Economics

• Topic 01

  Demand and Supply Analysis

  30 questions
• Topic 02

  Firm and Market Structures

  30 questions
• Topic 03

  Aggregate Output, Prices, and Economic Growth

  60 questions
• Topic 04

  Business Cycles and Economic Indicators

  30 questions
• Topic 05

  Monetary and Fiscal Policy

  66 questions
• Topic 06

  International Trade and Capital Flows

  66 questions
• Topic 07

  Currency Exchange Rates

  30 questions
• Topic 08

  Geopolitical Risk

  30 questions
• Topic 09

  Inflation, Deflation, and Asset Prices

  30 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. Which of the following best describes the difference between absolute advantage and comparative advantage?

   • A
     Absolute advantage determines trade patterns; comparative advantage determines which country is richer.
   • B
     Absolute advantage refers to producing more output with the same resources; comparative advantage refers to producing at a lower opportunity cost.
     Correct answer
   • C
     Absolute advantage applies only to goods; comparative advantage applies only to services.
   • D
     Absolute advantage refers to lower opportunity cost; comparative advantage refers to higher total output.
   Explanation

   Absolute advantage means a country can produce more of a good using the same inputs (higher productivity). Comparative advantage means a country can produce a good at a lower opportunity cost — giving up less of other goods. It is comparative advantage, not absolute advantage, that drives mutually beneficial trade.

2. What debt-to-GDP dynamics cause a government's debt ratio to rise even when the primary balance is zero?

   • A
     The debt ratio rises when the real interest rate (r) exceeds the real GDP growth rate (g): the government must borrow to pay interest on existing debt, raising the debt stock faster than GDP grows, even with no primary deficit.
     Correct answer
   • B
     The debt ratio rises when inflation exceeds the interest rate on existing debt, because real GDP falls relative to the nominal debt stock.
   • C
     The debt ratio rises only when nominal GDP is falling; when nominal GDP is positive, any primary balance can stabilise the debt ratio.
   • D
     The debt ratio rises when the central bank conducts QE, because QE increases the money supply and nominal GDP simultaneously.
   Explanation

   Debt dynamics: Δ(D/Y) ≈ (r − g) × (D/Y) − (primary surplus/Y), where r = real interest rate, g = real GDP growth, D = debt stock, Y = GDP. With a zero primary balance (primary surplus = 0): Δ(D/Y) ≈ (r − g) × (D/Y). If r > g: the debt ratio automatically rises even with zero deficit because interest compounds faster than GDP grows. The government must borrow to pay interest, adding to the debt stock faster than GDP expands. To stabilise the debt ratio when r > g, the government must run a primary surplus. This is the 'snowball effect.' Currently relevant as high-debt countries face rising real rates.

3. Monetary policy is best described as:

   • A
     The use of central bank instruments to influence money supply, interest rates, and credit conditions to achieve macroeconomic objectives.
     Correct answer
   • B
     The use of government spending and taxation to influence economic activity.
   • C
     The setting of exchange rates by the central bank to maintain competitiveness.
   • D
     The issuance of government bonds to fund public expenditure.
   Explanation

   Monetary policy refers specifically to the central bank's use of its instruments — policy rate, open market operations, reserve requirements, and forward guidance — to influence the cost and availability of credit and thereby achieve macroeconomic goals. Fiscal policy (government spending and taxation) is a separate policy lever controlled by the government rather than the central bank.