Level N Economics End of Year Final Exam

Revision Sheet
1. What is the definition of the study of economics?

2. What are the four economic resources?

3. When are resources considered scarce?

4. What is the difference between command economy and market economy?

5. Analyze a given PPC and determine the opportunity cost.

6. What is the difference between comparative advantage and absolute

advantage?

7. Which factors cause an increase in the demand for a normal good?

8. What factors are likely to change the supply of a product?

9. When does the equilibrium price increase?

10. How does a change in demand determinants and supply determinants affect
the equilibrium?

11. Show graphically how a minimum price is set and explain its effect on the
labor market.

12. What does the circular flow of income represent?

13. Where would the production of a foreign company operating in another

country be recorded?

Date 18-04-20 | Level N | 1

14. How is a nation’s GDP determined and what does it represent?

15. Which transactions must be recorded when calculating a country’s GDP and
which ones must be excluded?

16. What does an increase in real GDP definitely mean?

17. What is the difference between real GDP and nominal GDP?

18. How is aggregate demand calculated?

19. Why does the aggregate demand curve slope downward?

20. Consider the following graph.

Which of the following causes a movement from point e to point d?

21. Describe the short run aggregate supply.

22. Which factors result in a leftward shift in the short-run aggregate supply
curve, and what would this shift illustrate?

23. Why is the aggregate supply graphically represented differently by a

Classical and a Keynesian economist?

Date 18-04-20 | Level N | 2

24. What are the factors that cause a shift in the aggregate demand curve?

25. How could LRAS increase and what are the likely effects on real GDP and
price level?

26. How is the short run equilibrium graphically represented?

27. How is economic growth illustrated using the PPC and AS-AD model?

28. What does the unemployment rate measure?

29. What are the characteristics of a recession?

30. Who is considered as unemployed?

31. When does frictional unemployment occur?

32. What is cyclical unemployment and how can it be corrected?

33. When does an economy reach the natural rate of unemployment?

34. When does the natural rate of unemployment change?

35. Why is unemployment an economic and social problem?

36. In a simplified economy, you are given the following:

Price of Price of
Apples Oranges
Year each unit of each unit of
(units) (units)
apples ($) oranges ($)
2015 10 20 15 2
2016 11 30 20 3

Date 18-04-20 | Level N | 3

Assuming 2015 to be the base year, what are the values of nominal GDP, real
GDP, and the GDP deflator respectively in 2016?

37. What is meant by inflation?

38. What is the purpose of using CPI?

39. What is “real income” and when is it likely to change?

40. What are the possible long-run effects of increasing money supply?

41. What are the factors that would cause a shift in the SRPC?

42. How does the use of fiscal policy affect the AD curve?

43. Which fiscal policy needs to be used to remedy a recession? An inflation?

44. What is the effect of a change in income taxes on real GDP?

45. What is meant by fiscal policy?

46. What are the characteristics of automatic stabilizers?

47. What does the consumption function graph include?

48. How are MPC and MPS calculated?

49. How is the saving function determined?

50. What is the relationship between the interest rate and the level of planned
investment?

Date 18-04-20 | Level N | 4

51. What are the factors that cause a shift in the investment curve?

52. What effect does an increase in unplanned investment have on the economy?

53. If the change in investment and the MPC values are given, what will the
change in real GDP be equal to?

54. Define the simple expenditure multiplier and state how it is calculated.

55. When leakages are equal to injections, what will aggregate expenditure be
equal to?

56. What is the difference between M1 and M2?

57. Give examples to explain each function of money.

58. What is the present value of a $1,000 that will be received two years from
now, assuming a 3% interest rate?

59. What is the Federal Reserve System characterized with?

60. The required reserve is 15% and a bank receives a demand deposit of $50
million. If the banking system does not initially have excess reserves, what will be
the excess reserves created by this deposit?

61. How is the deposit expansion multiplier calculated?

62. Why would the Fed decide to lower the required reserve ratio?

63. What effect does an increase in budget deficit have on the demand for
loanable funds, the real interest rate, and the investment spending?

Date 18-04-20 | Level N | 5

64. What is a monetary policy?

65. What is the effect of monetary policy on interest rate, investment and GDP?

66. What is the effect of open market operations of buying/selling bonds on the
interest rate and the price of bonds?

67. What is the effect of a government’s sale/purchase of $20 billion government

securities on the money supply, given a 10% reserve requirement?

68. How can the Fed achieve a higher level of GDP using monetary policy tools?

69. When does money supply decrease?

70. What are the drawbacks of using fiscal policy?

Date 18-04-20 | Level N | 6

 Level N Economics End of Year Final Exam
Revision Sheet - Answers
1. What is the definition of the study of economics?
Sample question answer:
Economics is a study of how individuals overcome the problem of scarcity and
make the best use of the limited resources available.

2. What are the four economic resources?

Sample question answer:
There are four main resources known as factors of production:
 Land
 Labor
 Capital
 Entrepreneurship or enterprise

3. When are resources considered scarce?

Sample question answer:
A resource that is limited in supply and desired is considered scarce.

4. What is the difference between command economy and market economy?

Sample question answer:
A command economy is an economy in which a central government either
directly or indirectly sets output targets, incomes, and prices. However, a market
economy is an economic system in which economic decisions and the pricing of
goods and services are guided solely by the interactions of a country's consumers
and producers.

5. Analyze a given PPC and determine the opportunity cost.

Sample question answer:
The PPC shows the maximum possible quantity of one good that can be
produced, given the quantity of another good produced.

Date 18-04-20 | Level N | 7

6. What is the difference between comparative advantage and absolute
advantage?
Sample question answer:
A country enjoys a comparative advantage in the production of a good if that
good can be produced at lower cost in terms of other goods. However, a country
enjoys an absolute advantage over another country in the production of a good if
it uses fewer resources to produce that good than the other country does.

7. Which factors cause an increase in the demand for a normal good?

Sample question answer:
An increase in any of the following, ceteris paribus:
 Income available to the household
 Household’s amount of accumulated wealth
 Price of a substitute product
 Preference towards the product in question

8. What factors are likely to change the supply of a product?

Sample question answer:
The price of output is likely to affect the quantity of output supplied by a given
firm. However, factors that affect supply include the cost of producing the
product and the prices of related products.

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9. When does the equilibrium price increase?
Sample question answer:
The equilibrium price increases when the supply decreases and/or the demand
increases, ceteris paribus.

10. How does a change in demand determinants and supply determinants affect
the equilibrium?
Sample question answer:
Change Effect on equilibrium Effect on equilibrium
(ceteris paribus) price quantity
Increase in demand Increases Increases
Decrease in demand Decreases Decreases
Increase in supply Decreases Increases
Decrease in supply Increases Decreases
Increase in supply
and decrease in Decreases Indeterminate
demand
Decrease in supply
and increase in Increases Indeterminate
demand
Increase in supply
and increase in Indeterminate Increases
demand
Decrease in supply
and decrease in Indeterminate Decreases
demand

11. Show graphically how a minimum price is set and explain its effect on the
labor market.
Sample question answer:
A price floor results in excess supply, and this may pose some serious problems
for the government. In the case of minimum wage, this surplus will be
contributing to higher unemployment (i.e., labor supply > labor demand).

Date 18-04-20 | Level N | 9

12. What does the circular flow of income represent?
Sample question answer:
The circular flow of income or circular flow is a model of the economy in which
the major exchanges are represented as flows of money, goods, and services
between economic agents.

13. Where would the production of a foreign company operating in another

country be recorded?
Sample question answer:
In the GDP of the country where this factory is located.

14. How is a nation’s GDP determined and what does it represent?

Sample question answer:
GDP is the total market value of a country’s output. It is the market value of all
final goods and services produced within a given period of time by factors of
production located within a country.
GDP = C + Ig + G + Xn

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15. Which transactions must be recorded when calculating a country’s GDP and
which ones must be excluded?
Sample question answer:
In calculating GDP, we can sum up the value added at each stage of production
or we can take the value of final sales. We do not use the value of total sales in an
economy to measure how much output has been produced. GDP does not count
transactions in which money or goods changes hands but in which no new goods
and services are produced.

16. What does an increase in real GDP definitely mean?

Sample question answer:
Economic growth.

17. What is the difference between real GDP and nominal GDP?
Sample question answer:
Nominal GDP is GDP measured in current dollars—all components of GDP
valued at their current prices. However, nominal GDP adjusted for price
changes is called real GDP.

18. How is aggregate demand calculated?

Sample question answer:
By adding consumption by individuals, government spending, investment by
firms and net exports.
AD = C + I + G + net exports

19. Why does the aggregate demand curve slope downward?

Sample question answer:
- When price level increases, the value of assets saved decreases and spending by
consumers decrease forming an inverse relation.
- When the price level increases, demand for exports decreases and aggregate
demand decreases.
- When price level increases, so does interest rate which lowers borrowing and
results in a decrease in spending.

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20. Consider the following graph.

Which of the following causes a movement from point e to point d?

Sample question answer:
A decrease in any of the components of AD: Decrease in consumption, G,
exports, investment or an increase in imports and an increase in the interest rate.

21. Describe the short run aggregate supply.

Sample question answer:
The short-run aggregate supply curve is a graphical representation of the
relationship between the aggregate price level and the quantity of aggregate
output supplied that exists in the short run, the time period when many
production costs can be considered fixed.

22. Which factors result in a leftward shift in the short-run aggregate supply
curve, and what would this shift illustrate?
Sample question answer:
 Increased commodity costs
 Increased nominal wages
 Decreased productivity
 Increased price of imported raw materials
This leftward shift would illustrate cost-push inflation.

23. Why is the aggregate supply graphically represented differently by a

Classical and a Keynesian economist?
Sample question answer:
According to the classical school, there is one vertical aggregate supply at the full
employment output level. At this level, the economy is mainly affected by
changes in the quality and quantity of factors of production rather than by
changes in the price level. For this reason, AS curve is vertical, meaning that any
change in price will result in the same output level. Unlike the Keynesian view,

Date 18-04-20 | Level N | 12

the classical view does not divide the economy between the short run and the
long run.

24. What are the factors that cause a shift in the aggregate demand curve?
Sample question answer:
Changes in:
 Any of the components of AD (i.e., C, I, G, or Xn)
 Expectations
 Wealth
 Physical capital
 Government policies
 Foreign income
 Exchange rates

25. How could LRAS increase and what are the likely effects on real GDP and
price level?
Sample question answer:
LRAS could increase due to:
 Increased productivity
 Increased education
 Advanced technology
 Training programs
Price level is likely to decrease while real GDP is likely to increase.

26. How is the short run equilibrium graphically represented?

Sample question answer:
The points of intersection between SRAS and AD1, and SRAS and AD2 curves.

Date 18-04-20 | Level N | 13

27. How is economic growth illustrated using the PPC and AS-AD model?
Sample question answer:

28. What does the unemployment rate measure?

Sample question answer:
The unemployment rate is the percentage of the labor force unemployed.

29. What are the characteristics of a recession?

Sample question answer:
A recession is a period of decline in total output, income, and employment. This
downturn, which lasts 6 months or more, is marked by the widespread
contraction of business activity in many sectors of the economy. Along with
declines in real GDP, significant increases in unemployment occur. Recessions
are primarily caused by a decline in aggregate demand.

30. Who is considered as unemployed?

Sample question answer:
An individual becomes unemployed when he/she is jobless, within the working-
age range (above the school-leaving age and below the retirement age — usually
between 16 and 65), actively seeking a job, and readily available to work.

31. When does frictional unemployment occur?

Sample question answer:
Some of the individuals who are not working may be in a transitional stage
between two jobs. Individuals who are frictionally unemployed are subject to a
time lag between leaving their current job and joining a new one.

32. What is cyclical unemployment and how can it be corrected?

Sample question answer:
Cyclical unemployment occurs when the aggregate demand in the economy
decreases. Consequently, output decreases and employees are laid off as the
economy faces a downturn.

Date 18-04-20 | Level N | 14

Cyclical unemployment can be corrected through macroeconomic policies, such
as fiscal policy and monetary policy to increase aggregate demand.

33. When does an economy reach the natural rate of unemployment?

Sample question answer:
 The natural rate of unemployment (NRU) is the unemployment rate that
is consistent with full employment.
 At the NRU, the economy is said to be producing its potential output.
 The NRU is the sum of frictional and structural unemployment and it
occurs when cyclical unemployment is zero.
 The NRU or full employment can never be zero, because frictional and
structural unemployment are unavoidable.

34. When does the natural rate of unemployment change?

Sample question answer:
The NRU mainly composed of frictional and structural unemployment.
Therefore factors that affect these types of unemployment will alter the natural
rate. These factors include changes in:
 Characteristics of the labor force
 Labor unions and institutions
 Government policies

35. Why is unemployment an economic and social problem?

Sample question answer:
Because it lowers output and the standard of living. It increases crime rates,
vandalism, stress and other social problems.

36. In a simplified economy, you are given the following:

Price of Price of
Apples Oranges
Year each unit of each unit of
(units) (units)
apples ($) oranges ($)
2015 10 20 15 2
2016 11 30 20 3
Assuming 2015 to be the base year, what are the values of nominal GDP, real
GDP, and the GDP deflator respectively in 2016?
Sample question answer:
Nominal GDP = (11 × 30) + (20 × 3) = $390
Real GDP = (11 × 20) + (20 × 2) = $260
GDP deflator = Nominal GDP / Real GDP × 100 = 150

Date 18-04-20 | Level N | 15

37. What is meant by inflation?
Sample question answer:
Inflation refers to a persistent rise in the overall price level.

38. What is the purpose of using CPI?

Sample question answer:
The CPI is used to find the inflation rate through measuring the overall cost of a
basket of goods and services purchased by an individual representing a typical
consumer.

39. What is “real income” and when is it likely to change?

Sample question answer:
Real income refers to the income of an individual or group after taking into
consideration the effects of inflation on purchasing power. For example, if you
receive a 2% salary increase over the previous year and inflation for the year is
1%, then your real income only increases by 1%. Conversely, if you receive a 2%
raise in salary and inflation is at 3%, then your real income shrinks by 1%.

40. What are the possible long-run effects of increasing money supply?
Sample question answer:
In the long run, money supply changes can affect the price level in the economy;
increasing money supply would increase the price level, causing a decrease in the
purchasing power and in real incomes.

41. What are the factors that would cause a shift in the SRPC?
Sample question answer:
Anything that shifts SRAS to the right will shift SRPC to the left.
On the contrary, decreases in aggregate supply shift the short run Phillips Curve
to the right, and they include:
 An increase in expected inflation.
 An increase in the price of oil from abroad.
 A negative supply shock, such as damage from a hurricane.
 An increase in the minimum wage.

42. How does the use of fiscal policy affect the AD curve?
Sample question answer:
An expansionary fiscal policy would increase AD (i.e., shit the AD curve to the
right), while a contractionary fiscal policy would decrease AD (i.e., shift AD
curve to the left).

Date 18-04-20 | Level N | 16

43. Which fiscal policy needs to be used to remedy a recession? An inflation?
Sample question answer:
The government that intends to interfere to correct the recession would use
discretionary expansionary fiscal policy. However, the government that intends
to interfere to decrease inflation would use discretionary contractionary fiscal
policy.

44. What is the effect of a change in income taxes on real GDP?

Sample question answer:
Income taxes affect the relationship between the real GDP and consumption
since higher income taxes result in a lower disposable income. Therefore, a
decrease in income tax would increase disposable income, consumption, AD, and
real GDP. However, an increase in income tax would decrease disposable
income, consumption, AD, and real GDP.

45. What is meant by fiscal policy?

Sample question answer:
A macroeconomic policy based on taxes and government spending to impact the
level of aggregate demand

46. What are the characteristics of automatic stabilizers?

Sample question answer:
- They do not involve the same time lag caused by the use of discretionary fiscal
policies.
- They do not solve the economic problems, but rather reduce their intensities.
- They do not require any intervention by the government.
- If used in conjunction with macroeconomic policies, they help solve the
economic problems.

47. What does the consumption function graph include?

Sample question answer:
The 45 degree line where the equilibrium sets at the point of intersection between
the consumption function and the 45 degree line.

48. How are MPC and MPS calculated?

Sample question answer:
MPC = change in consumption/ change in disposable income
MPS = change in saving/change in disposable income

Date 18-04-20 | Level N | 17

49. How is the saving function determined?
Sample question answer:
Saving = - autonomous consumption when income is equal to 0 + MPS x
disposable income
S = -C0 + MPS x Yd

50. What is the relationship between the interest rate and the level of planned
investment?
Sample question answer:
There is an inverse relation between the interest rate and the planned investment
as the interest is considered as the cost of borrowing. Therefore, the higher the
interest rate, the lower the planned investment.

51. What are the factors that cause a shift in the investment curve?
Sample question answer:
Any factor that causes the GDP to increase:
- high confidence
- High economic growth
- high ability to borrow
- low restrictions on loans creation

52. What effect does an increase in unplanned investment have on the economy?
Sample question answer:
Output should be lowered to restore equilibrium since aggregate expenditure is
less than the output produced.

53. If the change in investment and the MPC values are given, what will the
change in real GDP be equal to?
Sample question answer:
Change in GDP = Change in I x expenditure multiplier (1/1-MPC)

54. Define the simple expenditure multiplier and state how it is calculated.
Sample question answer:
It is equal to the change in output/change in aggregate expenditure or 1/MPS or
1/1-MPC

Date 18-04-20 | Level N | 18

55. When leakages are equal to injections, what will aggregate expenditure be
equal to?
Sample question answer:
When the injections (exports, government spending, and investment) are equal
to the leakages (imports, taxes and savings), the economy is at equilibrium,
making the total aggregate expenditures being equal to the GDP.

56. What is the difference between M1 and M2?

Sample question answer:
M2 is broader, less liquid than M1 and M2 includes M1 components.

57. Give examples to explain each function of money.

Sample question answer:
Medium of exchange involves buying and paying for a good or service
Store of value involves saving money and maintain a high value of assets
Unit of account involves comparing the price of items and making decisions
based on price convenience
Method of deferred payment allows to buy now and pay in future installments

58. What is the present value of a $1,000 that will be received two years from
now, assuming a 3% interest rate?
Sample question answer:
PV= FV/ (1 + i)n = 1,000/ (1.03)2 = $942.59

59. What is the Federal Reserve System characterized with?

Sample question answer:
Responsible for setting and maintaining a stable and strong financial system.

60. The required reserve is 15% and a bank receives a demand deposit of $50
million. If the banking system does not initially have excess reserves, what will be
the excess reserves created by this deposit?
Sample question answer:
50m x 15% (required reserves) = 7.5
Excess reserves = initial deposit – required reserves = 50 – 7.5 = $42.5 million

61. How is the deposit expansion multiplier calculated?

Sample question answer:
1/RAR

Date 18-04-20 | Level N | 19

62. Why would the Fed decide to lower the required reserve ratio?
Sample question answer:
To increase the amount of loans given out and hence boost the economy and the
level of spending through increasing credit creation.

63. What effect does an increase in budget deficit have on the demand for
loanable funds, the real interest rate, and the investment spending?
Sample question answer:
Deficit increases, Demand for loanable funds increases, real interest increases,
investment and GDP decrease

64. What is a monetary policy?

Sample question answer:
A macroeconomic policy set by the Fed to control the lending and borrowing
power and influence the interest rate through adjusting the money supply.

65. What is the effect of monetary policy on interest rate, investment and GDP?
Sample question answer:
There is an inverse relation between money supply and the interest rate. As MS
increases, i decreases and I increases, resulting in a higher GDP and employment

66. What is the effect of open market operations of buying/selling bonds on the
interest rate and the price of bonds?
Sample question answer:
The fed buys bonds the price of bonds increases the returns in the form of
interest received decrease

67. What is the effect of a government’s sale/purchase of $20 billion government

securities on the money supply, given a 10% reserve requirement?
Sample question answer:
The purchase of bonds increases the money supply by the amount x money
multiplier, while the sale of bonds reduces the money supply by the same
amount:
- Purchase of $20 billion bonds: MS increases by $200 billion
- Sale of $20 billion bonds: MS decreases by $200 billion

68. How can the Fed achieve a higher level of GDP using monetary policy tools?
Sample question answer:
To increase GDP using monetary policy:
- Lower the interest rate

Date 18-04-20 | Level N | 20

- Lower the reserve requirement
- purchase bonds from individuals
- Increase the money supply
- Lower the discount rate

69. When does money supply decrease?

Sample question answer:
- Sale of government bonds by Fed
- Increase in interest rates and discount rates
- Increase in RAR

70. What are the drawbacks of using fiscal policy?

Sample question answer:
- Time lag between decision, approval, and effect of fiscal policy
- Could be inflationary if it involves increase in G and decrease in Taxes
- Could worsen the budget deficit if it requires a high level of government
spending that exceeds revenues collected from taxes.

Date 18-04-20 | Level N | 21