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ECONOMICS FIRST SEMESTER MODEL EXAM ACCURATE ANSWER WITH ITS
EXPLANATION
1. The marginal utility (MU) is best described as?
Answer: B The additional satisfaction from consuming one more unit of a good.
Explanation:
Marginal utility refers to the change in satisfaction or utility a consumer derives
from consuming an additional unit of a good or service. It is not about the total
satisfaction (which is "total utility") but the incremental benefit from the last unit
consumed.
For example, if eating one slice of pizza gives 10 units of satisfaction and eating a
second slice gives 8 additional units, the marginal utility of the second slice is 8.
2. According to the law of diminishing marginal utility, what happens as more of a
good is consumed?
Answer: C. Marginal utility decreases.
Explanation:
The law of diminishing marginal utility states that as a consumer consumes
more units of a particular good, the additional satisfaction (marginal utility)
derived from each subsequent unit decreases. This principle assumes that the
good is consumed continuously and in sufficient quantity.
For example, the first glass of water after a workout provides great satisfaction,
but the second or third glass provides progressively less satisfaction.
3. The term "preference" means in the context of consumer behavior?
Answer: A. The ability of a consumer to state or express choices among alternatives.
Explanation:
In economics, "preference" refers to a consumer's ability to rank different
bundles of goods or services based on their desirability. It does not directly
measure utility or satisfaction but rather reflects the consumer's subjective
choice when presented with alternatives. Preferences are the foundation of
demand theory and are used to explain choices under constraints.
4. Which of the following best describes the shape of a standard indifference curve?
Answer: A. Downward sloping and convex to the origin.
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Explanation:
A standard indifference curve represents combinations of two goods that provide
the same level of satisfaction to the consumer. It slopes downward because as
the quantity of one good decreases, the quantity of the other must increase to
maintain the same utility.
It is convex to the origin due to the principle of diminishing marginal rate of
substitution (MRS), meaning consumers are willing to give up fewer units of one
good to gain an additional unit of the other as they consume more of it.
5. What shape does an indifference curve take for perfect substitutes?
Answer: B. A straight line with a negative slope.
Explanation:
For perfect substitutes, goods can replace each other at a constant rate without
affecting overall utility. For instance, if a consumer considers one cup of tea
equivalent to one cup of coffee, the indifference curve will be a straight line with
a constant negative slope. This reflects that the consumer is equally satisfied
exchanging one good for the other in fixed proportions.
6. What does the budget line represent in consumer theory?
Answer: C. Combinations of two goods a consumer can buy given their income and
prices.
Explanation:
The budget line represents all the possible combinations of two goods that a
consumer can afford, given their income and the prices of the goods.
It reflects the trade-offs a consumer must make to maximize utility within their
budget constraints.
7. What happens to the budget line when a consumer's income increases, assuming
prices remain constant?
Answer: B. The budget line shifts outward.
Explanation:
When income increases while prices remain constant, the consumer can afford
more of both goods. This causes the budget line to shift outward in a parallel
manner, indicating increased purchasing power.
The slope remains unchanged because prices (and therefore the relative price
ratio) are constant.
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8. Which of the following is NOT an assumption when drawing the budget line?
Answer: C. The consumer's preferences are always increasing.
Explanation:
When drawing the budget line, the assumptions include: fixed prices, a fixed
income, and that the consumer spends their entire income on the goods.
However, consumer preferences, which relate to indifference curves, are
separate and not directly assumed in the construction of the budget line.
9. The area inside the budget line represents:
Answer: B. Combinations where total expenditure is less than total income.
Explanation:
The area inside the budget line includes all combinations of two goods that cost
less than the consumer's total income. It represents affordable but not fully
optimized consumption, as the consumer is not spending their entire income.
10. In the indifference curve analysis, what happens when a consumer moves along
the curve?
Answer: A. The consumer substitutes one good for another, but their total satisfaction
remains constant.
Explanation:
Moving along an indifference curve involves substituting one good for another
while maintaining the same level of total utility. This reflects the marginal rate of
substitution (MRS), which shows how much of one good the consumer is willing
to give up for an additional unit of another good without changing their
satisfaction level.
11. In which market structure do sellers face "no entry and exit barriers"?
Answer: B. Monopolistic Competition /&/ D. Perfect Competition
Explanation:
In a perfect competition and Monopolistic Competition market structure, there
are no barriers to entry or exit. Firms can freely enter the market if they see
profit opportunities and exit if they incur losses. This freedom ensures many
firms compete, leading to efficient market outcomes.
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12. What type of products are found in an oligopoly market structure?
Answer: B. Homogeneous or differentiated.
Explanation:
An oligopoly market can feature homogeneous products or differentiated
products. The key characteristic is that a small number of large firms dominate
the market, and their decisions significantly impact each other.
13. Which curve indicates the price at which a firm will shut down in the short run?
Answer: C. Average Variable Cost (AVC) curve.
Explanation:
A firm will shut down in the short run if the price falls below the minimum point
of the Average Variable Cost (AVC) curve because it can no longer cover its
variable costs. In such a scenario, continuing production would lead to greater
losses than shutting down, as fixed costs would still be incurred regardless of
production.
14. In the long run, a perfectly competitive firm achieves equilibrium when:
Answer: C. LMC = LAC = P = MC.
Explanation:
In the long run, a perfectly competitive firm operates at the minimum point of the
Long-run Average Cost (LAC) curve. At this point, the Long-run Marginal Cost
(LMC), price (P), and Marginal Cost (MC) are equal, ensuring both productive and
allocative efficiency. The firm earns zero economic profit in the long run.
15. What happens if a perfectly competitive firm produces at a quantity where price
equals average total cost?
Answer: C. The firm earns zero profits.
Explanation:
When price equals average total cost (ATC), the firm earns zero economic profit,
also known as normal profit.
This means the firm is covering all explicit and implicit costs, but there are no
extra profits above this level.
16. In the short-run equilibrium under monopoly, the profit-maximizing output is
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achieved when:
Answer: B. Marginal revenue equals marginal cost.
Explanation:
A monopolist maximizes profit by producing at the output level where Marginal
Revenue (MR) equals Marginal Cost (MC).
At this point, the difference between total revenue and total cost is maximized.
The price is then determined based on the demand curve.
17. Which of the following describes first-degree price discrimination?
Answer: C. Selling each unit of output at the maximum price the consumer is willing to
pay.
Explanation:
First-degree price discrimination occurs when a seller charges each consumer
the maximum price they are willing to pay for each unit of the good, capturing all
consumer surplus as producer surplus.
This type of discrimination is rare in practice due to the difficulty of determining
each consumer’s willingness to pay.
18. In monopolistic competition, the demand curve faced by a firm is:
Answer: B. Downward sloping, like a monopoly's.
Explanation:
In monopolistic competition, each firm faces a downward-sloping demand curve
because of product differentiation. Unlike perfect competition, where demand is
perfectly elastic, firms in monopolistic competition have some control over price
due to brand loyalty or perceived differences in their products.
19. In the short run, how does a monopolistically competitive firm determine its
equilibrium price and quantity?
Answer: C. By equating marginal revenue (MR) to marginal cost (MC).
Explanation:
In the short run, a monopolistically competitive firm maximizes profit or
minimizes losses by producing the quantity where Marginal Revenue (MR) equals
Marginal Cost (MC). The corresponding price is then determined based on the
demand curve.
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20. Which of the following is true about collusive oligopoly?
Answer: B. Firms collude to set prices and output to maximize joint profits.
Explanation:
In a collusive oligopoly, firms coordinate their pricing and output decisions to
behave like a monopoly, maximizing joint profits rather than competing against
each other. This can occur formally (e.g., a cartel) or informally. Collusion often
reduces competition and harms consumers by maintaining higher prices.
21. In a non-collusive oligopoly, firms:
Answer: B. Compete independently, with price inflexibility due to strategic
interdependence.
Explanation:
In a non-collusive oligopoly, firms act independently but are highly aware of their
competitors' actions due to strategic interdependence. Prices tend to be
inflexible because any price change by one firm could provoke reactions from
competitors, leading to a possible price war. This is often illustrated by the
kinked demand curve model.
22. Which of the following is NOT a benefit of national income accounting?
Answer: C. Provides a detailed record of individual income.
Explanation:
National income accounting is focused on aggregate economic indicators such as
GDP, GNP, and national income, rather than individual income records.
It provides insights into the overall economic performance, assists in policy
formulation, and enables cross-country comparisons, but it does not track
specific individual incomes.
23. How does national income accounting aid in policy formulation?
Answer: B. By providing evidence of the economy's performance and trends.
Explanation:
National income accounting helps policymakers by providing comprehensive
data on economic performance, such as growth rates, inflation, and
unemployment trends. This information is crucial for designing policies that
address economic issues and foster sustainable development.
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24. The main difference between Gross Domestic Product (GDP) and Gross National
Product (GNP) is:
Answer: C. GDP focuses on income earned within the country, while GNP considers the
nationality of the producer.
Explanation:
GDP measures the total value of goods and services produced within a country's
borders, regardless of the nationality of the producer. GNP, on the other hand,
includes the income earned by the country's nationals abroad and excludes
income earned by foreign nationals within the country.
25. One of the following approaches is used to measure national income by focusing on
adding the total value of goods and services provided at different stages of production:
Answer: B. The value-added approach.
Explanation:
The value-added approach calculates national income by summing the value
added at each stage of production across all industries.
This avoids double counting by focusing only on the additional value created at
each stage of production.
26. What does the expenditure approach of measuring GDP involve?
Answer: B. Summing up the market value of all final goods and services sold in the
economy.
Explanation:
The expenditure approach calculates GDP by adding up the total spending on
final goods and services in an economy. This includes consumption (C),
investment (I), government spending (G), and net exports (exports minus
imports). This approach focuses on final goods to avoid double counting
intermediate goods.
27. Which of the following is NOT included in the income approach to measuring GDP?
Answer: C. Net exports.
Explanation:
The income approach calculates GDP by summing all the incomes earned in the
production of goods and services. This includes employment compensation, rent
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payments, interest, and profits, along with adjustments for depreciation and
indirect taxes.
Net exports are part of the expenditure approach, not the income approach.
28. What is a major issue in measuring GDP in developing countries like Ethiopia?
Answer: C. The existence of a large informal sector.
Explanation:
Developing countries often have significant informal economies where
transactions are unrecorded. This creates challenges in accurately measuring
GDP, as much of the economic activity goes undocumented.
29. What does the GDP deflator measure?
Answer: A. The price of output (goods) relative to its price in the base year.
Explanation:
The GDP deflator reflects changes in the price level of all goods and services
included in GDP.
30. Which price index is used to measure the cost of a fixed basket of goods purchased
by a typical consumer?
Answer: B. Consumer Price Index (CPI).
Explanation:
The CPI tracks the price changes of a fixed basket of goods and services typically
purchased by households, serving as a measure of inflation experienced by
consumers.
31. How is net domestic product (NDP) calculated?
Answer: D. NDP = GDP - Capital consumption allowance.
Explanation:
Net Domestic Product (NDP) is GDP adjusted for depreciation, also called capital
consumption allowance.
It reflects the net value of goods and services produced after accounting for the
wear and tear on capital assets.
32. What is the key distinction between income earned and income received?
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Answer: B. Income earned is received by individuals directly, whereas income received
includes taxes, social security contributions, and undistributed profits.
Explanation:
Income earned refers to wages, salaries, and direct earnings, while income
received also includes indirect components like taxes and undistributed
corporate profits, which are part of the national income but not directly received
by individuals.
33. According to Keynes’s consumption function, what is the primary relationship
between consumption and disposable income?
Answer: C. Consumption increases as disposable income increases.
Explanation:
Keynes's consumption function suggests that consumption is positively related
to disposable income, though not in a one-to-one relationship.
As disposable income rises, consumption increases, but at a decreasing rate due
to the marginal propensity to consume (MPC).
34. What does the marginal propensity to consume (MPC) represent?
Answer: B. The rate of change in consumption for a unit change in disposable income.
Explanation:
The MPC measures the proportion of additional disposable income that a
consumer spends on goods and services.
35. If a consumer's income increases by 400 ETB and their consumption increases by
300 ETB, what is their marginal propensity to consume (MPC)?
Answer: A. 0.75
Explanation:
Using the formula:
MPC=Change in consumption /change in income
=300/400
= 0.75
36. Which of the following is NOT a determinant of saving?
Answer: D. Level of exports.
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Explanation:
Savings determinants include the rate of interest, future price expectations, and
income distribution.
Exports primarily affect a nation's trade balance and GDP, not household savings.
37. If a household saves 800 ETB out of a disposable income of 3200 ETB, what is its
Average Propensity to Save (APS)?
Answer: B. 0.25
Explanation:
Using the formula:
APS=Savings/Income
=800/3200
=0.25
38. If the Marginal Propensity to Save (MPS) is 0.6, what is the Marginal Propensity to
Consume (MPC)?
Answer: A. 0.4
Explanation:
The relationship between MPC and MPS is:
MPC+MPS=1 MPC + MPS = 1
If MPS=0.6 MPS = 0.6, then
MPC=1−0.6
=0.4
39. What does the 45° reference line in a savings and consumption graph represent?
Answer: D. Equality between income and expenditure.
Explanation:
The 45° line on a consumption-income graph shows where total income equals
total expenditure, with no savings or dissaving.
40. What is the difference between gross investment and net investment?
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Answer: A. Gross investment includes depreciation, while net investment excludes it.
Explanation:
Gross investment is the total investment, including replacement of depreciated
capital, while net investment subtracts depreciation:
Net Investment=Gross Investment−Depreciation
41. Which factor does NOT directly influence induced investment?
Answer: C. Government welfare policies.
Explanation:
Induced investment is influenced by income levels, profit expectations, and costs
(like wages and prices).
Welfare policies primarily affect consumption and government expenditure
rather than direct investment.
42. Which of the following best describes the focus of macroeconomics?
Answer: D. The performance and behavior of the overall economy.
Explanation:
Macroeconomics examines aggregate phenomena such as GDP, inflation,
unemployment, and overall economic growth, rather than focusing on individual
industries, businesses, or households.
43. What is a key determinant of economic growth in the long run?
Answer: B. Investment in capital goods and technology.
Explanation:
Sustained long-term economic growth depends on improvements in productivity,
which are driven by investments in capital, advancements in technology, and an
educated workforce.
44. What is the primary limitation of measuring economic growth using GDP in
developing countries?
Answer: C. Subsistence farming outputs are often underreported.
Explanation:
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In developing countries, GDP often underestimates economic activity because
informal and subsistence economies, such as small-scale farming, are not fully
captured in official statistics.
45. Which index is often used to measure development that incorporates factors like
education, health, and living standards?
Answer: C. Human Development Index (HDI).
Explanation:
The HDI is a composite index that assesses development by combining indicators
of health (life expectancy), education (mean and expected years of schooling),
and standard of living (GNI per capita).
46. When does a country experience a trade deficit?
Answer: B. When its imports exceed its exports.
Explanation:
A trade deficit occurs when the value of goods and services a country imports
exceeds the value of those it exports, leading to a negative trade balance.
47. What was the primary belief of classical economists regarding the economy's
ability to correct itself?
Answer: B. The economy will naturally return to full employment without government
intervention.
Explanation:
Classical economists believed in the self-correcting nature of markets through
price and wage flexibility, asserting that supply creates its own demand (Say's
Law) and government intervention is unnecessary.
48. One of the following is not true about the evolution and recent development of
Macroeconomics?
Answer: D. Monetarists argued that it is fiscal policy and not monetary policy that
addresses the macroeconomic problems.
Explanation:
Monetarists, led by Milton Friedman, emphasized the importance of monetary
policy over fiscal policy in addressing macroeconomic issues, arguing that
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managing the money supply is key to controlling inflation and stabilizing the
economy.
49. What is the central argument of monetarist economists like Milton Friedman?
Answer: C. Fiscal policy leads to crowding out of private investment.
Explanation:
Monetarists argue that fiscal policy is less effective due to the crowding out
effect, where increased government spending raises interest rates and reduces
private investment. They advocate for stable monetary policies instead.
50. What distinguishes new Keynesian economics from classical economic thought?
Answer: C. New Keynesians emphasize nominal rigidities and market imperfections.
Explanation:
New Keynesian economics builds on Keynesian ideas but incorporates nominal
rigidities (e.g., sticky prices and wages) and market imperfections to explain
short-run economic fluctuations and advocate for policy intervention.
51. The Aggregate Demand (AD) curve slopes downward because of which effect?
Answer: D. All the above.
Explanation:
The downward slope of the AD curve results from:
Real balance effect: Higher prices reduce purchasing power.
International trade effect: Higher domestic prices reduce exports and
increase imports.
Interest rate effect: Higher prices lead to higher interest rates, reducing
investment and consumption.
52. Which of the following will cause a rightward shift in the Aggregate Demand (AD)
curve?
Answer: A. A decrease in interest rates.
Explanation:
Lower interest rates reduce borrowing costs, encouraging consumption and
investment, which increases aggregate demand, causing a rightward shift in the
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AD curve.
53. A decrease in government purchases will cause what change in the Aggregate
Demand curve?
Answer: B. The curve shifts to the left.
Explanation:
A reduction in government purchases decreases overall demand in the economy,
leading to a leftward shift in the Aggregate Demand curve.
54. In the Classical model, which of the following is true regarding the long-run
Aggregate Supply curve?
Answer: C. It is vertical at the full employment level of output.
Explanation:
In the Classical model, the long-run Aggregate Supply (LRAS) curve is vertical
because output is determined by factors like technology and resource availability,
not by the price level. This represents the full employment level of output.
55. According to the Keynesian cross model, what happens when the economy is below
potential output?
Answer: D. The economy can increase output without raising the price level.
Explanation:
In the Keynesian framework, when the economy is below potential output, there
is slack (unemployed resources), allowing output to increase without inflationary
pressures.
56. What happens to the Short-Run Aggregate Supply (SRAS) curve when there is an
increase in wages?
Answer: C. The SRAS curve shifts to the left, indicating a decrease in output.
Explanation:
Higher wages increase production costs, reducing profitability for firms, which
leads to a leftward shift in the SRAS curve as output decreases.
57. If the price level rises and the nominal wage rate is sticky in the short run, what is
likely to happen?
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Answer: B. Firms will increase production because of lower real wages.
Explanation:
When wages are sticky, a rise in the price level reduces real wages, lowering
labor costs for firms. This encourages firms to increase production in the short
run.
58. At short-run equilibrium, where do the aggregate demand and short-run
aggregate supply curves intersect?
Answer: D. Where the quantity demanded of real GDP equals the quantity supplied of
real GDP.
Explanation:
Short-run equilibrium is the point where the Aggregate Demand (AD) and Short-
Run Aggregate Supply (SRAS) curves intersect, reflecting the balance between
real GDP demanded and supplied at a specific price level.
59. If there is an unexpected positive shock to aggregate demand, what is the effect on
the economy?
Answer: B. The aggregate demand curve shifts to the right, increasing both price level
and output.
Explanation:
A positive shock to aggregate demand (such as an increase in consumer spending
or government expenditure) causes the AD curve to shift rightward, leading to an
increase in both the price level and output in the short run.
60. Which of the following is a potential government response to address market
failure from externalities?
Answer: A. Providing subsidies for activities with positive externalities.
Explanation:
To correct for positive externalities (e.g., education, healthcare), the government
can provide subsidies to encourage more of these beneficial activities. This helps
to align private incentives with social benefits.
61. Which of the following is NOT a characteristic of public goods?
Answer: C. Consumed in private
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Explanation:
Public goods are typically non-rivalrous (one person’s use does not reduce
availability for others) and non-excludable (no one can be excluded from using
them). They are not consumed privately because they are available for public use
(e.g., clean air, national defense).
62. Which of the following is an example of a private provision of excludable public
goods?
Answer: D. Entrance fees for a national park.
Explanation:
A national park is a public good, but the government may charge an entrance fee
to make it excludable, limiting access only to those who pay. This is a private
provision of an excludable public good.
63. In the case of a positive externality, which of the following is true?
Answer: C. The social optimal output is higher than the private output.
Explanation:
In the presence of a positive externality (e.g., education), the social benefits (MSB)
exceed private benefits (MPB), leading to an underproduction of the good in the
market. The optimal output from a social perspective is higher than the private
market output.
64. What does asymmetric information refer to?
Answer: B. When one party has more information than the other party.
Explanation:
Asymmetric information occurs when one party in a transaction has more or
better information than the other, leading to market inefficiencies (e.g., in the
case of used car sales where the seller knows more about the car’s condition than
the buyer).
65. Which of the following is an example of a business malpractice that leads to
consumer exploitation?
Answer: C. Sale of sub-standard goods.
Explanation:
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The sale of sub-standard goods is a form of business malpractice where
consumers are sold products that are below expected quality, leading to
exploitation. This contrasts with ethical practices like providing accurate
information or offering warranties.
66. Which of the following is a consumer right under the Consumer Proclamation No.
813/2013 in Ethiopia?
Answer: B. Consumers should receive sufficient and accurate information about the
goods or services.
Explanation:
Under Consumer Proclamation No. 813/2013, consumers are entitled to clear and
truthful information about goods and services they purchase. This helps them
make informed decisions and protects them from exploitation.
67. What is the main purpose of macroeconomic policies?
Answer: B. To deal with fluctuations in economic activity and achieve desirable
economic outcomes.
Explanation:
Macroeconomic policies, including fiscal and monetary policies, aim to manage
overall economic performance. This involves stabilizing economic activity,
controlling inflation, reducing unemployment, and fostering economic growth.
68. Which of the following is an example of expansionary fiscal policy?
Answer: C. Increasing government spending on public works.
Explanation:
Expansionary fiscal policy aims to stimulate economic activity, and increasing
government spending on public works (such as infrastructure) is a key tool. It
boosts demand and can help reduce unemployment in a recession.
69. In a situation of excess demand, which fiscal policy instrument is used to control
inflation?
Answer: B. Increase taxes and reduce government spending.
Explanation:
In the case of excess demand, which can cause inflation, the government may use
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contractionary fiscal policy tools, such as increasing taxes and reducing
government spending, to reduce aggregate demand and control inflation.
70. When the central bank raises the reserve requirement, what is the likely outcome?
Answer: C. Reduced liquidity and credit expansion.
Explanation:
Raising the reserve requirement forces commercial banks to hold a larger portion
of their deposits as reserves, reducing their ability to lend out money. This
decreases liquidity in the banking system and limits credit expansion, helping to
control inflation.
71. In the case of a recession, how does expansionary monetary policy typically help?
Answer: C. By lowering interest rates to increase borrowing and spending.
Explanation:
In a recession, expansionary monetary policy aims to stimulate economic activity
by lowering interest rates. This encourages borrowing and spending by
businesses and consumers, helping to boost demand and economic growth.
72. In a perfectly competitive labor market, which of the following is true about the
supply curve for labor?
Answer: B. It slopes upward, showing that higher wages attract more workers.
Explanation:
In a perfectly competitive labor market, as wages increase, more individuals are
willing to supply their labor, resulting in an upward-sloping supply curve. Higher
wages act as an incentive for individuals to work more hours or join the labor
force.
73. What happens when a price floor is set above the equilibrium price?
Answer: A. It leads to an excess supply, or surplus, of goods or services.
Explanation:
A price floor set above the equilibrium price creates a situation where the price is
higher than what consumers are willing to pay and what producers are willing to
supply at equilibrium. This leads to a surplus, as the quantity supplied exceeds
the quantity demanded.
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74. What is the primary role of exchange rate policy?
Answer: B. To regulate foreign exchange transactions in the financial system.
Explanation:
Exchange rate policy primarily involves managing the value of a country’s
currency in the foreign exchange market. It aims to ensure stable currency values,
regulate the flow of capital, and support the balance of trade and foreign
investments.
75. What is the main cause of inflation after a devaluation of a currency?
Answer: C. The rise in the cost of imported goods.
Explanation:
When a currency is devalued, it becomes less valuable relative to other
currencies. This leads to higher costs for imported goods, as more of the local
currency is needed to purchase the same amount of foreign goods. This increase
in import prices often contributes to inflation.
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