CEA Economic Theory & Principles 5 — Questions and Answers
Question 1: The 'paradox of thrift' in Keynesian economics suggests that:
- Saving is always beneficial for economic growth
- An increase in individual saving can reduce aggregate demand and total savings economy-wide (Correct answer)
- Thrift leads to higher investment in the long run
- Government savings reduces private sector debt
Correct answer: An increase in individual saving can reduce aggregate demand and total savings economy-wide
When everyone saves more simultaneously, aggregate demand falls, reducing income and potentially total savings in the economy.
Question 2: Which theory argues that workers and firms form rational expectations about future inflation when negotiating wages, affecting the short-run Phillips Curve?
- Adaptive expectations theory
- Rational expectations theory (Correct answer)
- Permanent income hypothesis
- Keynesian wage rigidity model
Correct answer: Rational expectations theory
Rational expectations theory holds that economic agents use all available information efficiently, making systematic policy surprises impossible.
Question 3: A tariff imposed on imported goods primarily benefits:
- Domestic consumers of the good
- Foreign producers of the good
- Domestic producers of the good (Correct answer)
- Trading partners
Correct answer: Domestic producers of the good
Tariffs raise the price of imports, giving domestic producers a competitive advantage and allowing them to expand output and profits.
Question 4: The 'marginal propensity to consume' (MPC) is defined as:
- Total consumption divided by total income
- The change in consumption resulting from a one-unit change in income (Correct answer)
- The percentage of income saved after taxes
- The ratio of consumption to investment
Correct answer: The change in consumption resulting from a one-unit change in income
MPC measures how much of each additional dollar of income is spent on consumption rather than saved.
Question 5: Which of the following best describes a 'public good'?
- Any good sold by a government agency
- A good that is non-excludable and non-rivalrous in consumption (Correct answer)
- A good with high positive externalities
- A good provided free of charge to all citizens
Correct answer: A good that is non-excludable and non-rivalrous in consumption
Public goods are non-excludable (can't prevent use) and non-rivalrous (one person's use doesn't reduce availability to others).
Question 6: In supply and demand analysis, a binding price floor must be set:
- Below the equilibrium price
- At the equilibrium price
- Above the equilibrium price (Correct answer)
- At the marginal cost of production
Correct answer: Above the equilibrium price
A price floor only affects the market if set above equilibrium, creating a surplus by preventing prices from falling to clear the market.
Question 7: Which of the following best describes the concept of 'opportunity cost'?
- The explicit monetary cost of a decision
- The value of the next best alternative foregone when making a choice (Correct answer)
- The total cost of all alternatives considered
- The sunk cost already paid for a resource
Correct answer: The value of the next best alternative foregone when making a choice
Opportunity cost represents what is sacrificed — the value of the best alternative not chosen — rather than just money paid.
CEA Economic Theory & Principles 5
The 'paradox of thrift' in Keynesian economics suggests that: