CFA Level I

Question #1 of 12 Question ID: 1210908

An analyst is evaluating the degree of competition in an industry and compiles the following information:

Few significant barriers to entry or exit exist.

Firms in the industry produce slightly differentiated products.
Each firm faces a demand curve that is largely unaffected by the actions of other individual firms in the industry.

The analyst should characterize the competitive structure of this industry as:

A) oligopoly.

B) monopoly.

C) monopolistic competition.

Explanation

Both oligopoly and monopolistic competition are consistent with firms that produce slightly differentiated products. However, with
few significant barriers to entry and little interdependence among competitors, the industry does not fit the definition of an
oligopoly and would be best characterized as monopolistic competition. (Study Session 4, Module 13.4, LOS 13.h)

Question #2 of 12 Question ID: 1210907

Which of the following statements about the behavior of firms in a perfectly competitive market is least accurate?

A) A firm experiencing economic losses in the short run will continue to operate if its
revenues are greater than its variable costs.

B) A firm that is producing less than the quantity for which marginal cost equals the
market price would lose money by increasing production.

C) If firms are earning economic profits in the short run, new firms will enter the market and
reduce economic profits to zero in the long run.

Explanation

A firm that is producing more than the quantity where its marginal revenue (the market price in perfect competition) is equal to its
marginal cost is losing money on sales of additional units. A firm producing where marginal cost is less than price is foregoing
additional profit by not increasing production. The other responses accurately describe characteristics of firms in perfectly
competitive markets. (Study Session 4, Module 13.1, LOS 13.e)
Question #3 of 12 Question ID: 1210914

Compared to a customs union or a common market, the primary advantage of an economic union is that:

A) its members adopt a common currency.

B) its members have a common economic policy.
C) it removes barriers to imports and exports among its members.

Explanation

The advantage of an economic union is that its members establish common economic policies and institutions. A common
currency is a characteristic of a monetary union. All regional trading agreements remove barriers to imports and exports among
their members. (Study Session 5, Module 17.2, LOS 17.f)

Question #4 of 12 Question ID: 1210915

A country's balance of payments accounts show the following:

A net inflow of capital transfers.

Greater sales than purchases of non-financial assets.
Greater foreign-owned assets in the country than government-owned assets abroad.

The country is most accurately described as having:

A) a capital account deficit.

B) a current account deficit.

C) a financial account deficit.

Explanation

The components listed indicate that the capital and financial accounts are in surplus. This indicates that the current account must
be in deficit. (Study Session 5, Module 17.2, LOS 17.h)

Question #5 of 12 Question ID: 1210906

Other things equal, an increase of 2.0% in the price of Product X results in a 1.4% increase in the quantity demanded of Product
Y and a 0.7% decrease in the quantity demanded of Product Z. Which statement about products X, Y and Z is least accurate?

A) Products X and Y are substitutes.

B) Products X and Z are complements.

C) Products Y and Z are complements.

Explanation

It does not necessarily follow from the information given in the question that products Y and Z are complements.
The increase in the price of Product X caused the quantity demanded of Product Y to increase (positive cross-price elasticity)
and caused the quantity demanded of Product Z to decrease (negative cross-price elasticity). This suggests that Product Y is a
substitute for Product X, and Product Z is a complement to Product X.

But this does not mean Product Y is a complement to Product Z. For example, gasoline is a complement to automobiles;
bicycles are a substitute for automobiles; but gasoline is not a complement to bicycles. (Study Session 4, Module 12.1, LOS
12.a)

Question #6 of 12 Question ID: 1210916

The EUR/USD spot exchange rate is 0.70145, and one-year interest rates are 3% in EUR and 2% in USD. The forward
USD/EUR exchange rate is closest to:

A) 1.1426.
B) 1.4118.

C) 1.4396.

Explanation

0.70145 × 1.03 / 1.02 = 0.7083; 1 / 0.7083 = 1.4118.

(Study Session 5, Module 18.2, LOS 18.h)

Question #7 of 12 Question ID: 1210917

Depreciation of a country's currency is most likely to narrow its trade deficit when:

A) its imports are greater in value than its exports.

B) price elasticity of import demand is greater than one.

C) investment increases relative to private and government savings.

Explanation

The elasticities approach to evaluating the effect of exchange rates on the trade balance suggests that the more elastic both
import demand and export demand are, the more likely currency depreciation is to narrow a trade deficit. A country with a trade
deficit imports more than it exports by definition. An increase in investment relative to savings would tend to increase the trade
deficit (net exports equal private and government savings minus investment). (Study Session 5, Module 18.3, LOS 18.j)

Question #8 of 12 Question ID: 1210911

According to real business cycle theory, business cycles result from:

A) rational responses to external shocks.

B) inappropriate changes in monetary policy.

C) increases and decreases in business confidence.

Explanation

Real business cycle theory holds that economic cycles are driven by utility-maximizing individuals and firms responding to
changes in real economic factors, such as changes in technology. Keynesian cycle theory attributes the business cycle to
changes in business confidence. Monetarist theory attributes the business cycle to inappropriate changes in the rate of money
supply growth. (Study Session 4, Module 15.1, LOS 15.c)

Question #9 of 12 Question ID: 1210913

A decrease in the target U.S. federal funds rate is least likely to result in:

A) a proportionate decrease in long-term interest rates.

B) an increase in consumer spending on durable goods.
C) depreciation of the U.S. dollar on the foreign exchange market.

Explanation

Changes in the U.S. federal funds rate and changes in long-term interest rates are unlikely to be proportionate. Long-term rates
are the sum of short-term rates and a premium for the expected rate of inflation. If a decrease (increase) in the target federal
funds rate by the Fed causes economic agents to increase (decrease) their inflation expectations, the change in long-term rates
will be less than the change in the federal funds rate. Increases in spending on consumer durables and a decrease in the foreign
exchange value of the U.S. dollar are among the expected results of a decrease in the target U.S. federal funds rate. (Study
Session 5, Module 16.2, LOS 16.k)

Question #10 of 12 Question ID: 1210910

For an economy that is initially at full-employment real GDP, an increase in aggregate demand will most likely have what effects
on the price level and real GDP in the short run?

A) Both will increase in the short run.

B) Neither will increase in the short run.
C) Only one will increase in the short run.

Explanation

An increase in aggregate demand will cause short-run equilibrium to move along the short-run aggregate supply curve. This will
tend to increase both real GDP and the price level in the short run. (Study Session 4, Module 14.3, LOS 14.l)

Question #11 of 12 Question ID: 1210909

Potential real GDP is least likely to increase as a result of:

A) an improvement in technology.
B) an increase in the money wage rate.
 C) an increase in the labor force participation ratio.

Explanation

An increase in the money wage rate would not increase long-run aggregate supply (potential real GDP), but instead would
decrease the short-run aggregate supply curve. An improvement in technology would tend to increase potential real GDP. An
increase in the participation ratio increases the full-employment quantity of labor supplied and potential real GDP. (Study Session
4, Module 14.2, LOS 14.h)

Question #12 of 12 Question ID: 1210912

When the economy is operating at the natural rate of unemployment, it is most likely that:

A) inflation is accelerating.
B) frictional unemployment is absent.

C) structural unemployment is present.

Explanation

Structural and frictional unemployment are always present. The natural rate of unemployment is the lowest rate consistent with
non-accelerating inflation. (Study Session 4, Module 15.2, LOS 15.d)