Level II R11 Economic Growth and

the Investment Decision

Test Code: L2 R11 EGID Q-Bank Set 1
Number of questions: 12

Question Q-Code: L2-EC-EGID-001 LOS a Section 2

1 Which of the following is least likely a factor that limits economic growth in developing countries?

A) Low saving and investment.

B) Political instability.
C) No restrictions on trade and capital flow.

Answer C) No restrictions on trade and capital flow.

Explanation C is correct. Restrictions on international trade and capital flows is a limiting factor to growth in developing
countries. A & B are factors that limit economic growth. Section 2.7. LO.a.

Question Q-Code: L2-EC-EGID-002 LOS b Section 3

2 For a developed economy, the forecasted long-term growth rate of potential GDP is 3% and the forecasted long-
term inflation rate is 2%. The long-term equity market appreciation in this economy will be closest to:

A) 2%.
B) 3%.
C) 5%.

Answer C) 5%.

Explanation C is correct. The stock market price appreciation over the long term is equal to the growth rate of nominal GDP =
3% + 2% = 5%. In the long run, the increase in stock prices will approximately be the same as the increase in the
GDP growth rate. Section 3. LO.b.

Question Q-Code: L2-EC-EGID-003 LOS c Section 3

3 Which of the following statements is least accurate?

A) Higher rates of potential GDP growth translate into lower real interest rates.
B) All else equal, slower estimated potential GDP growth raises the perceived risk of sovereign debt.
C) Government budget deficits typically increase during recessions and decrease during expansions.

Answer A) Higher rates of potential GDP growth translate into lower real interest rates.

Explanation A is correct. Higher rates of potential GDP growth translate into higher real interest rates. Section 3. LO.c.

Question Q-Code: L2-EC-EGID-004 LOS d Section 4

4 Which of the following represents a move along the production function?

A) Capital deepening.
B) Technological progress.
C) Both capital deepening and technological progress.

Answer A) Capital deepening.

Explanation A is correct. Capital deepening means an increase in the capital-to-labor ratio. It is reflected by a move along the
production function. Technological progress causes an upward shift in the entire production function. Section 4.2.
LO.d.

Question Q-Code: L2-EC-EGID-005 LOS e Section 4

5 The projected growth rate in potential GDP is 5%. The labor force is expected to grow at 3% per year. According to
the growth accounting equation, the expected growth rate in labor productivity is closest to:

A) 8%.
B) 5%.
C) 2%.

Answer C) 2%.

Explanation C is correct. According to the growth accounting equation, Growth rate in potential GDP = Long-term growth rate
of labor force + Long-term growth rate in labor productivity. Therefore, Growth rate in labor productivity = 5 – 3 =
2%. Section 4.3. LO.e.

Question Q-Code: L2-EC-EGID-006 LOS f Section 4

6 Which of the following statements most accurately describes the ‘Dutch disease’?

A) Countries with less natural resources experience low growth as compared to countries with more natural
resources.
B) The manufacturing sector of countries rich in natural resources becomes globally uncompetitive leading to slow
economic growth.
C) Countries with less non-renewable resources as compared to renewable resources experience low growth.

Answer B) The manufacturing sector of countries rich in natural resources becomes globally uncompetitive leading to slow
economic growth.

Explanation B is correct. Dutch disease is a situation where currency appreciation driven by strong export demand for
resources makes other segments of the economy especially manufacturing, globally uncompetitive. Section 4.5.
LO.f.

Question Q-Code: L2-EC-EGID-007 LOS g Section 4

7 Which of the following will most likely have a positive impact on economic growth?

A) Decrease in the labor force participation rate.

B) Increase in immigration.
C) Decrease in the average hours worked.

Answer B) Increase in immigration.

Explanation B is correct. Heightened immigration increases the labor force of a country thereby increasing economic growth.
Section 4.6. LO.g.

Question Q-Code: L2-EC-EGID-008 LOS h Section 4

8 Analyst 1: Non - ICT spending can lead to capital deepening and thus have less impact on potential GDP growth.

Analyst 2: But ICT spending through their network externalities can increase GDP growth rate.

A) Analyst 1 is correct.
B) Analyst 2 is correct.
C) Both analysts are correct.

Answer C) Both analysts are correct.

Explanation C is correct. Non-ICT spending may result in capital deepening, therefore will not influence potential GDP growth. In
contrast, an increase in ICT investments in the economy, may increase potential GDP growth through their
externalities. Section 4.8. LO.h.

Question Q-Code: L2-EC-EGID-009 LOS i Section 5

9 According to which of the following theories does increasing the saving rate leads to a permanent increase in the
economic growth rate of a country?

A) Endogenous growth theory.

 B) Neoclassical model.
C) Classical model.

Answer A) Endogenous growth theory.

Explanation A is correct. According to the endogenous growth models, there are no diminishing marginal returns to capital for
the economy as a whole. Therefore, increasing the saving rate increases the economic growth rate perpetually.
Section 5.3. LO.i.

Question Q-Code: L2-EC-EGID-010 LOS j Section 5

10 ‘Countries with similar population growth rate, savings rate and production function will converge to the same level
of per capita output over time’. The type of convergence described here is most likely:

A) absolute convergence.
B) club convergence.
C) conditional convergence.

Answer C) conditional convergence.

Explanation C is correct. Conditional convergence implies that convergence to the same level of per capita output and steady
state growth rate happens for countries with the same saving rate, population growth rate and production
function. Section 5.4. LO.j.

Question Q-Code: L2-EC-EGID-011 LOS k Section 5

11 Governments should provide incentives for R&D investments because:

A) R&D is cheaper than other investments.

B) R&D has a higher return on capital than other investments.
C) The actual level of R&D in an economy may be too low when the external effects are ignored.

Answer C) The actual level of R&D in an economy may be too low when the external effects are ignored.

Explanation C is correct. The external effects of R&D on the overall economy are not fully evaluated by individual companies,
hence the level of R&D investment may be lower than the optimum level in an economy. Section 5.3. LO.k.

Question Q-Code: L2-EC-EGID-012 LOS l Section 6

12 Which of the following policies will least likely lead to high economic growth?

A) High level of spending on R&D and human capital development.

B) Inward oriented policies.
C) Outward oriented policies.

Answer B) Inward oriented policies.

Explanation B is correct. Inward-oriented policies attempt to develop domestic industries by restricting imports. These policies
encourage the production of domestic substitutes, even though it may be more expensive to do so, thus slowing
economic growth. In contrast, open and trade-oriented economies grow at a faster rate. Section 6. LO.l.