Economics — CFA Level I practice questions

A natural monopoly is most accurately defined as a market structure in which:

1. The government has explicitly granted a single firm an exclusive statutory operating license
2. Long-run average cost falls over the relevant output range so that one firm minimizes total cost
3. Demand is highly elastic and thereby prevents new entrants from covering their fixed cost load
4. Variable costs dominate fixed costs and short-run marginal cost lies below the average cost line

Answer: B — Long-run average cost falls over the relevant output range so that one firm minimizes total cost

A) That describes a legal (statutory) monopoly. B) Correct — declining LRAC is the technical definition. C) Elastic demand is not what defines a natural monopoly. D) Natural monopolies feature large fixed costs, not dominant variable costs.

If CPI rises 4% while wages rise 2%, real wages have:

1. Increased by about 2% in purchasing-power terms
2. Fallen by exactly 6% given the combined shift shown
3. Remained constant since both series move together
4. Fallen by roughly 2% in purchasing-power terms

Answer: D — Fallen by roughly 2% in purchasing-power terms

A) The sign is reversed; workers actually lose purchasing power. B) Adding the two magnitudes has no basis in the identity. C) Constant real wages would require identical nominal growth and inflation. D) Correct — real wage growth ≈ nominal growth − inflation ≈ 2% − 4% = −2%.

An inflation-targeting central bank raises its policy rate. In a floating-rate open economy the currency will MOST likely:

1. Appreciate as capital inflows chase higher yields
2. Depreciate because exporters lose competitiveness
3. Remain unchanged since rates do not drive FX
4. Depreciate as importers pay less for foreign goods

Answer: A — Appreciate as capital inflows chase higher yields

A) Correct — interest-rate differentials attract carry-trade capital and appreciate the currency in the short run. B) Trade competitiveness affects the long-run current account, not the immediate FX response. C) Empirically, policy rates strongly influence exchange rates. D) Import demand does not directly drive currency appreciation or depreciation.

GDP measured by the expenditure approach equals:

1. C + I + G + (X − M) components summed
2. Wages + interest + rent + profits earned
3. Value added summed at each production stage
4. Total tax revenue less government transfers paid

Answer: A — C + I + G + (X − M) components summed

A) Correct — expenditure sums Consumption, Investment, Government, and Net Exports. B) Describes the income approach. C) Describes the production/value-added approach. D) Is not an accepted GDP measurement method.

Negative (exclusionary) screening in ESG investing refers to which of the following portfolio-construction practices?

1. Engaging with company management on ESG issues through proxy voting, letters, and constructive shareholder-level dialogue
2. Selecting only the top ESG performers within each sector for inclusion in the target portfolio being managed for a client
3. Excluding sectors, companies, or specific business practices from a portfolio based on explicitly defined screening criteria

Answer: C — Excluding sectors, companies, or specific business practices from a portfolio based on explicitly defined screening criteria

A) That describes stewardship. B) That describes best-in-class screening. C) Correct — exclusion of specific sectors or practices is the standard definition.

Demand-pull inflation MOST often results from:

1. Aggregate demand exceeding the productive capacity
2. A negative supply shock like oil price spikes
3. A sudden contraction in the aggregate money supply
4. A permanent rise in the labor productivity growth

Answer: A — Aggregate demand exceeding the productive capacity

A) Correct — AD above full-employment AS pulls prices upward. B) Describes cost-push, not demand-pull, inflation. C) Money contraction is disinflationary, not inflationary. D) Higher productivity typically eases price pressures.

Under a system of flexible exchange rates, a country with persistently higher inflation than its trading partners will MOST likely see its currency:

1. Appreciate steadily over the long run period
2. Remain stable as trade balances adjust flows
3. Fluctuate randomly around a fixed reference peg
4. Depreciate over time under relative PPP theory

Answer: D — Depreciate over time under relative PPP theory

A) Higher inflation erodes purchasing power, not enhances it. B) Trade balance adjustment operates through exchange-rate movement, not stability. C) Flexible regimes have no peg by definition. D) Correct — relative PPP predicts higher-inflation currencies depreciate proportionally.

Greenwashing is best defined as which of the following practices in the marketing of ESG-labeled products?

1. Conveying a false or misleading impression that products, activities, or investments are more environmentally sound than they really are
2. The operational practice of using recycled or reclaimed water within a manufacturing company's own production facilities
3. A regulatory disclosure regime that requires firms to publish detailed sustainability-related reports on standardized schedules

Answer: A — Conveying a false or misleading impression that products, activities, or investments are more environmentally sound than they really are

A) Correct — greenwashing is misleading environmental claims. B) That describes an operational sustainability practice, not greenwashing. C) That describes mandatory disclosure regimes.

A demand curve shifts rightward when:

1. The good's own price falls, moving quantity higher
2. An excise tax is imposed on producers of the good
3. Production technology improves and supply cost drops
4. Income rises for a normal good or complements cheapen

Answer: D — Income rises for a normal good or complements cheapen

A) An own-price change is a movement along, not a shift of, the demand curve. B) An excise tax shifts the supply curve upward, not demand. C) Better technology shifts supply, not demand. D) Correct — income (normal good), complement prices, tastes, and expectations shift demand.

Gross Domestic Product (GDP) is best described as a flow measure that captures the:

1. Total stock of accumulated national wealth held by residents of the country at a point in time
2. Aggregate personal income received by domestic households before taxes and transfer payments
3. Market value of all final goods and services produced inside a country during a defined period
4. Country's net international investment position measured at year-end current market prices data

Answer: C — Market value of all final goods and services produced inside a country during a defined period

A) National wealth is a stock, not a flow, and different from GDP. B) That describes personal income, a related but distinct concept. C) Correct — GDP measures the flow of final output over a period. D) That describes the NIIP, an external-balance stock measure.

What causes currency appreciation?

Higher interest rates (attract foreign capital), trade surpluses, strong growth, lower relative inflation, capital inflows.

What is GDP?

Gross Domestic Product — total market value of all final goods and services produced within a country in a specific period.

What is the Taylor Rule?

Target Rate = Neutral Rate + 0.5(GDP growth − Trend) + 0.5(Inflation − Target). Guides central bank rate-setting.

What are the factors of production?

Land, Labor, Capital, and Entrepreneurship — the four inputs used to produce goods and services.