CH13 QB The economic environment of business and finance

Question 1

Anu manufactures pieces of classic furniture. Anu predicts that “if people’s incomes rise
next year, then the demand for my furniture will increase”.
The accuracy of Anu’s prediction depends on whether the pieces of furniture he produces:
A are normal goods
B have few substitutes
C have many complements
D have few complements

Answer 1

A With normal goods, a rise in incomes will be accompanied by a rise in demand for
them as opposed to a fall in demand for inferior goods. The existence of complements
and substitutes have no effect in this context.

Question 2

A market trader has noticed that when the price of cakes rises, consumers tend to buy more
biscuits instead. The effect operating here is:
A the income effect
B the diminishing marginal utility effect
C the substitution effect
D the price elasticity of demand

Answer 2

C The effect of a price rise in one good is to make the prices of other goods relatively
cheaper. The resultant shift in demand towards the relatively cheaper goods is an
example of the substitution effect.

Question 3

Potatoes are a Giffen good. An increase in the price of potatoes will cause:
A an increase in demand for potatoes
B a decrease in demand for substitutes for potatoes
C a decrease in demand for potatoes
D an increase in demand for substitutes for potatoes

Answer 3

A If potatoes are a Giffen good, then an increase in the price of potatoes will cause an
increase in demand for potatoes.

Question 4

Which of the following are examples of complementary goods?
A Milk and orange juice
B Pepsi and Coca-Cola
C French fries and tomato sauce
D Lamb and beef

Answer 4

C Complements are goods that tend to be bought and used together, so that an increase
in demand for one is likely to cause an increase in demand for the other. Options A, B
and D are substitutes rather than complements.

Question 5

Y is a complement of X in consumption. An increase in the price of Y will:
A increase the demand for Y and decrease the demand for X
B decrease the demand for Y and increase the demand for Y
C increase the demand for both Y and X
D decrease the demand for both Y and X

Answer 5

D If X is a complement of Y then they tend to be consumed together, so if demand for Y
falls as a result of the increase in its price then demand for X will also fall.

Question 6

A brand of cheese is an inferior good. A consultant has made two statements about the
cheese.
Statement (1) Demand for the cheese will rise as incomes rise.
Statement (2) Demand for the cheese only exists because of the effects of advertising.
Identify whether each statement is true or false.
A Statement (1) true; Statement (2) false
B Statement (1) false; Statement (2) false
C Statement (1) true; Statement (2) true
D Statement (1) false; Statement (2) true

Answer 6

B Both statements are false. Demand for an inferior good will fall with rises in income as
consumers shift to better quality goods that they can now afford with their higher
incomes. Demand for the inferior product could exist because of its price and the level
of incomes, not just because of advertising.

Question 7

Redium is a normal good which has become increasingly unfashionable during the past
year. What changes to supply, demand and market price will this change in tastes have
created?
A No impact on the demand curve, but a fall in market price and a fall in quantity supplied
B A shift in the demand curve to the right, a fall in market price and a fall in quantity
supplied
C A shift in the demand curve to the left, a fall in market price and a fall in quantity supplied
D No impact on the demand curve, no impact on the supply curve but a fall in market price

Answer 7

C A normal good which has become increasingly unfashionable will see its demand
curve shift to the left, a fall in market price and a fall in quantity supplied.

Question 8

The market for a product is a natural monopoly. Production of the product must be
associated with:
A high marginal costs
B low marginal costs
C economies of scope acting as a barrier to entry
D low fixed costs

Answer 8

B With a natural monopoly, fixed costs will be high, marginal costs will be low (B) and
economies of scale (rather than scope) provide an effective barrier to entry.

Question 9

Which of the following is an example of government intervention to correct a market
failure?
A An increase in corporation tax during an economic boom
B An increase in the rate of value added tax (VAT) on all goods and services
C The taxation of goods with negative externalities
D The taxation of Giffen goods

Answer 9

C Negative externalities (C) are an example of market failure because they represent
situations where the private costs of an activity differ from the social costs of the
activity. Economic booms (A) and Giffen goods (D) are not market failures. No market
failure is apparent in (B)

Question 10

The cross elasticity of demand between the Terra product and the Nova product is zero.
The two products are:
A complements
B substitutes
C veblen goods
D unrelated

Answer 10

D Zero cross-elasticity means the goods are unrelated.

Question 11

The price of Yellands has fallen by 4%. Over the same period demand for Dellows, where
there has been no price change, has risen by 6.5%. The cross elasticity of demand between
the two products is:
A –1.625
B –0.620
C 1.625
D 0.620

Answer 11

A +0.065/–0.04 = –1.625

Question 12

The UK government has recently imposed a maximum price on Pratex which is set at a
lower level than its equilibrium price. In future, therefore, it can be expected that there will
be:
A excess supply of the product
B excess demand for the product
C no effect on supply but an increase in demand
D no effect on demand but a decrease in supply

Answer 12

B A price below the market equilibrium price will attract demand but deter suppliers.

Question 13

An analyst with Lanes plc has drawn a supply curve for one of the company’s major
products, the Ledo. The curve is a vertical straight line. This indicates that supply of the
Ledo is:
A perfectly inelastic
B of unitary elasticity
C perfectly elastic
D one

Answer 13

A A vertical straight line implies that the supply of the Ledo is fixed whatever price is
offered.

Question 14

There has been a significant rise in factor costs for the Tempo product during recent
months. It can be expected that there will be:
A a contraction in demand and supply
B an expansion in demand and supply
C a contraction in demand and an expansion in supply
D an expansion in demand and a contraction in supply

Answer 14

A When factor costs rise demand contracts (moves along the demand curve) since the
price goes up, and the supply curve shifts to the left (contracts)

Question 15

In the market for the Optica product competitors do not compete through price. Instead
they spend substantial sums of money on raising consumer awareness through advertising.
There is some differentiation between products, often achieved through branding. There
are many buyers and sellers in the market for the product. The market for the Optica
product is characterised as:
A monopolistic competition
B oligopoly
C perfect competition
D monopol

Answer 15

A The key differentiator here is the large number of competing sellers. The earlier issues
identified in the question are shared by both monopolistic competition and oligopoly,
but it is the large number of sellers in the market that defines this market specifically as
monopolistic competition. SAMPLE PAPER

Question 16

Which three of the following are associated with conditions of perfect competition?
A Suppliers are price-makers
B Suppliers earn ‘normal’ profits
C Consumers lack influence over market price
D Differentiated products
E A single selling price

Answer 16

B,C,E
Suppliers are price-takers meaning that they can sell as much as they supply but only if
they sell at the market-determined equilibrium price (E). Differentiated products (D) are
a market imperfection creating imperfect rather than perfect competition

Question 17

Gromet plc has been able to achieve significant external economies of scale. This indicates
that the market for the company’s only product has been:
A static, so forcing the company to achieve economies of scale in production
B growing, so enabling the economies of scale to be achieved
C contracting, so enabling the company to cut costs in distribution
D volatile, meaning that internal economies of scale were unattainable

Answer 17

B External economies of scale arise by virtue of the market for the product growing,
enabling greater levels of business across which to spread the company’s costs.

Question 18

If the price of a particular product is £9.00 per unit, on average 150 units of the product are
sold per month. At a price of £10.00 per unit, on average 110 units per month are sold. The
price elasticity of demand for the product is:
A –0.42
B –2.40
C –0.27
D –0.11

Answer 18

B Proportional change in quantity demanded = 40/150  100 = –26.6%
Proportional change in price = 1/9  100 = 11.1%
PED = –26.6/11.1 = –2.40

Question 19

The minimum price for a good is set by the government above the current free market
equilibrium price. What will be the effect (if any) on demand for and supply of the good in
the short term?
A Demand for the good will fall; supply of the good will rise
B Demand for the good will rise; supply of the good will fall
C Both demand for and supply of the good will rise
D There will be no effect on either demand for or supply of the good

Answer 19

A Suppliers will be encouraged to supply at that price so supply will increase, whilst at a
price above the market equilibrium price demand will fall.

Question 20

Bench Ltd produces chairs. An economist predicts that, if average incomes rise next year,
demand for the chairs will increase in direct proportion to the rise in incomes (assuming all
other factors remain unchanged). The accuracy of the economist’s prediction depends on
whether the chairs:
A are normal goods
B have many complementary goods
C have few complementary goods
D have few substitutes

Answer 20

A With normal goods, if incomes rise demand for the product will rise and this will be the
case regardless of the existence of either substitutes or complements. SAMPLE PAPER

Question 21

The basic economic problem facing all national economies is:
A maximising economic growth
B unemployment
C inflation
D allocating scarce resources

Answer 21

D The basic economic problem is one of allocating scarce resources and economics is
the study of how those scarce resources are or should be used.

Question 22

Which of the following is regarded by economists as a factor of production?
A Demand
B Enterprise
C Supply
D Innovation

Answer 22

B Enterprise is one of the four factors of production, along with labour (including
management), land and capital.

Question 23

Which of the following is a source of economies of scale?
A The introduction of a new product
B Bulk buying
C The use of skills in production
D Cost savings resulting from new production techniques

Answer 23

B The ability to obtain discounts because of the size of orders (bulk buying, B) is a direct
result of larger scale operations. Technical improvements (D) could apply at any scale
of operations, as well as the employment of skills (C) and the introduction of a new
product (A).

Question 24

The marginal propensity to consume measures:
A the relationship between changes in consumption and changes in consumer utility
B the proportion of household incomes spent on consumer goods
C the proportion of total national income spent on consumer goods
D the relationship between changes in income and changes in consumption

Answer 24

D The relationship between changes in income and changes in consumption.

Question 25

``` Which of the following is the correct sequence in a business cycle? A Boom, Recession, Depression, Recovery B Recession, Recovery, Boom, Depression C Boom, Recovery, Recession, Depression D Recovery, Recession, Depression, Boom ```

Answer 25

A When an economy booms, it reaches a turning point and goes into recession. The recession deepens into a depression. Eventually, there is another turning point in the economy, and the business cycle goes into recovery and then back into boom, and so on.

Question 26

``` The recession phase of the business cycle will normally be accompanied by all of the following except: A a rise in the rate of inflation B a fall in the level of national output C an improvement in the trade balance D a rise in the level of unemployment ```

Answer 26

A Recession and declining demand go together. Inflation and declining demand do not. The trade balance is likely to improve due to a decrease in demand for imports

Question 27

The government may seek to reduce the rate of demand-pull inflation by any of the following means except: A reducing interest rates B increasing VAT C applying more stringent controls over bank lending D reducing public expenditure

Answer 27

A Lower interest rates (A) is likely to result in higher consumer borrowing and even stronger demand-pull inflation. B, C and D will all be measures which reduce the demand for goods and services. Higher value added tax (B) could increase total spending on goods and services inclusive of the tax, but spending net of tax will fall, and this should result in a reduction in demand-pull inflation. Bank lending (C) is largely used for spending on goods and services by the people who borrow the money. Public expenditure (D) represents the government's own demand.

Question 28

Which of the following would lead to demand pull inflation? A Rising import prices B Increase in wages C Increases in indirect taxation D High consumer expenditure such that aggregate demand exceeds aggregate supply

Answer 28

D Aggregate demand exceeding aggregate supply is an example of demand pull inflation.

Question 29

``` Which of the following are effects of reduced interest rates? 1 Consumer spending will increase 2 Business investment will be encouraged 3 Saving will increase A 1 only B 1 and 2 only C 2 and 3 only D 1, 2 and 3 ```

Answer 29

B Low interest rates will encourage spending rather than saving. Investment will be encouraged because the opportunity cost of investing is reduced.

Question 30

Which of the following is a fiscal policy measure by government? A To raise short-term interest rates in the money markets B To support the exchange rate for the country's currency C To control growth in the money supply D To alter rates of taxation

Answer 30

D Fiscal policy is concerned with the government's tax income, expenditure and borrowing (to make up the difference between income and expenditure).

Question 31

'Supply side' economics concerns: A the behaviour of the microeconomic supply curve B the supply of factors of production in response to changing levels of factor rewards C the behaviour of the aggregate supply curve in connection with the levels of prices, incomes and employment D the effect that an increase in the supply of money has on inflation

Answer 31

C It is aggregate supply in the economy which is at issue.

Question 32

``` If the government wishes to increase consumer spending, it should increase the rate of: A income tax B corporation tax C import duties D social security payments ```

Answer 32

D Higher social security payments (D) will give consumers more cash to spend. Higher taxation (A and B) will tend to reduce consumer spending. Higher import tariffs (C) might result in greater consumer expenditure on imports inclusive of tariffs, but the volume and the net-of-tariff value of imports purchased will fall.

Question 33

Economists in Zedland believe that the country's economy is entering a recovery phase. Which of the following features of the Zedland economy would support this view? A Rising levels of demand being met by increased production B Rising levels of demand being met by price increases C Capacity and labour being fully utilised D Bottlenecks occurring in industries which are unable to meet demand

Answer 33

A All of the other options are features of a 'boom' phase.

Question 34

Changes in the supply of a product which arise due to reduced costs of its manufacture will be represented on the product's supply curve by: A a shift to the right in the supply curve B a shift to the left in the supply curve C movements along the supply curve D none of these

Answer 34

A If supply conditions (such as the cost of making a product) alter, a different supply curve is created. When there is a fall in costs, suppliers will be willing to increase supply for a given selling price and the supply curve will shift to the right.

Question 35

Pinewood Ltd produces two complementary products, the Buggle and the Chine. Which of the following describes the cross elasticity of demand between the two products? A Negative B Indeterminate C Zero D Positive

Answer 35

A If products are complements, a rise in the price of one will decrease demand for that good and therefore also for the complementary good. Therefore the cross elasticity of demand between them is negative.

Question 36

The government of Zeeland is concerned about demand pull inflation. Which of the following statements describes the impact and cause of demand pull inflation on Zeeland's economy? A Price rises because of persistent excess of supply over demand in the economy as a whole. B Price rises because of persistent excess of demand over supply in the economy as a whole. C Price falls because of persistent excess of supply over demand in the economy as a whole. D Price falls because of persistent excess of demand over supply in the economy as a whole

Answer 36

B Demand pull inflation causes price rises in the economy and is the result of persistent excess of demand over supply in the economy as a whole.