FSOT Economic Principles 5 — Questions and Answers
Question 1: The term 'liquidity trap' describes a situation in which:
- Banks refuse to lend due to excessive regulation
- Monetary policy becomes ineffective because interest rates near zero cannot be lowered further (Correct answer)
- Consumers hoard cash instead of depositing it in banks
- The central bank runs out of foreign currency reserves
Correct answer: Monetary policy becomes ineffective because interest rates near zero cannot be lowered further
A liquidity trap occurs when interest rates are so low that monetary easing has no additional stimulative effect on the economy.
Question 2: Comparative advantage suggests that countries should specialize in producing goods where they have:
- The lowest absolute cost of production
- The most advanced technology
- The lowest opportunity cost relative to trading partners (Correct answer)
- The largest labor force
Correct answer: The lowest opportunity cost relative to trading partners
Comparative advantage is determined by opportunity cost; countries gain from specializing where their relative sacrifice of other goods is smallest.
Question 3: Which indicator is most commonly used to measure inflation in the United States?
- GDP deflator
- Producer Price Index (PPI)
- Consumer Price Index (CPI) (Correct answer)
- Industrial Production Index
Correct answer: Consumer Price Index (CPI)
The CPI measures the average change in prices paid by urban consumers for a basket of goods and services and is the most widely cited inflation measure.
Question 4: A monopsony is a market in which there is:
- A single seller with complete market control
- A single buyer with market power over sellers (Correct answer)
- Two dominant firms splitting the market
- Many buyers but only a few sellers
Correct answer: A single buyer with market power over sellers
A monopsony is characterized by a single buyer who can influence the price it pays, often seen in labor markets with dominant employers.
Question 5: In economic terms, a 'price floor' set above the equilibrium price will result in:
- A shortage of the good
- A surplus of the good (Correct answer)
- No change in market quantity
- Lower prices for consumers
Correct answer: A surplus of the good
A price floor above equilibrium keeps prices artificially high, causing quantity supplied to exceed quantity demanded, creating a surplus.
Question 6: Which of the following best describes 'structural unemployment'?
- Unemployment caused by a temporary economic downturn
- Workers between jobs who are actively seeking new positions
- Joblessness resulting from a mismatch between worker skills and job requirements (Correct answer)
- Seasonal fluctuations in labor demand
Correct answer: Joblessness resulting from a mismatch between worker skills and job requirements
Structural unemployment arises when the skills workers possess do not match the requirements of available jobs, often due to technological change or industry shifts.
Question 7: The J-curve effect in international economics describes how:
- Trade deficits initially worsen before improving after a currency depreciation (Correct answer)
- GDP growth follows a J-shaped path during recovery from recession
- Export volumes rise immediately after tariff reductions
- Interest rates fall then rise after central bank intervention
Correct answer: Trade deficits initially worsen before improving after a currency depreciation
After a currency depreciates, the trade balance often worsens initially (due to existing contracts) before improving as export volumes rise — tracing a J-shape.
FSOT Economic Principles 5
The term 'liquidity trap' describes a situation in which: