,000.
B. 1,163.
C. 7,143.
Answer = C
Page 31 of 34
92. Which of the following measures of profit is most likely necessary for a firm to stay in business in the
long run?
A. Normal
B. Economic
C. Accounting
Answer = A
A is correct. Normal profit is the level of accounting profit needed to just cover the implicit opportunity
costs ignored in accounting costs. This is all that a firm needs to earn in the long run to remain in
business. Failing to earn normal profits over the long run has a debilitating impact on the firms ability to
access capital and to function properly as a business enterprise.
93. A small country has a comparative advantage in the production of pencils. The government
establishes an export subsidy for pencils to promote economic growth. Which of the following will be
the most likely result of this policy?
A. As new domestic producers enter the pencils market, supply will increase and domestic prices
will decline.
B. The increase in the domestic producer surplus will exceed the sum of the subsidy and the
decrease in the domestic consumer surplus.
Page 32 of 34
C. Although domestic producers will receive a net benefit, the policy will give rise to inefficiencies
that cause a deadweight loss to the national welfare.
Answer = C
C is correct. Export subsidies interfere with the functioning of the free market and result in a deadweight
loss to society. The deadweight loss arises on the producer side as the higher subsidized price causes
inefficient producers to remain in the market; on the consumer side, the higher price causes those that
would have purchased at the lower price to be shut out of the market.
94. Assuming its trading partner does not retaliate, which of the following conditions must hold in order
for a large country to increase its national welfare by imposing a tariff?
A. It must have a comparative advantage in the production of the imported good.
B. The deadweight loss must be smaller than the benefit of its improving terms of trade.
C. It must auction the import licenses for a fee to offset the decline in the consumer surplus.
Answer = B
B is correct. The large country is able to cause the foreign exporter to reduce price in order to retain
market share. In the large country, domestic producers gain from higher volume and the government
gains from collecting the tariff. The sum of these two gains must exceed the deadweight loss to
domestic consumers to achieve a national welfare gain. The change in terms of trade causes income
redistribution from the foreign exporter to the domestic producer.
95. A country having a current account deficit most likely will still be able to consume more output than
it produces by:
A. increasing its net foreign liabilities.
B. restricting foreign direct investment.
C. adjusting interest rates to stimulate higher domestic savings.
Answer = A
A is correct. A current account deficit must be offset by a capital account surplus. Only by borrowing
money from foreigners can a country have a current account deficit and consume more output than it
produces (p. 475). An increase in net foreign liabilities is the result of borrowing from foreigners.
Page 33 of 34
96. In the classification of currency regimes, a currency board system (CBS) most likely differs from a
fixed-rate parity system in that:
A. a CBS has a discretionary target level of foreign exchange reserves.
B. a CBS can peg to a basket of currencies but a fixed-rate system cannot.
C. the monetary authority within a CBS does not act as a traditional lender of last resort.
Answer = C
C is correct. In a CBS, the monetary authority has an obligation to maintain 100% foreign currency
reserves against the monetary base. It thus cannot lend to troubled financial institutions. As long as the
country under a fixed-parity regime maintains its exchange peg, the central bank can serve as a lender of
last resort.
Page 34 of 34

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CFA Level 1 Practice Questions for Economics

CFA Level 1 Practice questions for Economics

A. experiences constant returns to scale.

B. produces a given output at the least possible cost.

C. chooses a plant size that minimizes the average fixed cost.

A. MRP increases for a monopoly.

B. MRP decreases for a firm in perfect competition.

C. MRP increases for both monopoly and a firm in perfect competition.

B. less than normal.

C. greater than normal.

8. Price discrimination is most likely an attempt by a monopoly to:

B. capture a producer surplus.

C. capture a consumer surplus.

9. Which of the following will most likely lead to cost-push inflation?

A. A decrease in the cost of financing.

B. An increase in the money prices of raw materials.

C. A technology change that lowers production costs.

C. Managing interest rates.

A. open market operations.

14. A recessionary gap is more likely to be observed when:

A. real GDP is above potential GDP.

B. real GDP is below potential GDP.

C. employment is above full-employment equilibrium.

A below full-employment equilibrium is a macro-economic equilibrium in which potential GDP exceeds

A. Sellers pay the entire tax.

B. Buyers bear the entire tax burden.

C. Buyers and sellers share the tax burden.

Under perfectly elastic demand sellers pay the entire tax.

16. A company compiles the following information:

The companys economic profit is closest to:

B. an increase in the marginal cost due to the law of diminishing returns.

C. a decrease in the marginal cost due to economies from greater specialization.

A. total cost pricing rule.

B. average cost pricing rule.

C. marginal cost pricing rule.

A. One firm complies and the other cheats.

20. The best characterization of the natural resources market is that:

B. price is determined by market demand in a renewable resources market and by supply in a

A. shift the demand curve for labor.

B. decrease the full-employment quantity of labor.

C. increase potential Gross Domestic Product (GDP).

A. the short-run but not the long-run Phillips curves.

B. both the short-run and the long-run Phillips curves.

C. neither the short-run nor the long-run Phillips curves.

C. Moderating long-term interest rates.

A. buyers are well informed about prices of other firms.

B. it can set its products price at or above the market price.

C. it produces a very small portion of the total output of a particular good.

A. marginal product only.

B. marginal revenue only.

C. both marginal product and marginal revenue.

C. subsidies and quotas.

29. An expansionary fiscal policy is least likely to include an increase in:

A. a price increase and the seller pays the entire tax.

B. a price increase and the buyer pays the entire tax.

C. no change in price and the seller pays the entire tax.

B. Economic profit decreases.

C. The number of firms decreases.

A. New housing construction expands.

B. Long-time tenants extract significant benefit from landlords.

C. Newcomers are given preferential entry into rent-controlled apartments.

The inflation rate (in %) for the period is closest to:

A. entirely economic rent.