MCQ Questions and Answers:

1. Question: Which policy is most likely to help to correct an adverse balance on the current account of the balance of payments?

A) Abolishing tariffs
B) Devaluing the currency
C) Reducing direct taxes
D) Reducing indirect taxes

Answer: B

Explanation: Devaluation of currency is expected to increase exports and decrease imports, hence improving the current account of the balance of payments. Other options are likely to have an adverse effect on the current account.

2. Question: What could explain why the terms of trade of most developing economies tend to worsen over time?

A) Their currencies are over-valued in foreign exchange markets.
B) They impose lower barriers on imports than developed economies.
C) They produce a narrower range of goods than developed economies.
D) They produce goods with a low income elasticity of demand.

Answer: D

Explanation: Goods with a low income elasticity of demand are considered essential and have stable demand with minimum variation in prices. Over-valued currency would improve the terms of trade, hence option A is incorrect.

3. Question: Which policy is most likely to reduce a balance of payments deficit without causing inflation?

A) A devaluation of the exchange rate
B) An increase in import tariffs
C) An increase in indirect taxes
D) An increase in direct taxes

Answer: D

Explanation: An increase in direct taxes would reduce disposable income and imports, helping to reduce the balance of payments deficit without causing inflation. Devaluation of the exchange rate, import tariffs, and indirect taxes all can reduce the deficit, but at the expense of inflation.

4. Question: An economy has underemployed resources. Which method of financing an increase in government expenditure is likely to have the greatest expansionary effect?

A) Borrowing from the central bank
B) Borrowing from the non-bank private sector
C) Increased direct taxation
D) Increased indirect taxation

Answer: A

Explanation: Borrowing from the central bank will increase the money supply in the economy and is likely to have the greatest expansionary effect. Borrowing from the private sector and increased taxation would have less expansionary effects as they do not increase the money supply.

5. Question: Why might a reduction in domestic interest rates have an adverse effect on a country’s balance of payment on the current account?

A) It will cause a rise in the exchange rate.
B) It will make the country’s industry less competitive.
C) The resulting higher level of economic activity is likely to increase imports.
D) There will be an outflow of capital from the country.

Answer: C

Explanation: Lower interest rates encourage consumer spending, leading to a rise in spending on imports and worsening the current account balance.

6. Question: What would be classified as a supply-side policy measure?

A) Additional legislation to restrict the power of trade unions
B) A reduction in the government’s fiscal deficit
C) An open market sale of securities
D) The imposition of a tariff on imported goods

Answer: A

Explanation: Supply-side policies are aimed at increasing productivity and efficiency in the economy. Additional legislation to restrict the power of trade unions would increase supply, making it a supply-side measure. Option B relates to fiscal policy, option C refers to monetary policy, and option D relates to trade policy.

7. Question: What would be an economic benefit to a major economy of imposing a tariff on imported goods?

A) It would increase labor productivity.
B) It would increase pressure on foreign suppliers to reduce their prices.
C) It would make the country’s exports more competitive.
D) It would reduce the prices paid by consumers for imported goods.

Answer: B

Explanation: Imposing a tariff on imported goods increases their prices, putting pressure on foreign suppliers to reduce prices to retain market share. Option B is the economic benefit of imposing a tariff.

8. Question: An economist wishes to judge whether an economy’s budget deficit is excessive. What would be the most appropriate way to measure the budget deficit when making this judgment?

A) As a percentage of foreign currency reserves
B) As a percentage of GDP
C) In inflation-adjusted terms
D) In purchasing power parity terms

Answer: B

Explanation: To judge whether an economy's budget deficit is excessive, measuring the deficit as a percentage of GDP is considered appropriate. It helps assess the size of the deficit relative to the overall economic output of the country.

9. Question: In 2009 the US central bank, the Federal Reserve, increased the money supply. Which policy measure taken by the Federal Reserve would have achieved this outcome?

A) A purchase of government securities in the open market
B) A reduction in the issue of short-term government debt
C) A requirement for commercial banks to increase their liquidity ratios
D) An increase in the bank rate

Answer: A

Explanation: By buying government securities in the open market, the Federal Reserve increases the money supply, which was the outcome in 2009.

10. Question: Why is it more effective to increase regressive taxes rather than progressive taxes when pursuing a deflationary fiscal policy?

A) Changes in VAT have minimal effect on consumers’ spending.
B) It is much more unfair to increase progressive taxes.
C) Many workers reduce the hours they work when income taxes are raised.
D) Low-income households spend a larger proportion of their incomes.

Answer: D

Explanation: Regressive taxes impact low-income households more, causing them to reduce their spending, which aligns with a deflationary fiscal policy. Progressive taxes would have less impact on reducing spending as they affect high-income individuals more.

11. Question: What is the main objective of supply-side policies?

A) To bring a country’s potential output up to the level of its actual output
B) To ensure a budget surplus
C) To ensure that the composition of output matches the pattern of demand
D) To increase potential output by increasing efficiency

Answer: D

Explanation: The main objective of supply-side policies is to increase potential output by improving efficiency and productivity in the economy.

12. Question: What is most likely to result from a devaluation of the £ sterling?

A) An increase in foreign direct investment in the UK by global manufacturing firms
B) An increase in the number of UK residents taking holidays abroad
C) An increase in the number of UK students applying for places in North American universities
D) An increase in the supply of foreign workers seeking temporary employment over the summer in the UK

Answer: A

Explanation: A devaluation of the £ sterling will make the UK more attractive for foreign direct investment, as it becomes cheaper for global manufacturing firms to invest in the UK.

13. Question: A government’s budget is balanced at a time when the economy is fully employed, but an aggregate demand shock causes a decline in national income. What will be the result if the government keeps its tax rates and level of spending unchanged?

A) A cyclical budget deficit
B) A cyclical budget surplus
C) A structural budget deficit
D) A structural budget surplus

Answer: A

Explanation: A decline in

national income due to an aggregate demand shock will lead to decreased tax revenue. If the government keeps its tax rates and spending unchanged, it will result in a cyclical budget deficit.

14. Question: In the absence of offsetting changes, what will result in an increase in a government’s fiscal deficit?

A) A decrease in household saving
B) A decrease in interest rates on government bonds
C) A decrease in private sector investment
D) A decrease in the country’s trade deficit

Answer: C

Explanation: A decrease in private sector investment will reduce tax revenue, leading to an increase in the government's fiscal deficit if there are no offsetting changes.

15. Question: When would an economic recession result in an increase in a government’s budget deficit?

A) The government increases tariffs on imports with inelastic demand and keeps the total amount it spends on unemployment benefit unchanged.
B) The government keeps the unemployment benefit rate and direct and indirect tax rates unchanged.
C) The government reduces foreign aid and widens the tax base.
D) The government reduces the unemployment benefit rate and decreases the tax-free allowance on income tax.

Answer: B

Explanation: In an economic recession, tax revenue may decrease due to reduced economic activity and increased unemployment. If the government keeps the unemployment benefit rate and tax rates unchanged, the budget deficit may increase.

16. Question: What will be most likely to rise if unemployment is increasing in an economy?

A) The human capital of unemployed workers
B) The living standards of all workers
C) The nominal money wage rate of employed workers
D) The tax burden on employed workers

Answer: D

Explanation: If unemployment is increasing, the government may need to increase taxes on employed workers to fund unemployment benefits for those who are unemployed, leading to a higher tax burden on employed workers.