AA Economics Theories 4

Question 1

Which theory predicts that real exchange rates adjust to equalize the purchasing power of currencies across countries?

Accepted Answer

Purchasing power parity (PPP)

Answer

PPP holds that exchange rates should reflect relative price levels so that a basket of goods costs the same in different currencies.

Question 2

Behavioral economics challenges classical theory by arguing that human decision-making is often:

Accepted Answer

Subject to biases, heuristics, and bounded rationality

Answer

Kahneman and Tversky showed that cognitive biases cause systematic departures from the rational actor model.

Question 3

In the Solow growth model, the 'steady state' is reached when:

Accepted Answer

Investment exactly offsets depreciation and population growth

Answer

At steady state, new capital investment just replaces worn-out capital and equips new workers, so capital per worker stops changing.

Question 4

The theory of comparative advantage suggests that trade benefits all countries if each specializes in goods where it has:

Accepted Answer

Lowest opportunity cost relative to other goods

Answer

David Ricardo showed that specializing in goods with relatively lower opportunity costs allows all trading partners to consume more.

Question 5

Supply-side economics, popularized in the 1980s, primarily advocates for:

Accepted Answer

Tax cuts and deregulation to stimulate production

Answer

Supply-siders argue that lower taxes and reduced regulation improve incentives to work, invest, and produce, shifting aggregate supply outward.

AA - Associate of Arts Practice Test