Foreign Service Officer Test (FSOT) Economics Syllabus

What is the tragedy of the commons?

The overuse and depletion of a shared, non-excludable but rival resource (a common-pool resource) because individuals acting in self-interest ignore the cost to the group.

What is asymmetric information, with an example?

When one party in a transaction has more information than the other. Examples: adverse selection (hidden information before a deal, e.g., used-car 'lemons') and moral hazard (hidden action after a deal, e.g., riskier behavior once insured).

What is consumer surplus?

The difference between what consumers are willing to pay and what they actually pay; graphically, the area below the demand curve and above the market price.

What is producer surplus?

The difference between the price producers receive and the minimum they would accept; graphically, the area above the supply curve and below the market price.

What is the law of diminishing marginal utility?

As a person consumes more units of a good, the additional (marginal) utility from each successive unit eventually declines.

What is the utility-maximizing rule for a consumer?

A consumer maximizes utility when the marginal utility per dollar spent is equal across all goods: MUx/Px = MUy/Py for every pair of goods.

What is the law of diminishing marginal returns?

As more of a variable input (e.g., labor) is added to a fixed input, the marginal product of the variable input eventually decreases.

Distinguish explicit costs from implicit costs.

Explicit costs are direct out-of-pocket payments (wages, rent). Implicit costs are the opportunity costs of using owned resources. Economic profit subtracts both; accounting profit subtracts only explicit costs.

What is the difference between fixed costs and variable costs?

Fixed costs do not change with output (e.g., rent) and exist even at zero production. Variable costs change with the level of output (e.g., raw materials, hourly labor).

What is GDP and what are its four expenditure components?

Gross Domestic Product is the market value of all final goods and services produced within a country in a year. Components: C (consumption) + I (investment) + G (government spending) + NX (net exports). GDP = C + I + G + NX.

What is the difference between nominal GDP and real GDP?

Nominal GDP is measured at current prices. Real GDP is adjusted for inflation using constant (base-year) prices, allowing comparison of output across time.

How is the unemployment rate calculated?

Unemployment rate = (number of unemployed / labor force) x 100, where the labor force = employed + unemployed people actively seeking work.

What are the three main types of unemployment?

Frictional (temporary, between jobs/job search), structural (skills or location mismatch with available jobs), and cyclical (caused by economic downturns/recessions).

What is the Consumer Price Index (CPI) and what does it measure?

The CPI measures the average change over time in prices paid by urban consumers for a fixed basket of goods and services; it is the most common gauge of inflation and cost of living.

What is the difference between inflation, deflation, and disinflation?

Inflation is a sustained rise in the general price level. Deflation is a sustained fall in the price level. Disinflation is a slowing of the inflation rate (prices still rise, but more slowly).

What are the four phases of the business cycle?

Expansion (peak), peak, contraction/recession, and trough, followed by recovery. Output, employment, and income fluctuate around a long-run growth trend.

What is the common rule-of-thumb definition of a recession?

Two consecutive quarters of declining real GDP. (In the US, the NBER officially dates recessions using a broader set of indicators.)

What is the difference between demand-pull and cost-push inflation?

Demand-pull inflation results from aggregate demand exceeding supply ('too much money chasing too few goods'). Cost-push inflation results from rising production costs (e.g., higher oil or wages) shifting aggregate supply left.

What primarily drives long-run economic growth?

Increases in productivity (output per worker), driven by capital accumulation, technological progress, human capital (education/skills), and growth in the labor force.

What is fiscal policy and who conducts it?

Fiscal policy is the use of government spending and taxation to influence the economy. In the US it is set by Congress and the President.

What is the difference between expansionary and contractionary fiscal policy?

Expansionary fiscal policy increases government spending and/or cuts taxes to stimulate a weak economy. Contractionary fiscal policy cuts spending and/or raises taxes to cool an overheating economy.

What is the spending multiplier and its formula?

The multiplier measures how an initial change in spending produces a larger change in total output. Simple multiplier = 1 / (1 - MPC) = 1 / MPS, where MPC is the marginal propensity to consume.

What is the difference between the budget deficit and the national debt?

A budget deficit is the shortfall when government spending exceeds revenue in a single year. The national debt is the cumulative total of all past deficits minus surpluses.

What is the difference between progressive, regressive, and proportional taxes?

A progressive tax takes a larger percentage from higher incomes (e.g., US income tax). A regressive tax takes a larger percentage from lower incomes (e.g., sales tax as a share of income). A proportional (flat) tax takes the same percentage from all incomes.

What is monetary policy and who conducts it in the US?

Monetary policy is the control of the money supply and interest rates to influence the economy; in the US it is conducted by the Federal Reserve (the Fed).

What are the three main tools of the Federal Reserve?

Open market operations (buying/selling government securities), the discount rate (rate charged to banks borrowing from the Fed), and reserve requirements (the fraction of deposits banks must hold).

How does the Fed use open market operations to ease policy?

It buys government securities, which injects money into the banking system, increases reserves, lowers interest rates, and expands the money supply (expansionary policy). Selling securities does the reverse.

What is the money multiplier in fractional reserve banking?

Money multiplier = 1 / reserve requirement ratio. It is the maximum amount the money supply can expand from a new deposit, e.g., a 10% reserve ratio gives a multiplier of 10.

What is the dual mandate of the US Federal Reserve?

To promote maximum (full) employment and stable prices (low, stable inflation). It also aims to moderate long-term interest rates.

What is the principle of comparative advantage?

A country should specialize in producing and exporting goods it can make at a lower opportunity cost than others, even if another country has an absolute advantage in everything; trade then makes both better off.

What is the difference between absolute advantage and comparative advantage?

Absolute advantage is producing more of a good with the same resources (greater efficiency). Comparative advantage is producing a good at a lower opportunity cost. Trade is driven by comparative, not absolute, advantage.

What is the difference between a tariff and a quota?

A tariff is a tax on imported goods that raises their price. A quota is a quantity limit on how much of a good can be imported. Both protect domestic producers but reduce trade and consumer surplus.

What determines exchange rates under a floating regime, and what does appreciation mean?

Exchange rates are set by supply and demand for currencies in the foreign exchange market. Appreciation means a currency gains value relative to another (buys more foreign currency); depreciation means it loses value.

How does currency depreciation affect a country's trade?

A weaker (depreciated) currency makes a country's exports cheaper to foreigners and imports more expensive domestically, tending to increase exports and reduce imports.

What is the balance of payments and its two main accounts?

The balance of payments records all economic transactions between a country and the world. Its two main parts are the current account (trade in goods/services, income, transfers) and the capital/financial account (investment and asset flows).

What is the difference between a trade deficit and a trade surplus?

A trade deficit occurs when a country imports more than it exports (negative net exports). A trade surplus occurs when exports exceed imports (positive net exports).

What is the role of the International Monetary Fund (IMF)?

The IMF promotes global monetary cooperation and financial stability, provides short-term loans to countries facing balance-of-payments crises, and offers economic surveillance and policy advice.

What is the role of the World Bank?

The World Bank provides long-term loans, grants, and technical assistance to developing countries to fund development projects and reduce poverty (distinct from the IMF's short-term stabilization role).

What is the role of the World Trade Organization (WTO)?

The WTO sets and enforces the rules of international trade, works to reduce trade barriers, and provides a forum for negotiating trade agreements and resolving trade disputes between member nations.