BA1: Fundamentals of Business Economics

• Topic 01

  Macroeconomic and Institutional Context

  82 questions
• Topic 02

  Microeconomic and Organisational Context

  90 questions
• Topic 03

  Informational Context of Business

  72 questions
• Topic 04

  Financial Context of Business

  57 questions

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

1. A company is evaluating a capital investment project with an expected return of 6% per year. The nominal interest rate on borrowing is 7%, and inflation is currently 4%. How should the financial director analyze this investment decision using real interest rates?

   • A
     The real return of 6% exceeds the real cost of 3%, so the project should be accepted
   • B
     The real borrowing cost is 3% (7%-4%), while the real return is 2% (6%-4%), so the project should be rejected as it destroys real value
     Correct answer
   • C
     The project should proceed as the real interest rate is positive at 3%
   • D
     The project should proceed because the 6% return is close to the 7% borrowing cost
   Explanation

   The correct analysis evaluates the real interest rates for both sides to assess true economic value:

   Real cost of borrowing = 7% - 4% = 3% Real return on project = 6% - 4% = 2%

   Since the real return (2%) is less than the real cost of capital (3%), the project destroys value in real terms.

   (Note: While a financial director would also reject this project based on nominal rates alone (6% return vs. 7% cost), evaluating it in real terms emphasizes the true economic impact: the company would be borrowing at a real cost of 3% to fund a project returning only 2% in real terms, resulting in a net loss of purchasing power.)

2. When the Bank of England raises the Bank Rate from 4% to 5%, what is the most likely immediate effect on household savings behavior?

   • A
     Savings deposits increase as consumers substitute away from current consumption toward future consumption
     Correct answer
   • B
     Savings remain unchanged as consumers have fixed savings targets
   • C
     Savings decrease as consumers withdraw funds to invest in stocks
   • D
     Savings increase only if inflation also rises by the same amount
   Explanation

   An increase in the Bank Rate leads to higher interest rates on savings accounts, making saving more attractive. This creates a substitution effect where consumers choose to save more now (delayed consumption) to benefit from higher returns, rather than spending immediately (current consumption).

3. Which of the following would cause the demand curve for a product to shift to the right?

   • A
     An increase in production costs for the product
   • B
     A fall in wages in the industry
   • C
     An increase in consumer incomes for a normal good
     Correct answer
   • D
     A decrease in the price of the product itself
   Explanation

   An increase in consumer incomes causes higher demand for normal goods at every price level, shifting the entire demand curve to the right. Changes in the price of the product itself cause movement along the demand curve, not a shift. Production costs, technology, and wages affect the supply curve, not the demand curve.

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