B5-1

Question 1

Which of the following indicates that the economy is in a recessionary phase?

a.

The purchasing power of money declines rapidly.

b.

The rate of unemployment decreases.

c.

There is a shortage of essential raw materials and costs are rising.

d.

Potential national income exceeds actual national income.

Answer 1

Choice “d” is correct. When potential national income (potential Gross Domestic Product, also referred to as the Long Run Aggregate Supply) is greater than the achieved national income, the short run aggregate supply curve is shifting to the left indicating a contraction or recession.

Choice “b” is incorrect. Declining unemployment (increasing employment) is indicative of a growing economy, not a recession.

Choice “a” is incorrect. Declining purchasing power is usually a sign of inflation. Inflation and, usually, the related occurrence of increased money supply are typically indicative of economic growth and not recession.

Choice “c” is incorrect. Shortages of raw materials are generally indicative that the economy is growing, not shrinking, and is placing greater demand on limited raw material resources than available capacity.

Question 2

An auditor is required to obtain an understanding of the entity’s business, including business cycles and reasons for business fluctuations. What is the audit purpose most directly served by obtaining this understanding?

a.

To allow the auditor to more accurately perform tests of controls.

b.

To enable the auditor to accurately identify significant deficiencies.

c.

To assist the auditor to accurately interpret information obtained during an audit.

d.

To decide whether it will be necessary to perform analytical procedures.

Answer 2

Choice “c” is correct. As part of audit planning, the auditor should obtain an understanding of the entity’s business. This understanding enables the auditor to better understand events, transactions, and practices that may affect the financial statements, to plan and perform appropriate audit tests, and to properly understand and evaluate the results of those tests.

Choice “b” is incorrect. Obtaining an understanding of the entity’s business would not be particularly helpful in identifying significant deficiencies. Significant deficiencies in internal control are typically identified during the fieldwork stage of the audit.

Choice “a” is incorrect. Obtaining an understanding of the entity’s business would not result in a more accurate performance of tests of controls. Accurate performance of audit tests is dependent upon factors such as existence of an appropriate audit trail, client cooperation, training and supervision of audit staff, etc.

Choice “d” is incorrect. Analytical procedures are always required in an audit during the planning and overall review stages.

Question 3

An increase (shift right) in aggregate demand causes:

a.

A decrease in the price level and a decrease in real GDP.

b.

A decrease in the price level and an increase in real GDP.

c.

An increase in the price level and a decrease in real GDP.

d.

An increase in the price level and an increase in real GDP.

Answer 3

Choice “d” is correct. As shown below, an increase in aggregate demand causes the equilibrium price level to rise and equilibrium output (real GDP) to increase.

[Image 70e8b0391341581f5d7a047403846c8b]

Choice “c” is incorrect. As shown above, equilibrium output increases, not decreases.

Choice “b” is incorrect. As shown above, the equilibrium price level increases, not decreases.

Choice “a” is incorrect. As shown above, the equilibrium price level increases, not decreases.

Question 4

Which of the following statements is correct if there is an increase in the resources available within an economy?

a.

The standard of living in the economy will rise.

b.

The economy will be capable of producing more goods and services.

c.

More goods and services will be produced in the economy.

d.

The technological efficiency of the economy will improve.

Answer 4

Choice “b” is correct. If there is an increase in the resources available in an economy, the economy will be capable of producing more goods and services. This increase is really an increase in the long-run aggregate supply (potential GDP). On the aggregate supply and demand chart, the long-run aggregate supply line (LRAS) is the vertical line that represents the potential or equilibrium level of output. If that line shifts to the right, then the economy is capable of expanding, but it will not automatically expand just because the line shifts to the right.

Choice “c” is incorrect. Just because there is an increase in the resources available in an economy, it does not mean that more goods and services will automatically be produced. There would have to be increased demand (a shift upward in the aggregate demand line) for more goods and services to actually be produced by suppliers.

Choice “a” is incorrect. If there is an increase in the resources available in an economy, the standard of living in the economy will not necessarily rise. It could rise, but it will not necessarily do that.

Choice “d” is incorrect. If there is an increase in the resources available in an economy, the technological efficiency of the economy will not automatically improve. This statement is backwards. An increase in technological efficiency of an economy will normally increase the resources available in the economy and potentially result in increased productivity.

Question 5

If an economy is currently experiencing both full employment and price stability, a major tax reduction will probably cause:

a.

No change in real GDP or the price level.

b.

A decrease in consumption.

c.

An increase in the unemployment rate.

d.

An acceleration in the inflation rate, unless government expenditures are also reduced.

Answer 5

Choice “d” is correct. A tax cut shifts the aggregate demand curve to the right causing the price level and therefore the inflation rate to rise.

Choice “c” is incorrect. The unemployment rate would fall, not rise.

Choice “a” is incorrect. The price level would rise, not remain unchanged.

Choice “b” is incorrect. Consumption would rise as disposable income rises, not fall.

Question 6

Which of the following might be considered the most expansionary set of fiscal policies?

a.

Increase government purchases, increase in taxes.

b.

Increase in government purchases, increase in the money supply.

c.

Decrease in taxes, increase in the money supply.

d.

Increase government purchases, decrease in taxes.

Answer 6

Choice “d” is correct. Expansionary fiscal policy involves increasing government purchases and/or decreasing taxes. Both increases in government spending and decreases in taxes cause the aggregate demand curve to shift right and thus cause real GDP (output) to increase.

Choice “a” is incorrect. An increase in taxes is an example of contractionary fiscal policy.

Choice “c” is incorrect. An increase in the money supply is expansionary monetary policy (not fiscal policy).

Choice “b” is incorrect per above explanation

Question 7

Suppose real GDP is rising while the overall price level is falling. This scenario results in:

a.

A rightward shift in the aggregate supply curve.

b.

A leftward shift in the aggregate supply curve.

c.

A leftward shift in the aggregate demand curve.

d.

A rightward shift in the aggregate demand curve.

Answer 7

Choice “a” is correct. If the aggregate supply curve shifts to the right, real GDP would increase and the price level would fall.

Choice “b” is incorrect. This would cause real GDP to fall, not rise.

Choice “c” is incorrect. This would cause real GDP to fall, not rise.

Choice “d” is incorrect. This would cause the overall price level to rise, not fall.

Question 8

Which of the following would most likely cause real GDP to increase the most:

a.

A rise in wealth and a rise in interest rates.

b.

A fall in interest rates and a fall in input costs.

c.

A rise in interest rates and a rise in input costs.

d.

A rise in consumer confidence and a fall in government spending.

Answer 8

Choice “b” is correct. A decline in interest rates would cause the aggregate demand curve to shift right, which increases real GDP. Similarly, a decline in input costs would cause the aggregate supply curve to shift right, which also increases real GDP.

Choice “c” is incorrect. Both of these events would cause real GDP to decline.

Choice “a” is incorrect. A rise in interest rates would cause real GDP to decline, not increase.

Choice “d” is incorrect. A decline in government spending would cause real GDP to decline, not increase.

Question 9

Economic fluctuations (or business cycles) are best described as:

a.

Fluctuations in the level of economic activity, relative to a long-term growth trend.

b.

Fluctuations of equal duration and equal severity in the level of economic activity over time.

c.

Changes in the profits of a given firm from one year to the next.

d.

Long run increases in a nations standard of living.

Answer 9

Choice “a” is correct. By the definition of business cycles.

Choice “d” is incorrect. This is economic growth.

Choice “c” is incorrect. Business cycles refer to overall economic activity not the activity of one firm.

Choice “b” is incorrect. Business cycles are not predictable and are not of equal duration nor of equal severity.

Question 10

Within the framework of the aggregate demand/aggregate supply model, an increase in short run aggregate supply will cause:

a.

Real output to decline and the price level to fall.

b.

Real output to expand and the price level to fall.

c.

Real output to expand and the price level to rise.

d.

Real output to decline and the price level to rise.

Answer 10

Choice “b” is correct. A shift right in short run aggregate supply causes output to increase and the price level to fall.

[Image c6a8a6b1aab6f2d53328ef75e5d9abea]

Choice “d” is incorrect. Real output would rise, not fall.

Choice “c” is incorrect. The price level would fall, not rise.

Choice “a” is incorrect. Real output would rise, not fall.

Question 11

Which of the following is not likely to cause a rightward shift in the aggregate demand curve?

a.

An increase in government spending.

b.

An increase in the general level of confidence about the economic outlook.

c.

An increase in the level of real interest rates.

d.

An increase in wealth.

Answer 11

Choice “c” is correct. An increase in real interest rates increases the cost of capital, which shifts the aggregate demand curve to the left.

Choice “d” is incorrect. An increase in wealth shifts the aggregate demand curve to the right.

Choice “a” is incorrect. An increase in government spending shifts the aggregate demand curve to the right.

Choice “b” is incorrect. An increase in consumer confidence shifts the aggregate demand curve to the right.

Question 12

An increase in the personal income tax will tend to cause:

a.

Real GDP to fall and unemployment to fall.

b.

Real GDP to rise and unemployment to fall.

c.

Real GDP to fall and unemployment to rise.

d.

Real GDP to rise and unemployment to rise.

Answer 12

Choice “c” is correct. An increase in the personal income tax will cause a decrease in aggregate demand (i.e., causes the aggregate demand curve to shift left). As a result, an increase in taxes causes real GDP to fall and unemployment to rise.

Choice “b” is incorrect. Real GDP will fall, not rise.

Choice “d” is incorrect. Real GDP will fall, not rise.

Choice “a” is incorrect. Unemployment will rise, not fall.

Question 13

An increase in government spending will tend to cause:

a.

Real GDP to fall and unemployment to fall.

b.

Real GDP to fall and unemployment to rise.

c.

Real GDP to rise and unemployment to fall.

d.

Real GDP to rise and unemployment to rise.

Answer 13

Choice “c” is correct. An increase in government spending causes an increase in aggregate demand (i.e., causes the aggregate demand curve to shift right). As a result, an increase in government spending causes real GDP to rise and unemployment to fall.

Choice “b” is incorrect. Real GDP will rise, not fall.

Choice “d” is incorrect. Unemployment will fall, not rise.

Choice “a” is incorrect. Real GDP will rise, not fall.

Question 14

Which one of the following is most likely to accompany a reduction in aggregate demand?

a.

A decrease in the unemployment rate.

b.

An increase in real GDP.

c.

A decrease in employment.

d.

An increase in the price level.

Answer 14

Choice “c” is correct. As aggregate demand falls, the unemployment rate rises so employment would decrease.

Choice “d” is incorrect. The price level would fall, not rise.

Choice “b” is incorrect. Real GDP would fall, not rise.

Choice “a” is incorrect. The unemployment rate would rise, not fall.

Question 15

At the peak of a business cycle, which of the following conditions is most true?

a.

There is likely to be an excess supply of labor and business inventories are likely to be high.

b.

Capacity constraints and labor shortages are likely to put upward pressure on the overall price level.

c.

Output (real GDP) tends to be below the potential level of output.

d.

The overall price level is likely to be falling.

Answer 15

Choice “b” is correct. The peak of a business cycle marks the highest point of economic activity. At that point, firms are likely to face capacity constraints and labor shortages, which will put upward pressure on the overall price level.

Choice “c” is incorrect. Real GDP is likely to be above, not below, its potential level.

Choice “a” is incorrect. Business inventories are likely to be low, not high, and there is likely to be excess demand for labor not an excess supply of labor.

Choice “d” is incorrect. The overall price level is likely to be rising not falling.

Question 16

The trough of a business cycle is generally characterized by:

a.

Declining purchasing power and unused productive capacity.

b.

Unused productive capacity and an unwillingness to risk investments.

c.

Increasing purchasing power and increasing capital investments.

d.

Shortages of essential raw materials and rising costs.

Answer 16

Choice “b” is correct. The trough of a business cycle is an economic low point with no positive indicators for the future. It is characterized by unused productive capacity and an unwillingness to risk new investments.

Choice “d” is incorrect. Shortages may occur during a peak.

Choice “c” is incorrect. Increasing purchasing power and increasing capital investments come with recovery.

Choice “a” is incorrect. Declining purchasing power comes with inflation; unlikely in a trough.

Question 17

The full-employment gross domestic product is $1.3 trillion, and the actual gross domestic product is $1.2 trillion. The marginal propensity to consume is 0.8. When inflation is ignored, what increase in government expenditures is necessary to produce full employment?

a.

$10 billion

b.

$100 billion

c.

$80 billion

d.

$20 billion

Answer 17

Choice “d” is correct. Government expenditures must increase by $20 billion in order to increase the GDP by $100 billion (from $1.2 trillion to $1.3 trillion). Government expenditures will benefit from the multiplier effect, i.e., the multiplied increase in the level of economic activity that results from increased spending in the economy. The multiplier effect results from the marginal propensity to consume. The level of spending required to achieve a $100 billion increase in the economy, assuming a 0.8 marginal propensity to consume, is as follows:

Spending
(1 − MPC)

=

Change in GDP

Spending
(1 − 0.8)

=

$100,000,000,000

Spending

=

$100,000,000,000 × (1 − 0.8)

Spending

=

$20,000,000,000

Choices “b”, “c”, and “a” are incorrect based on the above calculation.

Question 18

A country’s currency conversion value has recently changed from 1.5 to the U.S. dollar to 1.7 to the U.S. dollar. Which of the following statements about the country is correct?

a.

Its purchases of the U.S. dollar will cost less.

b.

Its exports are less expensive for the United States.

c.

Its currency has appreciated.

d.

Its imports of U.S. goods are more affordable.

Answer 18

Choice “b” is correct. The foreign country’s exports will be less expensive for the United States since it will require fewer U.S. dollars to buy the foreign goods. If the conversion factor is 1.5 FCU to the USD, it takes $.666 to purchase one currency unit. When the conversion factor changes to 1.7 FCU to the USD, it takes $.588 to purchase one currency unit. Therefore, with the higher exchange rate the country’s exports will be less expensive for the United States.

Choice “c” is incorrect. The currency has depreciated.

Choice “d” is incorrect. Imports of U.S. goods are less affordable. It will now require 1.7 units rather than the old 1.5 units to purchase every dollar of the same U.S. goods.

Choice “a” is incorrect. The currency of the foreign country will be able to buy fewer U.S. dollars per unit as a result of the change in the exchange rate.

Question 19

Which of the following segments of the economy will be least affected by the business cycle?

a.

Machinery and equipment industry.

b.

Commercial construction industry.

c.

Healthcare industry.

d.

Residential construction industry.

Answer 19

Choice “c” is correct. The business cycle is the rise and fall of economic activity relative to its long-term growth trend. During a contraction or a recession, most industries experience a decline in sales and profits. Similarly, during an expansion, most industries experience an increase in sales and profits. However, health care services are typically not affected by business cycles. People need medical services regardless of whether or not the economy is doing well. Thus, the health care industry is the least affected by the business cycle.

Choice “b” is incorrect. During a downturn in economic activity (recession or contraction), firm investment in new plants and equipment typically drops off substantially. Thus, the demand for commercial construction is typically low during a contraction and high during an expansion. Thus, the commercial construction industry is sensitive to the business cycle.

Choice “a” is incorrect. During a downturn in economic activity (recession or contraction) firm investment in new plants and equipment typically drops off substantially. Thus, the machinery and equipment industry is sensitive to business cycles. Sales grow during an expansion, but they tend to decline during a contraction or recession.

Choice “d” is incorrect. The residential construction industry is sensitive to interest rates, unemployment rates, and consumer wealth. All of these fluctuate with the business cycle. As a result, the residential construction industry is sensitive to the business cycle.

Question 20

A large increase in nominal wages, perhaps orchestrated by unions, would most likely result in:

a.

An increase in real GDP and a decrease in the price level.

b.

A decrease in real GDP and a decrease in the price level.

c.

An increase in real GDP and an increase in the price level.

d.

A decrease in real GDP and an increase in the price level.

Answer 20

Choice “d” is correct. An increase in nominal wages represents an increase in input costs. This would shift the aggregate supply curve to the left resulting in a decrease in real GDP and an increase in the overall price level. Note that the increase in input costs raises the price level from P0 to P1; thus, the price level increases. Graphs, such as the one above, are a great worksheet methodology to visually arrive at or verify your conclusions.

Choice “a” is incorrect. Real GDP would decrease, not increase.

Choice “b” is incorrect. The price level would increase, not decrease.

Choice “c” is incorrect. Real GDP would decrease, not increase.

Question 21

If the U.S. dollar increases in value relative to the other major currencies, aggregate demand should:

a.

Increase as U.S. goods become more attractive overseas.

b.

Depends on supply of foreign goods.

c.

Not necessarily change.

d.

Decrease as U.S. goods become less attractive overseas.

Answer 21

Choice “d” is correct. If the dollar gains in value, net exports will suffer as U.S. goods become more expensive overseas; hence aggregate demand will decrease. The supply of foreign goods domestically should increase as imports become cheaper.

Choice “a” is incorrect. Demand should decrease, not increase.

Choice “b” is incorrect. Irrelevant to the question.

Choice “c” is incorrect. Demand should decrease, not remain the same.

Question 22

Which of the following conditions is most true during a recession:

a.

Output (real GDP) will be increasing.

b.

Potential output will exceed actual output.

c.

Actual output will exceed potential output.

d.

The natural rate of unemployment will increase dramatically.

Answer 22

Choice “b” is correct. During a recession, potential output (real GDP) will exceed actual output (real GDP).

Choice “a” is incorrect. Real GDP is falling during a recession.

Choice “d” is incorrect. The natural rate of unemployment will not be affected by the various phases of the business cycle. Actual unemployment will change with the cycle.

Choice “c” is incorrect. Actual output will not exceed potential output except at the peak of the cycle, and perhaps not then.

Question 23

Which one of the following most accurately describes the normal sequence of a business cycle?

a.

Peak, contraction, expansion, and trough.

b.

Trough, contraction, expansion, and peak.

c.

Expansion, contraction, trough, and peak.

d.

Expansion, peak, contraction, and trough.

Answer 23

Choice “d” is correct. The sequence of a typical business cycle includes an expansionary phase, a peak of economic activity, a contractionary phase, and a trough of economic activity.

[Image 1ffb34a027bcce0a65e9ac27a6b1ec59]

Choice “c” is incorrect. A peak does not follow a trough.

Choice “a” is incorrect. A trough does not follow an expansion.

Choice “b” is incorrect. A contraction does not follow a trough.

Question 24

Which of the following would cause the national output of country X to fall?

a.

A fall in real interest rates, a rise in the value of country X’s currency, a decrease in government spending, and an increase in consumer taxes.

b.

A rise in real interest rates, a fall in the value of country X’s currency, a decrease in government spending, and an increase in consumer taxes.

c.

A rise in real interest rates, a rise in the value of country X’s currency, a decrease in government spending, and an increase in consumer taxes.

d.

A rise in real interest rates, a rise in the value of country X’s currency, an increase in government spending, and an increase in consumer taxes.

Answer 24

Choice ‘‘c’’ is correct. Stated activity in each of these factors would cause the national output to fall. Factors listed in the proposed answers generally relate to shifts in the demand curve. Leftward shifts in the demand curve will cause supply (national output) to fall at equilibrium. Changes in factors that cause the demand curve to shift to the left and cause output to fall are intuitive and are listed below as TWICE Govt:

Choices “a”, “d”, and “b” are incorrect as reversing any of these elements would cause a rise in the national output.

Question 25

The measure most often used to compare standards of living across countries or across time is:

a.

Government spending.

b.

Real GDP.

c.

Real GDP per capita.

d.

Real consumption expenditures.

Answer 25

Choice “c” is correct. Real GDP per capita is real GDP divided by population. Real GDP per capita is typically used to compare standards of living across countries or across time. By dividing real GDP by population, this measure adjusts for differences in the size of countries and for differences in population over time.

Choice “a” is incorrect. Government spending is not a measure of the standard of living of a country.

Choice “b” is incorrect. Countries with larger populations tend to have higher levels of real GDP. This however does not mean they have a higher standard of living. To adjust for differences in population, real GDP per capita is typically used to compare standards of living, not real GDP.

Choice “d” is incorrect. Real consumption expenditures are only a part of real GDP and thus do not measure all economic activity. Furthermore, real consumption expenditures do not adjust for differences in population. It is therefore not used as a measure of the standard of living.

Question 26

A significant decline in the exchange rate of the U.S. dollar generally will have which of the following effects?

a.

It will benefit U.S. importers.

b.

It will hurt all U.S. business.

c.

It will benefit U.S. exporters.

d.

It will make foreign goods cheaper for U.S. consumers.

Answer 26

Choice “c” is correct. A decline in the exchange rate of the U.S. dollar will result in U.S. goods being less expensive for purchasers outside of the U.S. The currency for a foreign purchaser will be worth more relative to the U.S. dollar, allowing that purchaser to afford more U.S. goods than before. As a result, this will benefit U.S. exporters, who will be able to sell more of their goods to foreign purchasers.

Choice “b” is incorrect. U.S. businesses who sell goods to foreign purchasers will benefit from the depreciated U.S. dollar, as these purchasers will be able to afford more U.S. goods due to the decline in the exchange rate.

Choice “a” is incorrect. U.S. importers will be hurt by the decline in the exchange rate, as goods denominated in foreign currencies will now be more expensive for a U.S. purchaser. A decline in the exchange rate of the U.S. dollar implies that foreign currencies are now more expensive relative to the dollar.

Choice “d” is incorrect. Foreign goods will now be more expensive to U.S. consumers, as the U.S. dollar will be worth less relative to foreign currencies.

Question 27

A period during which real GDP is rising and unemployment is falling is called a(n):

a.

Recession.

b.

Expansion.

c.

Peak.

d.

Trough.

Answer 27

Choice “b” is correct. During an expansion, real GDP is rising and unemployment is falling.

Choice “a” is incorrect. A recession is when real GDP is falling NOT rising.

Choice “c” is incorrect. A peak is the highest point of economic activity. It is the point where real GDP is at its highest level in the cycle and unemployment is at its lowest level in the cycle.

Choice “d” is incorrect. A trough is the lowest level of economic activity. It is the point where real GDP is at its lowest level in the cycle and unemployment is at its highest level in the cycle.

Question 28

Greenwood Corporation has been in business for 20 years. This year its profits have hit a record low and three of its factories are working a three-day week as a result of low product demand. Redwood Corporation, however, has shown steadily rising profits over the last three years and is actively recruiting the staff being laid off by Greenwood.

Select the answer that most appropriately describes the phase of business experienced by these two businesses.

~Redwood

~Greenwood

a.

Peak

Expansionary

b.

Recovery

Contractionary

c.

Expansionary

Declining

d.

Expansionary

Trough

Answer 28

Choice ‘‘d’’ is correct. Redwood is showing rising profits, but there is no indication of its having reached a peak. It is recruiting staff, and that is a clear indication of an expansionary phase. Greenwood has clearly hit a record low as stated in the question and is reducing staff (a clear indication of the trough phase).

Choices ‘‘c’, ‘‘a’’, and ‘‘b’’ are incorrect per the above explanation.

Question 29

Gross domestic product includes which of the following measures?

a.

The total monetary value of all final goods and services produced within a nation in one year.

b.

The total monetary value of goods and services including barter transactions within a nation in one year.

c.

The size of a population that must share a given output within one year.

d.

The negative externalities of the production process of a nation within one year.

Answer 29

Choice “a” is correct. Gross domestic product (GDP) is the total dollar (monetary) value of all new final products and services produced within the economy in a given time period. The emphasis is on the final goods and services.

Choice “c” is incorrect. The size of a population that must share a given output within one year is not a part of the GDP calculation.

Choice “d” is incorrect. The negative (or positive) externalities of the production process of a nation within one year are nota part of the GDP calculation. In economics, externalities are the effects that the acts of consumers or producers have on each other. Externalities range from technological changes to changes in the range of options available to consumers. Externalities may also be regarded as the unanticipated side effects of courses of action.

Choice “b” is incorrect. The total monetary value of goods and services, including barter transactions, is not a part of the GDP calculation. GDP includes only monetary value, not barter value.

Question 30

A recession can be caused by:

a.

A decrease in aggregate supply.

b.

An increase in aggregate demand.

c.

Both “a” and “d”.

d.

A decrease in aggregate demand.

Answer 30

Choice “c” is correct. Both choices “a” and “d” can cause a recession. A recession is defined as a period of falling GDP and rising unemployment. GDP will fall if there is a decrease in aggregate demand or a decrease in aggregate supply.

Choice “b” is incorrect. An increase in aggregate demand will cause GDP to increase NOT decrease.

Choice “a” is incorrect, per the above explanation.

Choice “d” is incorrect, per the above explanation.