Principles of Economics Exam Practice Tests
Course Introduction
Principles of Economics introduces the fundamental concepts and tools used in the study of how societies allocate scarce resources to satisfy unlimited wants. The course covers essential topics such as supply and demand, market equilibrium, consumer behavior, production costs, and the role of government in the economy. Students will explore both microeconomic principles, focusing on individual markets and decision-making by households and firms, and macroeconomic principles, addressing issues like inflation, unemployment, economic growth, and fiscal and monetary policy. Through real-world examples and critical analysis, the course aims to develop a foundational understanding of how economic forces shape everyday life and global events.
Recommended Textbook
The Economics of Money Banking and Financial Markets 5th Canadian Edition by
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Page 2
Frederic S. Mishkin
Chapter 1: Why Study Money, banking, and Financial Markets
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Sample Questions
Q1) The gross domestic product is the ________.
A) the value of all wealth in an economy
B) the value of all goods and services sold to other nations in a year
C) the market value of all final goods and services produced in an economy in a year
D) the market value of all intermediate goods and services produced in an economy in a year
Answer: C
Q2) During a recession,output declines resulting in ________.
A) lower unemployment in the economy
B) higher unemployment in the economy
C) no impact on the unemployment in the economy
D) higher wages for the workers
Answer: B
Q3) Bonds of different maturities ________.
A) show no common features
B) have interest rates that tend to move together
C) have interest rates that can differ substantially
D) Both B and C
Answer: D
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Chapter 2: An Overview of the Financial System
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Q1) A financial market in which previously issued securities can be resold is called a ________ market.
A) primary
B) secondary
C) tertiary
D) used securities
Answer: B
Q2) The liquidity of assets in contractual savings institutions ________.
A) is an important consideration
B) is not an important consideration
C) is restricted
D) is an undertaking
Answer: B
Q3) Which of the following are not contractual savings institutions?
A) Life insurance companies
B) Credit unions
C) Pension funds
D) Government retirement funds
Answer: B
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Chapter 3: What Is Money
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Q1) In the money index used by the Bank of Canada: M = X1+X2+ ...+Xn,the Xs are
A) the proportional weights for calculating M
B) the increasing weights in calculating M
C) the n monetary components of M
D) the decreasing weights in calculating M
Answer: C
Q2) If an individual moves money from a demand deposit account to a money market mutual fund,________.
A) M1+ decreases and M2 stays the same
B) M1+ stays the same and M2+ increases
C) M1+ stays the same and M2 stays the same
D) M1+ increases and M2 decreases
Answer: B
Q3) A person's house is part of her ________.
A) money
B) income
C) liabilities
D) wealth
Answer: D
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Chapter 4: Understanding Interest Rates
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Q1) Assuming the same coupon rate and maturity length,the difference between the yield on a Real Return Bond and the yield on a Canada bond provides insight into
A) the nominal interest rate
B) the real interest rate
C) the nominal exchange rate
D) the expected inflation rate
Q2) A $10,000 8 percent coupon bond that sells for $10,000 has a yield to maturity of ________.
A) 8 percent
B) 10 percent
C) 12 percent
D) 14 percent
Q3) If a security pays $55 in one year and $133 in three years,its present value is $150 if the interest rate is ________.
A) 5 percent
B) 10 percent
C) 12.5 percent
D) 15 percent
Q4) Explain why the current bond prices and interest rates are negatively related.
Page 6
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Chapter 5: The Behaviour of Interest Rates
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Q1) Of the four effects on interest rates from an increase in the money supply,the one that works in the opposite direction of the other three is the ________.
A) liquidity effect
B) income effect
C) price level effect
D) expected inflation effect
Q2) Pieces of property that serve as a store of value are called ________.
A) assets
B) units of account
C) liabilities
D) borrowings
Q3) A business cycle expansion increases income,causing money demand to ________ and interest rates to ________,everything else held constant.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
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Chapter 6: The Risk and Term Structure of Interest Rates
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Q1) Which of the following securities has the lowest interest rate?
A) Junk bonds
B) Canada bonds
C) Investment-grade bonds
D) Corporate Baa bonds
Q2) According to the segmented markets theory of the term structure ________.
A) bonds of one maturity are close substitutes for bonds of other maturities, therefore, interest rates on bonds of different maturities move together over time
B) the interest rate for each maturity bond is determined by supply and demand for that maturity bond
C) investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward
D) because of the positive term premium, the yield curve will not be observed to be downward-sloping
Q3) What is the shape of the yield curve when short-term rates are expected to rise sharply in the mid-term and moderately in the long-term?
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Chapter 8: An Economic Analysis of Financial Structure
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Q1) Equity contracts ________.
A) are claims to a share in the profits and assets of a business
B) have the advantage over debt contracts of a lower costly state verification
C) are used much more frequently to raise capital than are debt contracts
D) are not subject to the moral hazard problem
Q2) That most used cars are sold by intermediaries (i.e.,used car dealers)provides evidence that these intermediaries ________.
A) have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars
B) are able to prevent potential competitors from free-riding off the information that they provide
C) have failed to solve adverse selection problems in this market because "lemons" continue to be traded
D) have solved the moral hazard problem by providing valuable information to their customers
Q3) Explain how high net worth and collateral reduce the problem of moral hazard.
Q4) Explain the principal-agent problem as it pertains to equity contracts.
Q5) Why does the free-rider problem occur in the debt market?
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Chapter 9: Financial Crises
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Q1) A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession.This process is called ________.
A) debt deflation
B) moral hazard
C) insolvency
D) illiquidity
Q2) Factors that lead to worsening conditions in financial system include ________.
A) increases in net worth
B) unanticipated increases in the price level
C) unanticipated increases in the value of the domestic currency
D) unanticipated declines in the value of the domestic currency
Q3) The mismanagement of financial liberalization in emerging market countries can be understood as a severe ________.
A) principal/agent problem
B) asymmetric information problem
C) lemons problem
D) free-rider problem
Q4) Describe an asset-price bubble.
Q5) What triggered the 2007-2008 financial crises ?
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Chapter 10: Economic Analysis of Financial Regulation
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Q1) The CDIC does not insure term deposits with an initial maturity date of more than ________.
A) 5 years
B) 2 years
C) 1 year
D) 90 days
Q2) The 2011 premium rate (as a percentage of insured deposits)for member institutions in risk category 1 was ________.
A) 1/36 of 1 percent
B) 1/18 of 1 percent
C) 1/9 of 1 percent
D) 2/9 of 1 percent
Q3) The Japanese banking system went through a cycle of ________ in the 1990s similar to the one that occurred in the U.S.in the 1980s.
A) regulatory forbearance
B) policy antagonism
C) regulatory ignorance
D) policy renewal
Q4) What are the three pillars that Basel 2 is based on?
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Chapter 11: Banking Industry: Structure and Competition
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Q1) Holding companies are viable options for financial groups if the transition to a holding company would be ________ and exhibit ________.
A) tax-neutral; decreased costs
B) tax-neutral; economies of scope
C) tax-free; decreased costs
D) tax-free; fewer joint ventures
Q2) ATMs were developed because of breakthroughs in technology and as a ________.
A) means of avoiding restrictive branching regulations
B) means of avoiding paying interest to corporate customers
C) way of concealing transactions from the SEC
D) increasing the competition from foreign banks
Q3) The agreement to provide a standardized commodity to a buyer on a specific date at a specific future price is ________.
A) a put option
B) a call option
C) a futures contract
D) a mortgage-backed security
Q4) Explain why the profitability of traditional banking has declined and how banks have responded.
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Chapter 12: Nonbank Finance
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Q1) The three types of finance companies are ________.
A) sales, investment, and business
B) credit, consumer, and business
C) sales, consumer, and business
D) credit, consumer, and bank
Q2) Which of the following is true?
A) Insider information is public information.
B) Brokerage firms act as brokers, dealers, and investment bankers.
C) Dealers are pure intermediaries who act as agents.
D) Brokers make their living by selling securities at a higher price than what they paid for them.
Q3) To stimulate the export of Canadian goods and services,the government established ________.
A) Export Canada
B) Export Credit Canada
C) Export Development Canada
D) Canada Export Corporation
Q4) According to critics,how did the Fed's involvement in organizing the rescue of Long-Term Capital increase moral hazard?
Q5) What are three suggestions given for privatizing public pension plans?
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Chapter 13: Banking and the Management of Financial Institutions
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Q1) Because ________ are less liquid for the depositor than ________,they earn higher interest rates.
A) money market deposit accounts; time deposits
B) chequable deposits; savings account
C) savings account; chequable deposits
D) savings account; time deposits
Q2) Which of the following are not reported as assets on a bank's balance sheet?
A) Cash items in the process of collection
B) Loans
C) Securities
D) Demand deposits
Q3) Through correspondent banking,large banks provide services to small banks,including ________.
A) loan guarantees
B) foreign exchange transactions
C) issuing stock
D) debt reduction
Q4) How can specializing in lending help to reduce the adverse selection problem in lending?
Q5) What is a loan sale and how does it work?
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Chapter 14: Risk Management With Financial Derivatives
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Q1) An option that gives the owner the tight to sell a financial instrument at the exercise price within a specified period of time is a(n)________.
A) call option
B) put option
C) American option
D) European option
Q2) If a money manager believes stock prices will fall and knows that a block of funds will be received in the future,then he should ________.
A) sell stock index futures short
B) buy stock index futures long
C) stay out of the futures market
D) borrow and buy securities now
Q3) All other things held constant,premiums on put options will increase when the ________.
A) exercise price falls
B) volatility of the underlying asset falls
C) term to maturity increases
D) term to maturity decreases
Q4) What are the pros and cons of forward contracts?
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Chapter 15: Central Banks and the Bank of Canada
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Q1) The Bank of Canada has regional offices in which of the following cities?
A) Saskatoon
B) Edmonton
C) Montreal
D) Winnipeg
Q2) As the federal government's fiscal agent the Bank of Canada provides ________ management services for the federal government.
A) debt
B) cost
C) financial
D) economic
Q3) The benefit of the Ban k of Canada's role as the lender-of-last-resort include ________.
A) easing liquidity problems of any financial institution
B) deterring bank runs and panics
C) reducing the monetary base to increase liquidity
D) Both A and B
Q4) Describe the function and structure of the board of governors of the federal reserve system.
Q5) How do political cycles influence aggregate economic activity?
Page 17
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Chapter 16: The Money Supply Process
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Q1) If a bank has excess reserves of $7,000 and demand deposit liabilities of $100,000,and if the reserve requirement is 10 percent,then the bank has actual reserves of ________.
A) $14,000
B) $17,000
C) $22,000
D) $27,000
Q2) If a bank has excess reserves of $15,000 and demand deposit liabilities of $80,000,and if the reserve requirement is 20 percent,then the bank has total reserves of
A) $11,000
B) $21,000
C) $31,000
D) $41,000
Q3) The formula for the simple deposit multiplier can be expressed as ________.
A) \( \Delta \mathrm{R}=\frac{1}{\mathrm{r}} \times \Delta \mathrm{T} \)
B) \( \Delta \mathrm{D}=\frac{1}{\mathrm{r}} \times \Delta \mathrm{R} \)
C) \( \Delta \mathrm{r}=\frac{1}{\mathrm{R}} \times \Delta \mathrm{T} \)
D) \( \Delta \mathrm{R}=\frac{1}{\mathrm{r}} \times \Delta \mathrm{D} \)
Q4) How changes in the nonborrowed monetary base affect the money supply?
Page 18
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Chapter 17: Tools of Monetary Policy
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Q1) Changes to the operating band are announced by the Bank of Canada ________ times a year.
A) eight
B) six
C) four
D) two
Q2) The Bank of Canada neutralizes special PRA operations so as to ________.
A) not to leave the system in a surplus position at the end of the day
B) to leave the system in a surplus position at the end of the day
C) to leave the system changed at the end of the day
D) as to leave the system in a deficit position at the end of the day
Q3) To keep inflation from falling below the target range,the Bank of Canada ________.
A) decreases the target for the overnight rate which causes the dollar to go down
B) decreases the target for the overnight rate which causes the dollar to go up
C) increases the target for the overnight rate which causes the dollar to go down
D) increases the target for the overnight rate which causes the dollar to go up
Q4) What are the advantages and disadvantages of the Bank's lending policy?
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Chapter 18: The Conduct of Monetary Policy: Strategy and Tactics
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Q1) According to the Taylor Principle,when the inflation rate rises,the nominal interest rate should be ________ by ________ than the inflation rate increase.
A) increased; more
B) increased; less
C) decreased; more
D) decreased; less
Q2) Which of the following is the best description of the monetary policy strategy followed by the European Central Bank (ECB)?
A) The ECB follows monetary targeting.
B) The ECB follows inflation targeting.
C) The ECB has a hybrid strategy with elements of both monetary targeting and inflation targeting.
D) The ECB has a Fed-like "just do it" approach.
Q3) The rate of inflation increases when ________.
A) the unemployment rate equals the NAIRU
B) the unemployment rate exceeds the NAIRU
C) the unemployment rate is less than the NAIRU
D) the unemployment rate increases faster than the NAIRU increases
Q4) What criteria apply when choosing a policy instrument?
Page 20
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Chapter 19: The Foreign Exchange Market
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Q1) Suppose that the latest Consumer Price Index (CPI)release shows a higher inflation rate in the Canadian than was expected.Everything else held constant,the release of the CPI report would immediately cause the demand for Canadian assets to ________ and the Canadian dollar would ________.
A) increase; appreciate B) increase; depreciate
C) decrease; appreciate D) decrease; depreciate
Q2) ________ in the expected future domestic exchange rate causes the demand for domestic assets to shift to the left and the domestic currency to ________,everything else held constant.
A) An increase; appreciate
B) An increase; depreciate
C) A decrease; appreciate
D) A decrease; depreciate
Q3) If the dollar depreciates relative to the Swiss franc,________.
A) Swiss chocolate will become cheaper in Canada
B) American computers will become more expensive in Switzerland
C) Swiss chocolate will become more expensive in Canada
D) Swiss computers will become cheaper in Canada
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Chapter 20: The International Financial System
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Q1) Under a fixed exchange rate system,countries that ran large,persistent balance of payments surpluses would ________ international reserves,thereby pressuring them into ________ their exchange rate.
A) gain; devaluing
B) gain; revaluing C) lose; devaluing D) lose; revaluing
Q2) If a central bank does not want to allow the domestic currency to appreciate,it will ________ international reserves by selling its currency,thereby ________ the monetary base and increasing the risk of higher inflation.
A) lose; decreasing B) lose; increasing
C) acquire; decreasing D) acquire; increasing
Q3) Under the Bretton Woods system,the United States was designated as the
A) reserve-currency country
B) fixed-rate country
C) par-standard country
D) dollar-standard country
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Chapter 21: Quantity Theory, inflation, and the Demand for Money
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Q1) The classical economists believed that if the quantity of money doubled,________.
A) output would double
B) prices would fall
C) prices would double
D) prices would remain constant
Q2) Financial innovation will ________ and ________.
A) improve the liquidity of alternative assets; decrease the demand for money
B) improve the liquidity of alternative assets; increase the demand for money
C) reduce the relative liquidity of money; increase the demand for money
D) both A and C
Q3) The Keynesian demand for real balances can be expressed as ________.
A) Md = f(i,Y)
B) Md/P = f(i)
C) Md/P = f(Y)
D) Md/P = f(i,Y)
Q4) Explain how financing a persistent deficit by money creation will lead to a sustained inflation.
Q5) Describe what the liquidity trap is.Explain how it can be problematic for monetary policymakers.
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Chapter 22: The Is Curve
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Q1) Everything else held constant,if aggregate output is to the ________ of the IS curve,then there is an excess supply of goods which will cause aggregate output to
A) right; fall
B) right; rise
C) left; fall
D) left; rise
Q2) In the Keynesian framework,as long as output is below the equilibrium level,unplanned inventory investment will remain negative,firms will continue to ________ production,and output will continue to ________.
A) lower; fall
B) lower; rise
C) raise; fall
D) raise; rise
Q3) Equilibrium output is reduced by an increase in ________.
A) planned investment
B) taxes
C) government spending
D) net exports
Q4) Define the IS curve.
Page 24
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Chapter 23: The Monetary Policy and Aggregate Demand
Curves
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Q1) An increase in government purchases causes the IS curve to shift ________ and the aggregate demand curve to shift ________.
A) left; left
B) left; right
C) right; left
D) right; right
Q2) If the Bank of Canada conducts open market sales,the money supply ________,shifting the MP curve to the ________,everything else held constant.
A) decreases; right
B) decreases; left C) increases; right
D) increases; left
Q3) Describe how the Bank of Canada would apply the Taylor principle.
Q4) An autonomous rise in ________ shifts the MP curve to the ________,everything else held constant.
A) net exports; right
B) net exports; left
C) money demand; right
D) money demand; left
25
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Chapter 24: Aggregate Demand and Supply Analysis
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Q1) The aggregate demand curve is downward sloping because a decrease in the price level increases the ________ money supply which ________ interest rates and increases the equilibrium level of aggregate output,everything else held constant. A) real; lowers B) real; raises C) nominal; lowers D) nominal; raises
Q2) The increase in energy prices that occurred in 2007 - 2008 led to a ________ in the ________ aggregate supply curve.
A) fall; short run
B) fall; long run C) rise; short run
D) rise; long run
Q3) Explain through the component parts of aggregate demand why the aggregate demand curve slopes down with respect to the price level.Be sure to discuss two channels through which changes in prices affect demand.
Q4) What is the shape of the long-run aggregate supply curve? Why?
Q5) Explain how not following the Taylor principle leads to unstable inflation
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Chapter 25: Monetary Policy Theory
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Q1) Friedman and Schwartz found that the rate of money growth fell prior to business cycle downturns in ________.
A) about three out of every four instances
B) four out of every five instances
C) about two out of every three instances
D) every instance studied
Q2) If the particular channels through which changes in the money supply affect aggregate income are diverse and continually changing,the best evidence of monetary policy's effect is likely to come from ________.
A) reduced-form models
B) structural models
C) median-voter models
D) indirect models
Q3) In the new classical model in Figure 27-4,an anticipated increase in aggregate demand that is less than expected ________.
A) moves the economy from point 1 to point 2 to point 3
B) moves the economy from point 1 to point 5 to point 3
C) moves the economy from point 1 to point 4 to point 3
D) moves the economy from point 1 to point 3
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Chapter 26: The Role of Expectations in Monetary Policy
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Q1) Some economists contend that a policy of shifting the aggregate demand curve will be costly because it produces more volatility in both the price level and output.These economists likely are advocates of ________ policy.
A) supply-side
B) discretionary
C) demand-management
D) nondiscretionary
Q2) Suppose that there is a negative aggregate demand shock and the central bank commits to an inflation rate target.If the commitment is credible,then ________.
A) the public's expected inflation will remain unchanged
B) the short-run aggregate supply curve will rise
C) over time inflation will fall
D) all of the above
E) both A and C
Q3) The best way to keep inflation under control is to ________.
A) abandon discretionary policy
B) abandon expansionary policy
C) invoke activist solutions
D) both A and B
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Chapter 27: Transmission Mechanisms of Monetary Policy
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Q1) The monetarist position on the importance of monetary policy is probably best supported by ________ evidence.
A) timing
B) statistical
C) historical
D) structural
Q2) Reverse causation between money and aggregate output is likely to be a problem when a central bank targets ________.
A) a monetary aggregate
B) an interest rate
C) the exchange rate
D) the inflation rate
Q3) The monetarist statistical evidence examines the correlations between both ________ and ________ with ________.
A) money; aggregate spending; the unemployment rate
B) money; autonomous expenditures; the unemployment rate
C) money; consumption spending; aggregate spending
D) money; autonomous expenditures; aggregate spending
Q4) What are the advantages of reduced-form evidence?
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Chapter 28: The ISLM Model
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Q1) In the long-run ISLM model and with everything else held constant,an increase in the money supply leaves the level of output and interest rates unchanged,an outcome called ________.
A) interest rate overshooting
B) long-run money neutrality
C) long-run crowding out
D) the long-run Phillips curve
Q2) If the ________ curve is relatively more unstable than the ________ curve,a money supply target is preferred.
A) IS; IS
B) IS; LM
C) LM; IS
D) LM; LM
Q3) In the money market,a condition of excess supply of money can be eliminated by a ________ in aggregate output or a ________ in the interest rate,everything else held constant.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
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