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Free CFA-Level-I Exam Braindumps (page: 362)

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"Decision makers systematically err in their forecasts of economic variables." This is implied by which of the following:

  1. Rational Expectations hypothesis.
  2. Adaptive Expectations hypothesis.
  3. Random Expectations hypothesis.
  4. Constant Expectations hypothesis.

Answer(s): B

Explanation:

According to the Adaptive Expectations hypothesis, people consider the recent past as the best predictor of the immediate future. Hence, when an economic variable is increasing, they will consistently tend to under-estimate the future value of that variable and vice versa. Thus, they systematically err in their decision-making, without learning from past mistakes.



Within the simple Keynesian model, when an economy operates below its long-run, full employment output constraint, an increase in aggregate demand will lead to an

  1. increase in unemployment.
  2. increase in prices.
  3. increase in interest rates and money income, but employment and real income will remain constant.
  4. increase in employment, output and real income.

Answer(s): D

Explanation:

Since according to the Keynesian model aggregate demand determines the level of output in the economy, an increase in the demand will cause output to increase. Since output is equivalent to income, real income also increases. The increase in output stimulates increases in labor demand and thus unemployment declines.
Increases in aggregate demand below the full employment capacity of the economy has no effect on prices.



An economic researcher publishes evidence that the consensus inflation estimation for the following year has no correlation with the actual inflation level the year before. The estimation error is often very large, but does not display a pattern. Which of the following theories would this evidence support?

  1. rational ignorance
  2. mean reversion
  3. heteroskedasticity
  4. monetarist theory
  5. rational expectations hypothesis
  6. adaptive expectations hypothesis

Answer(s): E

Explanation:

Under the rational expectations hypothesis, individuals will form inflation expectations based on all relevant information available. Therefore a comparison of expected and realized inflation would show a random estimation error and no correlation with past estimates. The adaptive expectations hypothesis suggests that individuals will base their views of the future on their recent experience.
Under this theory, estimations would show a pattern in the error. Expected inflation would tend to be too high following a period of high inflation, and then too low follow a period of limited inflation.



During an economic boom, the AD-AS model indicates that

  1. both the real interest rate and real wage rates will decline.
  2. real interest rate will decline and real wage rates will rise.
  3. real interest rate will rise and real wage rates will decline.
  4. both the real interest rate and real wage rates will increase.
  5. real wage rates will remain constant while the real interest rate will rise.

Answer(s): D

Explanation:

High demand for resources (like labor) during an economic boom will increase the price of labor (the real wage rate). Similarly high demand for loanable funds during a boom will cause the real interest rate to rise.






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