Understanding Economic Principles Flashcards

Which economic theory argues that markets naturally self-correct and government intervention in the economy is generally unnecessary?

Answer: Classical economics

Classical economics holds that flexible prices and wages allow markets to clear efficiently, making recessions self-correcting without government intervention.

An increase in Canada's money supply, all else equal, would most likely lead to:

Answer: Lower interest rates and potential inflationary pressure

Expanding the money supply typically lowers interest rates in the short run, stimulating borrowing and spending, but risks generating inflationary pressure over time.

In analyzing economic cycles, which asset class has historically acted as a leading indicator by typically declining before a recession begins?

Answer: Equities (common shares)

Equity markets are considered leading indicators because falling stock prices reflect investors' expectations of lower future corporate earnings ahead of an actual economic downturn.

The 'terms of trade' for a country refers to:

Answer: The ratio of export prices to import prices

A country's terms of trade measures how many imports it can acquire for a given quantity of exports; an improvement means exports buy more imports.

Which scenario demonstrates the 'paradox of thrift' identified by John Maynard Keynes?

Answer: When all households increase saving simultaneously, total income falls, reducing aggregate saving

The paradox of thrift holds that individually prudent saving, if adopted collectively, reduces total spending, lowering income and potentially leaving society no better off in aggregate.

How does a supply-side economic shock, such as a sudden large increase in oil prices, affect both inflation and output?

Answer: It raises inflation while reducing output, creating stagflationary conditions

A negative supply shock raises production costs across the economy, pushing prices up while simultaneously reducing output and employment.

In the context of investment analysis, why is understanding the economic cycle important for fund managers?

Answer: Different asset classes and sectors tend to outperform or underperform at different stages of the cycle

Cyclical analysis helps fund managers rotate into sectors or asset classes positioned to benefit from the current or anticipated stage of the economic cycle.