Chartered Financial Analyst · Level I
CFA L1 Economics: practice questions with answers
6 free exam-style questions on Economics for CFA L1 Level I. Try each one, then open the answer to read the explanation. Fincora has 52 original questions on this syllabus area.
Question 1
A firm in a perfectly competitive market produces 10,000 units per month at a market price of USD 18 per unit. At this output, total variable cost is USD 150,000 and total fixed cost is USD 60,000 per month. The firm should most likely:
- A shut down immediately because it is making an economic loss.
- B continue operating in both the short run and the long run because price exceeds average variable cost.
- C continue operating in the short run but exit the market in the long run if the price does not rise.
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Answer: C. AVC = 150,000 / 10,000 = USD 15; ATC = (150,000 + 60,000) / 10,000 = USD 21. Because AVC < P < ATC: operating gives a loss of 180,000 - 210,000 = -USD 30,000, smaller than the USD 60,000 loss from shutting down, so the firm operates in the short run. In the long run it must cover ATC; if price stays below USD 21, it should exit.
Question 2
For an economy, private saving is 18% of GDP, private investment is 22% of GDP and the government runs a budget deficit equal to 3% of GDP. Based on the macroeconomic identity linking saving, investment and the external balance, the current account balance as a percentage of GDP is closest to:
- A -7%
- B -1%
- C -4%
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Answer: A. From the national income identity, X - M = (S - I) + (T - G). The private sector saves 4% of GDP less than it invests (18% - 22% = -4%), and the government dissaves 3% of GDP (T - G = -3%). The current account is therefore -4% - 3% = -7% of GDP, which must be financed by a capital (financial) account surplus, that is, net borrowing from abroad.
Question 3
In Calvoria, average hourly wages rose by 5.2% over the past year, while output per hour worked (labor productivity) rose by 1.8%. Over the year, Calvoria's unit labor cost increased by approximately:
- A 5.2%
- B 3.3%
- C 7.0%
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Answer: B. Unit labor cost (ULC) is the average labor cost of producing one unit of output:
ULC = total labor compensation per hour / output per hour
Growth in ULC = (1 + wage growth) / (1 + productivity growth) - 1 = 1.052 / 1.018 - 1 = 3.34%, or approximately 5.2% - 1.8% = 3.4%.
A sustained rise in unit labor cost is a common signal of cost-push inflation: when wages grow faster than productivity, firms' costs per unit rise and they tend to pass at least part of the increase on in higher prices. Analysts therefore watch ULC alongside wage growth when judging inflation pressure late in a business cycle.
Question 4
Following a diplomatic dispute, the government of Castavia bars investors based in Merovia from buying stakes in Castavian companies and limits Merovian entities' access to Castavia's domestic currency market. In the classification of the tools of geopolitics, these measures are best described as:
- A national security tools.
- B financial tools.
- C economic tools.
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Answer: B. Countries use three broad groups of tools to pursue geopolitical goals:
| Tool | Cooperative use | Non-cooperative use |
|---|---|---|
| National security | Military alliances | Armed conflict, espionage |
| Economic | Multilateral trade agreements, harmonized tariff rules | Nationalization, trade barriers |
| Financial | Free currency exchange, allowing foreign investment | Limiting access to local currency markets, restricting foreign investment |
Castavia's ban on Merovian investment in its companies and its limits on access to the domestic currency market are non-cooperative financial tools.
Question 5
The spot SEK/EUR exchange rate (SEK per EUR) is 11.2000 and the one-year forward rate is 11.0300. The one-year EUR interest rate is 3.00%. Assuming that covered interest rate parity holds, the one-year SEK interest rate and the forward premium or discount of the SEK relative to the EUR are best described as:
- A 1.44%; the SEK trades at a forward premium.
- B 1.44%; the SEK trades at a forward discount.
- C 4.59%; the SEK trades at a forward discount.
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Answer: A. Covered interest rate parity, with the exchange rate quoted as price currency (SEK) per base currency (EUR):
F / S = (1 + i_SEK) / (1 + i_EUR)
Solving for the SEK rate:
1 + i_SEK = (F / S) x (1 + i_EUR) = (11.0300 / 11.2000) x 1.03 = 0.984821 x 1.03 = 1.014366
i_SEK = 1.44%
The forward rate (11.0300) is below spot (11.2000), so the base currency (EUR) trades at a forward discount and, equivalently, the SEK trades at a forward premium. This is consistent with parity: the currency with the higher interest rate (EUR, 3.00%) trades at a forward discount, offsetting its interest rate advantage, and the lower-yielding currency (SEK, 1.44%) trades at a forward premium.
Question 6
Lismore has a floating exchange rate and no restrictions on capital flows. Its central bank unexpectedly raises its policy rate by 100 basis points. Through the exchange rate channel of the monetary transmission mechanism, the most likely effect is that Lismore's currency:
- A depreciates, increasing Lismore's net exports.
- B appreciates, reducing Lismore's net exports.
- C appreciates, increasing Lismore's net exports.
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Answer: B. A higher policy rate raises the return on domestic interest-bearing assets relative to foreign ones. With free capital mobility, inflows of foreign capital increase demand for the domestic currency, which appreciates.
An appreciation makes exports more expensive abroad and imports cheaper at home, so net exports fall. Together with the effects of higher rates on borrowing, asset prices and expectations, this reduces aggregate demand and inflation pressure, as intended by a contractionary policy.
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