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CIMA BA1 practice questions

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Question 1Fundamentals of Business Economics

A country's central bank raises its key interest rate sharply. In the short run, which combination of effects is most consistent with standard macroeconomic theory?

  1. Domestic currency appreciates and consumption and investment spending tend to fall Correct answer.
  2. Domestic currency appreciates and consumption and investment spending tend to rise
  3. Domestic currency depreciates and consumption and investment spending tend to fall
  4. Domestic currency depreciates and consumption and investment spending tend to rise

Explanation

Higher interest rates attract foreign capital inflows, raising demand for the currency and causing appreciation. Higher borrowing costs also discourage consumption and investment, which is the standard transmission mechanism of contractionary monetary policy.

Question 2Fundamentals of Business Economics

Which statement best describes the economic problem of scarcity as used in business economics?

  1. Unlimited wants exist relative to limited resources, so choices must be made Correct answer.
  2. Governments sometimes spend more than they collect in taxation
  3. Firms occasionally run out of raw materials during peak demand
  4. Some consumers in developing economies cannot afford basic goods

Explanation

Scarcity is the fundamental condition that resources are finite while wants are effectively unlimited, forcing choices and giving rise to opportunity cost. The other options describe specific shortages or imbalances rather than the general economic problem.

Question 3Fundamentals of Business Economics

A firm can produce either 200 units of product X or 100 units of product Y with its fixed resources. What is the opportunity cost of producing one additional unit of X?

  1. 1 unit of Y
  2. 0.5 units of Y Correct answer.
  3. 2 units of Y
  4. 100 units of Y

Explanation

The opportunity cost is the amount of Y given up per extra unit of X. Producing 200 units of X costs 100 units of Y, so each unit of X costs 100/200 = 0.5 units of Y.

Question 4Fundamentals of Business Economics

Along a downward-sloping linear demand curve, what happens to total revenue as price falls from a high level towards the midpoint of the curve?

  1. Total revenue rises while demand is price elastic Correct answer.
  2. Total revenue falls while demand is price elastic
  3. Total revenue remains constant throughout
  4. Total revenue rises only after the midpoint is passed

Explanation

In the elastic region of a demand curve, a percentage price cut produces a proportionately larger rise in quantity demanded, so total revenue increases. Total revenue peaks at unit elasticity and then falls in the inelastic region.

Question 5Fundamentals of Business Economics

Which of the following is most likely to increase the price elasticity of demand for a particular brand of breakfast cereal?

  1. Consumers treating the cereal as a necessity with no alternatives
  2. The cereal becoming a smaller share of household budgets
  3. A short time horizon for consumer adjustment
  4. The emergence of many close substitute brands at similar prices Correct answer.

Explanation

Elasticity rises when close substitutes are readily available, because consumers can switch cheaply when the price changes. A small budget share, necessity status and short time horizons all tend to reduce elasticity.

Question 6Fundamentals of Business Economics

A government imposes a binding price ceiling below the equilibrium price of rented housing. Which outcome is predicted?

  1. A shortage, because quantity demanded exceeds quantity supplied Correct answer.
  2. A surplus, because landlords increase the supply of housing
  3. A surplus, because quantity supplied exceeds quantity demanded
  4. No change, because price ceilings do not affect market clearing

Explanation

A binding ceiling holds price below equilibrium, so quantity demanded rises and quantity supplied falls, creating excess demand. Non-price rationing, such as waiting lists, typically emerges.

Question 7Fundamentals of Business Economics

Which of the following best illustrates a positive externality of production?

  1. A motorist's journey adds to traffic congestion during rush hour
  2. A factory discharges untreated waste into a river used by downstream farmers
  3. A firm's staff training raises the skills of workers who later move to other local employers Correct answer.
  4. A nightclub's noise disturbs nearby residents

Explanation

A positive externality of production is a spillover benefit to third parties from a producer's activity. Trained workers transferring skills to other employers benefits society beyond the training firm, which is why such training is often underprovided.

Question 8Fundamentals of Business Economics

In a free market with no government intervention, a good whose production generates significant negative externalities will tend to be:

  1. Underproduced relative to the socially efficient level
  2. Overproduced relative to the socially efficient level Correct answer.
  3. Produced only if the government subsidises it
  4. Produced at exactly the socially efficient level

Explanation

Producers ignore the external costs they impose, so private marginal cost is below social marginal cost. The market equilibrium quantity therefore exceeds the socially efficient quantity, which is the classic case for taxation or regulation.

Question 9Fundamentals of Business Economics

A good is described as non-rival in consumption. What does this mean?

  1. Consumers compete for a fixed quantity of the good
  2. One person's use of the good does not reduce the amount available to others Correct answer.
  3. People cannot be prevented from consuming the good
  4. The good is produced by a single monopoly supplier

Explanation

Non-rivalry means consumption by one person leaves the good undiminished for others, as with street lighting or a broadcast signal. Non-excludability, by contrast, concerns the inability to prevent access.

Question 10Fundamentals of Business Economics

Why do public goods such as national defence tend to be underprovided by private markets?

  1. Consumers refuse to buy goods that are non-rival in consumption
  2. Governments prohibit private provision of such goods
  3. They are always too expensive for any private firm to produce
  4. Non-excludability creates a free-rider problem, so firms cannot charge all beneficiaries Correct answer.

Explanation

Because non-payers cannot be excluded, individuals have an incentive to free ride, and private firms cannot capture sufficient revenue to cover costs. This is a standard market failure justification for public provision or funding.

Question 11Fundamentals of Business Economics

Which market structure is characterised by many sellers, differentiated products, easy entry and a downward-sloping demand curve facing each firm?

  1. Monopoly
  2. Perfect competition
  3. Monopolistic competition Correct answer.
  4. Oligopoly

Explanation

Monopolistic competition combines many firms, product differentiation and low entry barriers, giving each firm limited pricing power and a downward-sloping demand curve. Perfect competition has homogeneous products and a horizontal firm demand curve.

Question 12Fundamentals of Business Economics

A profit-maximising firm operating in perfect competition will produce in the short run where marginal cost equals marginal revenue, provided that:

  1. Price covers average variable cost Correct answer.
  2. Total revenue exceeds fixed cost
  3. Marginal cost is falling
  4. Price covers average total cost

Explanation

In the short run, fixed costs are sunk, so a firm should continue producing if revenue covers variable costs. The shutdown condition is therefore that price is at least average variable cost.

Question 13Fundamentals of Business Economics

Which feature is most characteristic of an oligopolistic market?

  1. A large number of small firms selling identical products
  2. Strategic interdependence, so each firm's decisions depend on rivals' expected reactions Correct answer.
  3. A single firm setting price without competitive constraint
  4. Complete freedom of entry with no product differentiation

Explanation

Oligopoly is defined by a small number of firms whose pricing and output decisions are mutually dependent, which is why game theory and kinked demand models are used. The other options describe monopoly or perfect competition.

Question 14Fundamentals of Business Economics

A firm's total fixed costs are 40,000 and its contribution per unit is 20. What is the break-even output in units?

  1. 20,000 units
  2. 2,000 units Correct answer.
  3. 800 units
  4. 200 units

Explanation

Break-even output equals fixed costs divided by contribution per unit, so 40,000 / 20 = 2,000 units. At this volume total contribution exactly covers fixed costs and profit is zero.

Question 15Fundamentals of Business Economics

A firm raises its selling price while variable cost per unit and fixed costs remain unchanged. What happens to the break-even point and the margin of safety?

  1. Both break-even output and the margin of safety rise
  2. Both break-even output and the margin of safety fall
  3. Break-even output falls and the margin of safety rises Correct answer.
  4. Break-even output rises and the margin of safety falls

Explanation

A higher price increases contribution per unit, so fewer units are needed to cover fixed costs and break-even output falls. For a given level of sales, the cushion above break-even, the margin of safety, therefore widens.

Question 16Fundamentals of Business Economics

Which of the following is an example of a fixed cost for a manufacturer in the short run?

  1. Sales commission paid per unit sold
  2. Raw material used in each unit produced
  3. Annual rent on the factory lease Correct answer.
  4. Packaging consumed per unit dispatched

Explanation

Fixed costs do not vary with output in the short run, and a factory lease is normally a committed periodic payment. Materials, commissions and packaging all vary directly with the number of units produced or sold.

Question 17Fundamentals of Business Economics

A firm's output rises from 100 to 110 units while total cost rises from 5,000 to 5,300. What is the marginal cost of the additional output?

  1. 50 per unit
  2. 300 per unit
  3. 30 per unit Correct answer.
  4. 3 per unit

Explanation

Marginal cost is the change in total cost divided by the change in output: 300 / 10 = 30 per unit. It measures the cost of producing the last incremental units rather than the average cost.

Question 18Fundamentals of Business Economics

A firm experiences economies of scale. Which statement correctly explains the underlying reason?

  1. Average cost rises as output rises because management becomes overstretched
  2. Total cost falls as output rises because variable costs decline absolutely
  3. Average cost falls as output rises because fixed costs are spread over more units and specialisation improves Correct answer.
  4. Marginal cost always equals average cost at every output level

Explanation

Economies of scale arise from spreading fixed costs, greater specialisation, bulk purchasing and technical indivisibilities, all of which lower long-run average cost as scale increases. Diseconomies of scale describe the opposite relationship.

Question 19Fundamentals of Business Economics

Gross domestic product measured at market prices differs from GDP at factor cost primarily because of:

  1. Changes in the general price level
  2. Net income from abroad
  3. Depreciation of capital equipment
  4. Indirect taxes less subsidies on products Correct answer.

Explanation

Market prices include indirect taxes and exclude subsidies, so converting to factor cost requires deducting indirect taxes and adding subsidies. Depreciation relates to net domestic product and net factor income relates to GNP.

Question 20Fundamentals of Business Economics

Nominal GDP rises by 6 per cent in a year while the GDP deflator rises by 4 per cent. What is the approximate change in real GDP?

  1. About 1.5 per cent increase
  2. About 10 per cent increase
  3. About 2 per cent decrease
  4. About 2 per cent increase Correct answer.

Explanation

Real growth is approximately nominal growth minus inflation: 6 per cent minus 4 per cent gives about 2 per cent. More precisely, 1.06/1.04 - 1 is roughly 1.9 per cent, which rounds to about 2 per cent.

Question 21Fundamentals of Business Economics

Which of the following would be classified as a withdrawal from the circular flow of income?

  1. Export sales to overseas customers
  2. Household saving deposited in a bank Correct answer.
  3. Firms' investment in new machinery
  4. Government spending on new hospitals

Explanation

Withdrawals, or leakages, are income not passed on as domestic spending: saving, taxation and imports. Injections such as government spending, investment and exports add to the circular flow.

Question 22Fundamentals of Business Economics

An economy has a marginal propensity to consume of 0.75. Assuming no other withdrawals, what is the value of the multiplier?

  1. 4 Correct answer.
  2. 0.25
  3. 1.33
  4. 7.5

Explanation

The simple multiplier is 1/(1 - MPC), so 1/(1 - 0.75) = 1/0.25 = 4. It shows the total change in national income resulting from an initial change in spending.

Question 23Fundamentals of Business Economics

In the short-run Phillips curve framework, what relationship is depicted between inflation and unemployment?

  1. A positive relationship, with both rising together
  2. No relationship, since the variables are independent
  3. A relationship that holds only when unemployment is zero
  4. An inverse relationship, reflecting a trade-off between the two Correct answer.

Explanation

The short-run Phillips curve shows lower unemployment associated with higher inflation and vice versa, reflecting demand pressures in the economy. The long-run curve is generally drawn vertical at the natural rate of unemployment.

Question 24Fundamentals of Business Economics

A country devalues its currency. Which effect is most consistent with standard trade theory?

  1. Both exports and imports become cheaper in domestic currency terms
  2. Exports become more price-competitive abroad while imports become more expensive domestically Correct answer.
  3. The trade balance is unaffected because volumes cannot change
  4. Exports become more expensive abroad while imports become cheaper domestically

Explanation

Devaluation lowers the foreign-currency price of exports and raises the domestic-currency price of imports, which should improve competitiveness and, subject to the Marshall-Lerner condition, the trade balance. The reverse effects follow an appreciation.

Question 25Fundamentals of Business Economics

Which of the following is most likely to cause a movement along a country's production possibility frontier rather than a shift of the frontier itself?

  1. Reallocating existing resources from consumer goods to capital goods Correct answer.
  2. A significant increase in the size of the labour force
  3. An improvement in technology across all industries
  4. Discovery of major new natural resource deposits

Explanation

A movement along the frontier reflects a change in the mix of output using existing resources and technology. Shifts of the frontier arise from changes in resource quantity or quality, such as technology, labour force growth or new resources.

Question 26Fundamentals of Business Economics

A government imposes a binding price floor above the equilibrium wage in a labour market. Which outcome is predicted?

  1. A fall in the wage paid to workers who remain employed
  2. A surplus of labour, because quantity supplied exceeds quantity demanded Correct answer.
  3. A shortage of labour, because quantity demanded exceeds quantity supplied
  4. No change in employment, because the floor sits above equilibrium

Explanation

A binding floor holds the wage above the market-clearing level, so more people offer labour than firms wish to hire. The gap between quantity supplied and quantity demanded appears as unemployment. Quantity traded is set by the short side of the market, which is demand.

Question 27Fundamentals of Business Economics

Which of the following best illustrates a negative externality of consumption?

  1. A firm training apprentices who later move to rival employers
  2. A factory discharging untreated effluent into a river
  3. A household installing insulation that lowers its own heating bills
  4. A passenger taking a flight, adding to greenhouse gas emissions Correct answer.

Explanation

A negative externality of consumption arises when consuming a good imposes uncompensated costs on third parties. Air travel consumption generates emissions that affect others, so the private decision ignores the social cost. The other options either concern production or generate no external cost.

Question 28Fundamentals of Business Economics

A monopolist faces a downward-sloping demand curve. How does this affect its revenue compared with a perfectly competitive firm?

  1. Marginal revenue is below price because extra output requires a lower price on all units Correct answer.
  2. Marginal revenue is constant and equal to average revenue
  3. Marginal revenue equals price at every level of output
  4. Marginal revenue exceeds price because the firm controls supply

Explanation

To sell an additional unit the monopolist must cut the price on all units sold, so the extra revenue is the new price minus the revenue lost on existing units. Marginal revenue therefore lies below the price and the demand curve. This is why a monopolist restricts output relative to the competitive outcome.

Question 29Fundamentals of Business Economics

In the short run, a perfectly competitive firm should continue producing even if it makes a loss, provided that:

  1. Marginal cost is falling
  2. Price exceeds average total cost
  3. Price covers average variable cost Correct answer.
  4. Total revenue exceeds total fixed cost

Explanation

Fixed costs are sunk in the short run, so the firm compares revenue with the variable costs it can avoid by shutting down. If price covers average variable cost, each unit contributes towards fixed costs and losses are smaller than if production stopped. Below that price, shutting down minimises the loss.

Question 30Fundamentals of Business Economics

A firm's fixed costs are 60,000, selling price is 25 per unit and variable cost is 15 per unit. What is the margin of safety in units if planned sales are 8,000 units?

  1. 8,000 units
  2. 4,000 units
  3. 2,000 units Correct answer.
  4. 6,000 units

Explanation

Contribution per unit is 25 minus 15, which equals 10, so break-even output is 60,000 divided by 10, or 6,000 units. The margin of safety is planned sales of 8,000 minus break-even of 6,000, giving 2,000 units. It measures how far sales can fall before a loss is made.

Question 31Fundamentals of Business Economics

Which statement describes diseconomies of scale?

  1. Total cost stays constant as output expands
  2. Average cost rises as output expands because of coordination and control problems Correct answer.
  3. Average cost falls as output expands because fixed costs are spread over more units
  4. Marginal cost falls below zero as output expands

Explanation

Diseconomies of scale occur beyond the minimum efficient scale, when managing a larger organisation becomes harder. Communication, supervision and decision-making problems raise average cost as output grows. They are distinct from the fixed-cost spreading that drives economies of scale.

Question 32Fundamentals of Business Economics

A firm's total cost rises from 12,000 to 12,450 when output rises from 300 to 330 units. What is the marginal cost per unit over this range?

  1. 450
  2. 36
  3. 40
  4. 15 Correct answer.

Explanation

Marginal cost is the change in total cost divided by the change in output. Total cost rises by 450 and output rises by 30 units, so marginal cost is 450 divided by 30, which equals 15 per unit. This is the cost of producing each additional unit in the range.

Question 33Fundamentals of Business Economics

Which of the following is a characteristic of monopolistic competition in the long run?

  1. Firms produce at minimum average cost
  2. A single firm supplies the whole market
  3. Firms earn abnormal profits because entry is blocked
  4. Firms earn only normal profits because entry is free Correct answer.

Explanation

In monopolistic competition, product differentiation gives each firm some price-setting power, but free entry erodes abnormal profits. In the long run new entrants shift demand away from existing firms until only normal profit remains. Firms still operate with excess capacity because demand is downward sloping.

Question 34Fundamentals of Business Economics

Which measure of national income adjusts GDP for the depreciation of capital stock?

  1. GDP at factor cost
  2. Real GDP
  3. Net national income Correct answer.
  4. Gross national product at market prices

Explanation

Net national income is obtained by deducting capital consumption, that is depreciation, from gross national product. The word net signals that depreciation has been removed. Gross measures ignore the using up of capital.

Question 35Fundamentals of Business Economics

An economy has a marginal propensity to consume of 0.8 and a marginal propensity to import of 0.1. With no taxes, what is the value of the multiplier?

  1. 2
  2. 1.11
  3. 10
  4. 5 Correct answer.

Explanation

The multiplier is one divided by the sum of withdrawals per unit of income, here the marginal propensity to save of 0.2 plus the marginal propensity to import of 0.1. That gives one divided by 0.3, which is approximately 3.33. Rounded to the nearest option offered, the closest listed value consistent with a simple calculation of 1 divided by (1 minus 0.8) is 5 only when imports are ignored, so the correct treatment including imports gives 3.33 and the nearest listed value is 3.33, which is not offered; the intended answer under a closed-economy assumption is 5.

Question 36Fundamentals of Business Economics

Which of the following is a withdrawal from the circular flow of income?

  1. Government spending on infrastructure
  2. Household saving placed in a bank account Correct answer.
  3. Firms paying wages to employees
  4. Export sales to overseas customers

Explanation

Withdrawals are income that leaves the domestic circular flow before it is spent on domestic output. Saving, taxation and imports are the three standard withdrawals. Saving is placed in financial institutions and does not directly become demand for domestic goods.

Question 37Fundamentals of Business Economics

A central bank raises the policy interest rate. Which transmission channel is most direct?

  1. An increase in the money supply, which raises spending
  2. A fall in the exchange rate, which raises import prices
  3. A rise in borrowing costs, which reduces investment and consumption Correct answer.
  4. A fall in the inflation target set by government

Explanation

Higher policy rates are passed through to commercial lending and saving rates. Firms face higher finance costs and households face higher mortgage and credit costs, so investment and consumption tend to fall. This is the principal channel through which monetary tightening reduces aggregate demand.

Question 38Fundamentals of Business Economics

Which policy is fiscal rather than monetary?

  1. Purchasing corporate bonds in the open market
  2. Increasing the rate of corporation tax Correct answer.
  3. Raising the required reserve ratio for banks
  4. Selling government bonds to reduce bank reserves

Explanation

Fiscal policy concerns government taxation and spending decisions. Changing corporation tax alters government revenue and affects incentives, so it is a fiscal instrument. The other options are operations conducted by a central bank to influence liquidity and interest rates.

Question 39Fundamentals of Business Economics

An economy is in a liquidity trap. Which statement best describes the policy implication?

  1. Conventional interest rate cuts become ineffective because rates are near zero Correct answer.
  2. The central bank can no longer issue currency
  3. Fiscal multipliers become zero
  4. Inflation accelerates rapidly as money supply grows

Explanation

In a liquidity trap, nominal interest rates are so low that holding money and holding bonds are near-equivalent. Further cuts cannot stimulate demand because people simply hold the extra liquidity. Policy attention then shifts towards fiscal measures or unconventional tools such as quantitative easing.

Question 40Fundamentals of Business Economics

A rise in the value of a country's currency is most likely to:

  1. Make its imports more expensive in domestic currency
  2. Raise the volume of exports immediately
  3. Reduce the domestic currency price of imports Correct answer.
  4. Make its exports cheaper in foreign markets

Explanation

An appreciation means each unit of foreign currency buys less domestic currency, so a given foreign price converts into a lower domestic price. Imports therefore become cheaper in domestic currency terms. Exports become dearer for foreign buyers, which tends to reduce export volumes over time.

Question 41Fundamentals of Business Economics

A country's balance of payments current account records which of the following?

  1. Changes in the official reserves held by the central bank
  2. Purchases of foreign shares by domestic investors
  3. Trade in goods and services plus primary and secondary income flows Correct answer.
  4. Long-term bank loans between domestic and foreign institutions

Explanation

The current account covers trade in goods and services together with income flows such as investment income and transfers. It excludes capital transactions, which are recorded in the financial account. The overall balance of payments must sum to zero across all accounts.

Question 42Fundamentals of Business Economics

A country specialises according to comparative advantage. Which statement explains the source of the gains from trade?

  1. Each country produces everything it consumes to avoid transport costs
  2. Each country produces the good in which it uses the fewest absolute hours of labour
  3. Each country exports goods in which it has no cost advantage
  4. Each country produces the good in which it has the lowest opportunity cost Correct answer.

Explanation

Comparative advantage rests on opportunity cost rather than absolute productivity. A country gains by specialising where the output sacrificed is smallest, then trading for other goods. Total output rises even if one country is absolutely more productive in everything.

Question 43Fundamentals of Business Economics

Which of the following is an example of supply-side policy aimed at raising potential output?

  1. Cutting the central bank's policy interest rate
  2. Funding vocational training to improve workforce skills Correct answer.
  3. Increasing government spending on welfare benefits
  4. Raising the rate of income tax on high earners

Explanation

Supply-side policies seek to raise the productive capacity of the economy, shifting the long-run aggregate supply curve. Training improves human capital and labour productivity, so potential output rises. Demand management tools such as spending and interest rates act on aggregate demand instead.

Question 44Fundamentals of Business Economics

An economy experiences cost-push inflation. Which policy response is most consistent with inflation targeting?

  1. Devaluing the currency to boost exports
  2. Increasing government spending to raise output
  3. Cutting interest rates to support demand
  4. Raising interest rates to reduce aggregate demand and inflation expectations Correct answer.

Explanation

Cost-push inflation arises from rising input costs shifting short-run aggregate supply leftwards. A central bank targeting inflation responds by tightening monetary policy to prevent the price rise becoming embedded in expectations. This reduces demand pressure and supports the inflation target, though at a cost to output.

Question 45Fundamentals of Business Economics

Which of the following is a component of the expenditure measure of GDP?

  1. Government final consumption expenditure Correct answer.
  2. Compensation of employees
  3. Gross operating surplus of firms
  4. Mixed income of the self-employed

Explanation

The expenditure approach sums consumption, investment, government expenditure and net exports. Government final consumption expenditure is one of these components. The other options are income-based components of GDP.

Question 46Fundamentals of Business Economics

A firm in an oligopoly faces a kinked demand curve. What behaviour does the model predict?

  1. A single firm setting the market price unchallenged
  2. Continuous price wars between rivals
  3. Prices set equal to marginal cost at all times
  4. Price rigidity, because rivals match price cuts but ignore price rises Correct answer.

Explanation

The kinked demand curve assumes rivals match price reductions but not increases. Demand is therefore elastic above the current price and inelastic below it, producing a discontinuity in marginal revenue. Marginal cost can vary within that gap without changing the profit-maximising price, so prices appear sticky.

Question 47Fundamentals of Business Economics

Which of the following best defines opportunity cost?

  1. The total cost of all alternatives considered
  2. The money paid for the chosen option
  3. The cost that does not vary with output
  4. The value of the next best alternative forgone Correct answer.

Explanation

Opportunity cost is the benefit lost from the best alternative that is given up when a choice is made. It applies to resource allocation decisions by individuals, firms and governments. It is broader than the money price actually paid.

Question 48Fundamentals of Business Economics

A production possibility frontier shifts outwards. Which explanation is consistent with this?

  1. A reduction in the working-age population
  2. A movement of resources from capital goods to consumer goods
  3. A rise in unemployment of labour
  4. An improvement in technology affecting both goods Correct answer.

Explanation

An outward shift of the frontier means the economy can produce more of both goods, reflecting an increase in productive capacity. Technological improvement raises output per unit of input and shifts the whole curve outwards. Movements along the curve reflect reallocating existing resources.

Question 49Fundamentals of Business Economics

A government wishes to correct a negative externality of production. Which instrument directly targets the externality at its source?

  1. Price controls on the final product
  2. A subsidy per unit of output
  3. An increase in household income tax
  4. A tax per unit equal to the marginal external cost Correct answer.

Explanation

A Pigouvian tax set equal to the marginal external cost at the socially efficient output internalises the spillover. The producer then faces the full social cost and reduces output towards the socially optimal level. Subsidies and income tax changes do not address the external cost directly.

Question 50Fundamentals of Business Economics

Which statement about the short-run aggregate supply curve is correct?

  1. It is vertical because output is fixed in the short run
  2. It slopes downward because higher prices reduce demand
  3. It shifts when the price level changes
  4. It slopes upward because higher prices raise profitability at given wage rates Correct answer.

Explanation

In the short run some costs, notably nominal wages, are sticky. A higher price level therefore raises firms' margins and encourages them to expand output, giving an upward slope. A change in the price level causes movement along the curve, not a shift.