WORLD

ECONOMICS
CUP
SAMPLE QUESTIONS
For National / Regional Cups and Continental Qualifier
Instructions:
This is a sample question paper for the national/regional cups and continental qualifiers of the
World Economics Cup. Keep this sample as a reference.

The sample question paper consists of THREE sections:

 Fundamentals - 50 single-choice questions of 1 mark each.
 Deep Comprehension - 3 reading materials and 20 single-choice questions of 1.5 marks
each.
 Thinking and Innovation - 1 case material and 10 single-choice questions of 2 marks each.

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Fundamentals

1. ____ examines how people use their scarce resources to satisfy their unlimited wants.
A) Economics
B) Budgeting
C) Research
D) Prioritizing

2. ____ measures the market value of all final goods and services produced in a country during a
given period, usually a year.
A) Gross domestic product
B) Net production
C) Consumer price index
D) Productivity

3. A combination of high inflation and high unemployment is known as _____.

A) superficial inflation
B) superflation
C) natural rate of unemployment
D) stagflation

4. _____ is an important indicator about the relative scarcity of a product or service.

A) The "invisible hand"
B) Product popularity
C) Market price
D) Cost of production

5. An increase in the quantity and quality of capital per worker is called _____.
A) capital interest
B) capital growth
C) capital deepening
D) inflated capital

6. The law of _____ states that each additional increment of one good requires the economy to
give up successively larger increments of the other good.
A) supply and demand
B) increasing opportunity cost
C) productivity
D) diminishing return

7. Politicians running for national office are concerned about current _____ conditions.
A) microeconomic
B) macroeconomic
C) consumer behavior
D) personal salary

8. An oligopoly is comprised of _____ firm(s).

A) one
B) many
C) a few
D) most

9. Taxpayers are coerced because they _____.

A) are forced to pay for programs they do not support
B) cannot change things by voting
C) exercise choice when funding programs
D) are forced to obey laws they do not support

10. _____ measures how much output is produced from given inputs.
A) Capital deepening
B) Productivity
C) Standard of living
D) Capital

11. The most important category of investment is new _____.

A) exports
B) physical capital
C) imports
D) stocks

12. As long as the demand curve slopes downward, a leftward shift of the supply curve _____.
A) increases price but reduces the quantity
B) increases price and increases the quantity
C) decreases demand
D) increases supply

13. Total income for an entire group of people is referred to as _____ income.
A) personal
B) aggregate
C) gross
D) net

14. The government finances goods (roads, schools, etc) and services (care of the elderly). Which
statement represents this concept the best?
A) The government produces the services but not the goods.
B) Government workers perform all the needed tasks.
C) Private firms charge more than the government for the same good or service.
D) The government hires private firms to produce some goods and services.

15. When the marginal tax rate is high it _____.

A) reduces people's incentive to work
B) stimulates the stock market
C) raises the after-tax income
D) encourages people to work longer hours

16. Supply indicates how much of a good producers _____.

A) are willing and able to offer
B) have sold
C) have yet to sell
D) produce

17. Voters adopt a stance of rational ignorance when they _____.

A) vote the wrong way on an issue
B) vote strictly along party lines
C) do not educate themselves on public matters
D) exercise poor judgment

18. All of the following reduce demand except _____.

A) an increase in consumer income
B) a decrease in the price of a substitute
C) a decrease in consumer income
D) a decline in the number of consumers

19. The amount by which actual output in the short run exceeds the economy's potential is called
_____.
A) a contract gap
B) potential output
C) an expansionary gap
D) aggregate supply

20. _____ means being able to do something using fewer resources than other producers
require.
A) Specialization
B) Division of labor
C) Absolute advantage
D) Comparative advantage

21. _____ is an example of a progressive tax.

A) Sales tax
B) Income tax
C) Value added tax
D) Flat tax

22. Macroeconomics are affected positively by _____.

A) lack of consumer confidence
B) government deficit spending
C) increased demand for exports
D) high unemployment rates

23. The process of turning an invention into a marketable product is called _____.
A) intrapreneurship
B) innovation
C) entrepreneurship
D) speculation

24. Elasticity of supply indicates how _____.

A) responsive producers are to a change in price
B) much the product costs
C) many products are in stock
D) adaptable the supply is

25. _____ causes prices to move to reach equilibrium in competitive markets.

A) The government
B) The labor market
C) Individual buyers and sellers
D) The stock market

26. An economy's maximum sustained output in the long run is known as its _____.
A) resource quotient
B) maximum output
C) fiscal policy
D) potential output

27. Checking the want ads for a job instead of going door to door _____.
A) increases newspaper circulation
B) reduces your transaction costs
C) reduces the number of jobs available
D) increases job competition

28. Newspaper headlines read: Business Orders Down Nationwide/Workers Laid Off/Households
Cutting Back on Spending. What conclusion could be drawn from the headlines?
A) a possible recession is near
B) interest rates are high
C) a depression is unavoidable
D) consumer confidence is high
29. An excise tax is levied on things like _____.
A) hamburgers
B) housing
C) clothing
D) cigarettes

30. Low demand for a product and high supply will tend to _____ the price.
A) not affect
B) double
C) lower
D) raise

31. Real income refers to _____.

A) your income minus taxes
B) your income minus taxes and benefits
C) how much money you actually earn
D) how many goods and services you can buy

32. The demand for a resource is tied to the _____.

A) value of the output produced by that resource
B) latest social trends
C) economic conditions
D) available supply

33. An example of a commodity would be _____.

A) an automobile
B) a bushel of wheat
C) a one-of-a-kind brand
D) a book that has a copyright

34. Natural monopolies such as electric transmission firms or gas delivery systems are regulated
by government to protect _____ interests.
A) government
B) public
C) entrepreneurial
D) special

35. The _____ economy is an economic system in which all resources are government-owned,
and production is coordinated by the central plans of government.
A) pure market
B) traditional
C) mixed
D) command
36. _____ sorts the production process into separate tasks to be carried out by separate workers.
A) Division of labor
B) Absolute advantage
C) Flattened organization
D) Comparative advantage

37. In an effort to maximize individual political support, politicians establish relationships with
special interest groups. What expression best describes this relationship?
A) Know where your bread is buttered.
B) The squeaky wheel gets the grease.
C) People who live in glass houses should not throw stones.
D) A penny saved is a penny earned.

38. _____ includes the machines, buildings, roads, airports, communications networks, and other
manufactured creations used to produce goods and services.
A) Physical capital
B) Productive assets
C) Labor productivity
D) Human capital

39. In long-run equilibrium, firms in monopolistic competition are said to operate _____.
A) with efficiency
B) with balanced capacity
C) with excess capacity
D) free of government interference

40. Which statement is the most accurate?

A) The elasticity of supply is typically greater with a greater quantity of products on hand.
B) The elasticity of supply typically is not affected by time at all.
C) The elasticity of supply is typically diminished the longer the period of adjustment.
D) The elasticity of supply is typically greater the longer the period of adjustment.

41. Gross domestic product does not include _____.

A) media advertising
B) domestic housework
C) assembly lines
D) raw materials

42. A public good _____.

A) must be approved by voters
B) is available everyone
C) can be purchased by the public
D) can only be enjoyed by taxpayers
43. During the contractionary phase of the business cycle, _____.
A) smaller companies expand into larger companies
B) unemployment generally rises
C) inflation typically increases
D) business profitability increases

44. One of the ways the government finances its debt is with the sale of _____.
A) stamps
B) stocks
C) real estate
D) bonds

45. An economic boom _____.

A) reduces the need for human capital
B) has no impact on the workforce
C) has a direct impact on the workforce
D) frequently occurs during recession

46. The market clearing price is also called the _____ price.
A) equilibrium
B) unit
C) fair market
D) sale

47. The _____ shows how much output a country’s producers are willing and able to supply at
each price level.
A) equilibrium market
B) aggregate supply curve
C) aggregate demand curve
D) GDP per capita

48. _____ tax is not an example of the ability-to-pay tax principle.

A) Income
B) Property
C) Sales
D) Luxury

49. A deficit _____.

A) indicates the government is owed money
B) is always followed by a balanced budget
C) is necessary for government to run effectively
D) is a way of billing future taxpayers for today's spending
50. The demand for roofers would _____ if the price of shingles dropped by 50 percent.
A) fluctuate downward
B) rise
C) not be affected
D) fall

Answer Keys:
1. A 11. B 21. B 31. D 41. B
2. A 12. A 22. C 32. A 42. B
3. D 13. B 23. B 33. B 43. B
4. C 14. D 24. A 34. B 44. D
5. C 15. A 25. C 35. D 45. C
6. B 16. A 26. D 36. A 46. A
7. B 17. C 27. B 37. B 47. B
8. C 18. A 28. A 38. A 48. C
9. A 19. C 29. D 39. C 49. D
10. B 20. C 30. C 40. D 50. B
Deep Comprehension

Material I
Currency Fluctuations: How They Affect the Economy

Currency fluctuations are a natural outcome of the floating exchange rate 1 system, which is the
norm for most major economies. Numerous fundamental and technical factors influence the
exchange rate of one currency compared to another. These include relative supply and demand
of the two currencies, economic performance, an outlook for inflation, interest rate differentials,
capital flows, technical support and resistance levels, and so on. As these factors are generally in
a state of perpetual flux, currency values fluctuate from one moment to the next.

A common false idea that most people hold is that a strong domestic currency is a good thing
because it makes it cheaper to travel to Europe, for example, or to pay for an imported product.
Realistically, an unduly strong currency can exert a significant drag on the underlying economy
over the long term as entire industries are rendered noncompetitive and thousands of jobs are
lost. While consumers may disdain a weaker domestic currency, a weak currency can result in
more economic benefits.

The value of the domestic currency in the foreign exchange market is an important instrument in
a central bank’s toolkit, as well as a key consideration when it sets monetary policy. Directly or
indirectly, currency levels affect a number of key economic variables. They may play a role in the
interest rate you pay on your mortgage, the returns on your investment portfolio, the price of
groceries in your local supermarket, and even your job prospects.

A currency’s level has a direct impact on the following aspects of the economy:

(1) Merchandise Trade

This refers to a nation’s international trade or its exports and imports. In general terms, a weaker
currency will stimulate exports and make imports more expensive, thereby decreasing a nation’s
trade deficit2 (or increasing surplus) over time.

For example, assume you are a US exporter who sold a million widgets at $10 each to a buyer in
Europe two years ago when the exchange rate was €1=$1.25. The cost to your European buyer
was, therefore, €8 per widget. Your buyer is now negotiating a better price for a large order, and

1 Floating exchange rate: A regime where the currency price of a nation is set by the forex market based on
supply and demand relative to other currencies. This is in contrast to a fixed exchange rate, in which the
government entirely or predominantly determines the rate.
2 Trade deficit: An economic measure of international trade in which a country's imports exceed its exports. It

represents an outflow of domestic currency to foreign markets. It is also referred to as a negative balance of
trade.
because the dollar has declined to 1.35 per euro, you can afford to give the buyer a price break 3
while still clearing at least $10 per widget.

Even if your new price is €7.50, which amounts to a 6.25% discount from the previous price, your
price in dollars would be $10.13 at the current exchange rate. The depreciation in your domestic
currency is the primary reason why your export business has remained competitive in
international markets.

(2) Economic Growth

The basic formula for an economy’s GDP is:

GDP = Y = C + I + G + (X – M)

where:
C = Consumption or consumer spending, the biggest component of an economy
I = Capital investment by businesses and households
G = Government spending
(X−M) = Exports – Imports, or net exports (NX)

From this equation, it is clear that the higher the value of net exports, the higher a nation’s GDP.
As discussed earlier, net exports have an inverse correlation with the strength of the domestic
currency.

(3) Inflation
A devalued currency can result in “imported” inflation for countries that are substantial importers.
A sudden decline of 20% in the domestic currency may result in imported products costing 25%
more since a 20% decline means a 25% increase to get back to the original price point.

(4) Interest Rates

A strong domestic currency exerts a drag on the economy, achieving the same end result as
tighter monetary policy (i.e., higher interest rates). In addition, further tightening of monetary
policy at a time when the domestic currency is already unduly strong may exacerbate the
problem by attracting more hot money from foreign investors, who are seeking higher yielding
investments (which would further push up the domestic currency).

Questions 51-56 are based on Material I.

51. What causes currency fluctuations?

A) Supply and demand for currencies.
B) Economic growth of countries.
C) Capital flows.

3 Price break: A reduction in price, especially for bulk purchase - the purchase of much larger quantities than the

usual.
D) All of the above.

52. The identity that shows that GDP is both total income and total expenditure is represented
by:
A) GDP = Y.
B) Y = PI + DI + NX.
C) Y = C + I + G + NX.
D) GDP = GNP - NX.

53. If more Americans want to suddenly purchase goods in Mexico, what likely happens?
A) Demand for pesos increases, dollar falls in value compared to peso
B) Demand for dollars increases
C) Demand for pesos decreases
D) No change or effect on currencies

54. Assume there is an increase in nation’s imports. This will cause the nation’s currency to _____
and its trade balance to move toward a _____.
A) appreciate; surplus
B) depreciate; deficit
C) appreciate; deficit
D) depreciate; surplus

55. Under a system of freely floating exchange rates, if the United States decrease its importation
of Chinese goods (and Chinese importation of goods from the United States was unchanged),
_____.
A) the yuan price of dollars would increase
B) the dollar price of yuan would increase
C) yuan would be rationed in the united states
D) nothing would happen to dollar price of yuan or to the yuan price of dollars

56. How can an importer deal with currency fluctuations properly?

A) By transferring the risk to the supplier by asking them to quote in the desired currency.
B) By purchasing forward cover to protect him from fluctuations.
C) By adding an exchange rate risk to the margins and carry the risk himself.
D) All of the above.

Answer Keys:
51. D
52. C
53. A
54. B
55. A
56. D
Material II
Exchange Rate Risk: Economic Exposure

In the present era of increasing globalization and heightened currency volatility, changes in
exchange rates have a substantial influence on companies’ operations and profitability. Exchange
rate volatility affects not just multinationals and large corporations, but it also affects small and
medium-sized enterprises, including those who only operate in their home country. While
understanding and managing exchange rate risk is a subject of obvious importance to business
owners, investors should also be familiar with it because of the huge impact it can have on their
holdings.

Companies are exposed to three types of risk caused by currency volatility:

 Transaction exposure. This arises from the effect that exchange rate fluctuations have on a
company’s obligations to make or receive payments denominated in foreign currency. This
type of exposure is short-term to medium-term in nature.
 Translation exposure. This exposure arises from the effect of currency fluctuations on a
company’s consolidated financial statements, particularly when it has foreign subsidiaries.
This type of exposure is medium-term to long-term.
 Economic (or operating) exposure. This is lesser-known than the previous two but is a
significant risk nevertheless. It is caused by the effect of unexpected currency fluctuations
on a company’s future cash flows and market value and is long-term in nature. The impact
can be substantial, as unanticipated exchange rate changes can greatly affect a company’s
competitive position, even if it does not operate or sell overseas.

The degree of economic exposure is directly proportional to currency volatility. Economic

exposure increases as foreign exchange volatility increases and decreases as it falls. Economic
exposure is obviously greater for multinational companies that have numerous subsidiaries
overseas and a huge number of transactions involving foreign currencies. However, increasing
globalization has made economic exposure a source of greater risk for all companies and
consumers. Economic exposure can arise for any company regardless of its size and even if it only
operates in domestic markets.

Unlike transaction exposure and translation exposure, economic exposure is difficult to measure
precisely and hence challenging to hedge 4. Economic exposure is also relatively difficult to hedge
because it deals with unexpected changes in foreign exchange rates, unlike expected changes in
currency rates, which form the basis for corporate budgetary forecasts.

For example, small European manufacturers that sell only in their local markets and do not

4 Hedge: A hedge is an investment that protects your finances from a risky situation. Hedging is done to minimize
or offset the chance that your assets will lose value. It also limits your loss to a known amount if the asset does
lose value. It's similar to home insurance. You pay a fixed amount each month. If a fire wipes out all the value of
your home, your loss is the only the known amount of the deductible.
export their products would be adversely affected by a stronger euro, since it would make
imports from other jurisdictions such as Asia and North America cheaper and increase
competition in European markets.

Economic exposure can be mitigated either through operational strategies or currency risk
mitigation strategies. Operational strategies involve diversification of production facilities,
end-product markets, and financing sources, since currency effects may offset each other to
some extent if a number of different currencies are involved. Currency risk-mitigation strategies
involve matching currency flows, risk-sharing agreements, and currency swaps.

To better understand economic exposure, we take a look at the following example. Assume that a
large U.S. company that gets about 50% of its revenue from overseas markets has factored in a
gradual decline of the U.S. dollar against major global currencies — say 2% per annum — into its
operating forecasts for the next few years. If the dollar appreciates instead of weakening
gradually in the years ahead, this would represent economic exposure for the company. The
dollar’s strength means that the 50% of revenues and cash flows the company receives from
overseas will be lower when converted back into dollars, which will have a negative effect on its
profitability and valuation.

Questions 57-62 are based on Material II.

57. _____ exposure deals with cash flows that result from existing contractual obligations.
A) Operating
B) Translation
C) Transaction
D) Economic

58. _____ exposure measures the change in the present value of the firm resulting from
unexpected changes in exchange rates.
A) Economic
B) Transaction
C) Translation
D) Accounting

59. According to the definition of economic exposure, we can infer that each of the following can
refer to economic exposure EXCEPT:
A) operating exposure
B) strategic exposure
C) accounting exposure
D) competitive exposure

60. Which of the following is not a form of exposure to exchange rate fluctuations?
A) Transaction exposure
B) Economic exposure
C) Translation exposure
D) Credit exposure

61. Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should
_____ the variability of expected cash flows to a firm and at the same time, the expected value of
the cash flows should _____.
A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change

62. Vada, Inc. exports computers to Australia invoiced in U.S. dollars. Its main competitor is
located in Japan. Vada is subject to _____.
A) economic exposure
B) transaction exposure
C) translation exposure
D) All of the above

Answer Keys:
57. C
58. A
59. C
60. D
61. B
62. A
Material III
Assets Market Bubbles

Share prices are not only volatile hour-by-hour and day-by-day. They can also display large swings,
often referred to as bubbles. Figure 3.1 shows the value of the Nasdaq Composite Index between
1995 and 2004. This index is an average of prices for a set of stocks, with companies weighted in
proportion to their market capitalization. The Nasdaq Composite Index at this time included
many fast-growing and hard-to-value companies in technology sectors.

Figure 3.1 The tech bubble: Nasdaq Composite Index (1995–2004).

The index began the period at less than 750, and rose in five years to more than 5,000 with a
remarkable annualized rate of return of around 45%. It then lost two-thirds of its value in less
than a year, and eventually bottomed out at around 1,100, almost 80% below its peak. The
episode has come to be called the tech bubble. The term bubble refers to a sustained and
significant departure of the price of any asset (financial or otherwise) from its fundamental value.

Because stock price movements often reflect important information about the financial health of
a firm, traders who lack this information can try to deduce it from price movements. Using
Hayek’s5 language, changes in prices are messages containing information. If markets are to work
well, traders must respond to these messages. But when they interpret a price increase as a sign
of further price increases (momentum trading6 strategies), the result can be self-reinforcing
cycles of price increases, resulting in asset price bubbles followed by sudden price declines, called
crashes.

Three distinctive and related features of markets may give rise to bubbles:

5 Hayek: Friedrich August von Hayek, often referred to by his initials F. A. Hayek, was an Austrian-British
economist and philosopher best known for his defence of classical liberalism.
6 Momentum trading: Share trading strategy based on the idea that new information is not incorporated into

prices instantly, so that prices exhibit positive correlation over short periods.
 Resale value: The demand for the asset arises both from the benefit to its owner and
because it offers the opportunity for speculation on a change in its price. Similarly, a
landlord may buy a house both for the rental income and also to create a capital gain by
holding the asset for a period of time and then selling it.
 Ease of trading: In financial markets, the ease of trading means that you can switch between
being a buyer and being a seller if you change your mind about whether you think the price
will rise or fall.
 Ease of borrowing to finance purchases: If market participants can borrow to increase their
demand for an asset that they believe will increase in price, this allows an upward
movement of prices to continue, creating the possibility of a bubble and subsequent crash.

Could we explain the price movements in Figure 3.1 in a more economic model?

Figure 3.2 The beginning of a bubble in FCC shares.

Figure 3.2 illustrates the supply and demand for shares in a (so far) hypothetical firm called the
Flying Car Corporation (FCC). Initially the share price is $50 on the lowest demand curve. When
potential traders and investors receive good news about expected future profitability, the
demand curve shifts to the right, and the price increases to $60 (for simplicity, we assume that
the supply curve doesn’t move).

Then, how do bubbles come to an end? A bubble bursts when some participants in the market
perceive a danger that the price will fall. Then would-be buyers hold back, and those who hold
the assets will try to get rid of them. The process in Figure 3.2 is reversed. Figure 3.3 uses the
supply and demand model to illustrate what happens. At the top of the bubble the shares trade
at $80. Both the supply and demand curves shift when the bubble bursts, and the price collapses
from $80 to $54 — leaving those who owned shares when the price was $80 with large losses.
 Figure 3.3 The collapse of FCC’s share price.

If the price of an asset has been driven up solely by beliefs about future price rises, there should
be opportunities for those who are well informed about the value to profit from their superior
information. So if the rise in the Nasdaq index in Figure 3.1 was indeed a bubble, why did those
who identified it as a bubble fail to profit by placing gigantic bets on a major price decline?

As it happens, many large investors did ‘lean against the wind’ by placing bets on the bubble
bursting, including some well-known fund managers on Wall Street. They did so by selling short 7
(shorting): borrowing shares at the current high price and immediately selling them, with the
intention of buying them back cheaply (to return to the owner) after the price crashed. But this is
an extremely risky strategy, since it requires accuracy in timing the crash — if prices continue to
rise, the losses can become unsustainable. You may be right about the bubble but if you get the
timing wrong, then when you are due to buy the shares and return them to the owner, the price
is higher than it was when you sold them. You will make a loss and may not be able to repay your
loan.

Questions 63-70 are based on Material III.

63. Asset price bubbles occur when _____.

A) the fundamental value of an asset exceeds its price
B) the price of an asset exceeds its book value
C) the price of an asset exceeds its fundamental value
D) the book value of an asset exceeds its price

7 Short selling: The sale of an asset borrowed by the seller, with the intention of buying it back at a lower price.
This strategy is adopted by investors expecting the value of an asset to decrease.
64. A bubble in asset prices is usually followed by a _____.
A) crash
B) revolution
C) depression
D) recession

65. The tech bubble happens in _____.

A) 1998-1999
B) 1999-2000
C) 2000-2001
D) 2001-2002

66. What are bubbles ultimately based on?

A) The government’s fiscal policies.
B) The market participants’ expectation.
C) The companies’ marketing campaigns.
D) The speculators’ intentional operations.

67. According to Hayek, changes in prices are messages containing information. What does
“information” refer to in this case?
A) The financial health of a firm
B) The financial health of the nation
C) The financial health of the market
D) The financial health of investment portfolio

68. Which of the following statements about bubbles is correct?

A) A bubble occurs when the fundamental value of a share rises too quickly.
B) A bubble is less likely to occur in a market where people can easily switch from buying to
selling.
C) Momentum trading strategies make bubbles more likely to occur.
D) Bubbles can only occur in financial markets.

69. Which of the following statements about asset prices is correct?

① A bubble occurs when beliefs about future prices amplify a price rise.
② When beliefs restrain price rises, the market equilibrium is stable.
A) Only ①.
B) Only ②.
C) Both ① and ②.
D) Neither ① nor ②.

70. Which of the following statements about short selling (shorting) is correct?
A) Shorting is used to benefit from a price fall.
B) Shorting involves selling shares that you currently own.
C) The maximum loss a trader can incur by shorting is the price he receives from the sale of the
shares.
D) Shorting is a sure way of profiting from a suspected bubble.

Answer Keys:
63. C
64. A
65. B
66. B
67. A
68. C
69. C
70. A
Thinking and Innovation

Reducing Domestic GHG Emissions

Although shifts around the world are reducing the greenhouse gases (GHG) intensity of fuel use,
growth in population, and especially rapid GDP growth in some countries, such as China and India,
is leading to the continued global increase in GHG emissions. In a sense there are two
fundamental choices for this problem:
 mitigation: refers to taking steps today to reduce GHG emissions so as to delay or reduce
global temperature increases.
 adaptation: refers to the efforts of future generations to adjust in ways that will
substantially reduce the negative impacts of these temperature increases.

Because CO2 is the main GHG, we focus on the issue of reducing global CO2 emissions. It needs
to be recognized, however, that there are many things that could be done to mitigate CO2
emissions, and that these come at different costs. It is very important, therefore, to keep the
concept of cost-effectiveness clearly in mind when developing contemporary mitigation steps.
Effective global action to combat global warming will require individual countries to undertake
steps to reduce their GHG emissions. The question is: How should this be undertaken? In the
short run, say over the next 20 years or so, the emphasis will be on getting increases in fuel
conservation and efficiency, switching to lowcarbon fuels, and reducing the use and emissions of
chemicals with high greenhouse impacts.

Cost to Reduce GHG Emissions

Given the long histories of command-and-control policies in the United States and other
countries, many are likely to be attracted to technology or emission standards. This has been the
tradition in the United States (as well as most other countries), so first efforts here have been
directed at subsidizing, or requiring, technology options. This is because there are really
substantial differences among technical options in terms of GHG control costs.

Table 1 Cost-Effectiveness of Alternative Means of Reducing CO2, United States, 2030.

Costs per ton of carbon
Means
dioxide equivalent ($ CO2e)
Coal-fired power plants, carbon capture storage 55
Afforestation of pasture land 15
Nuclear power 10
Residential efficiency 47
Fuel economy, light trucks −70
Fuel economy, cars −80
Active forest management 20
Commercial buildings, combined heat and power −35
Onshore wind 20
Solar power 35
Table 1 shows some cost-effectiveness results obtained from a large study by the analysts at
McKinsey and Company. Some cost figures that stand out are the low estimates for afforestation,
as essentially an add-on to the current conservation reserve program, and the high costs of GHG
removal through CO2 capture and storage. Afforestation is not an emission reduction method,
but an attempt to augment the CO2-absorbing capacity of the earth’s ecosystem.

Incentive-Based Approaches for Reducing GHG Emissions

Technical options are diverse and subject to change, and new ones will undoubtedly be found
and developed. What is vitally important is that we have strong incentives permeating through
the economy to bring about these changes. And this implies that the best policies to combating
the greenhouse effect are ones that create strong incentives for reducing GHG emissions.

When there are substantial differences among sources and technologies in terms of the costs of
reducing GHG emissions, the use of incentive-based policies can get a substantially bigger bang
for the buck than traditional command-and-control policies. In the United States, and many other
countries, therefore, analysts and policymakers are emphasizing the two major types of
incentive-based approaches:
 Cap-and-trade plan: quantity-based plans, in which a quantitative limit is placed on
emissions and prices are established on emission permit markets.
 Emission taxes or charges: price-based policies, where a monetary fee on emissions is set
and the quantity of emissions is adjusted as polluters react to that fee.

71. One of the biggest impacts of global climate change will be in forestry and agriculture. The
agricultural impacts will hit _____ harder.
A) developed nations
B) the western hemisphere
C) developing nations
D) the southern hemisphere

72. The quantity of GHG emissions depends on the following factors:

A) population.
B) energy use per person.
C) GDP per capita.
D) Both A and C.

73. As a specific approach to reducing the impact of green house gasses, mitigation refers to
A) new legislation that allows for lawsuits for those who do not comply with emission limits.
B) taking steps to reduce emissions today to delay or reduce global temperature increases.
C) adjustments to reduce the negative impacts of temperature increases.
D) protecting specific key resources from temperature increases.

74. In recent years, the most important factors in reducing CO2 emissions have been
A) population and GDP per capita.
B) energy use per person and CO2 emissions per goods sold.
C) energy efficiency and CO2 produced per energy used.
D) All of the above.

75. The United States and other countries have a long history of using _____. This approach will
increase the cost of controlling GHG.
A) command and control policies
B) decentralized policies
C) incentive based strategies
D) market trading systems

76. Afforestation is an example of _____.

A) an emission reduction method
B) augmenting the CO2 absorption capacity of the ecosystem
C) a technology standard
D) a CO2 capture and storage method

77. Which of the following statements is FALSE based on Table 1?

A) The costs of achieving greater fuel efficiency for cars and trucks are negative.
B) The most costly methods is coal-fired power plants, carbon capture storage.
C) How much it costs to dramatically reduce GHG emissions depends on how it is done.
D) All listed methods aim to eliminate greenhouse gases without considering energy cost savings.

78. When there are substantial differences among sources and technologies in terms of the costs
of reducing greenhouse gasses, the use of _____ is more cost effective than the use of _____.
A) incentives; fines.
B) fines; incentives.
C) incentive based policies; command and control policies.
D) command and control policies; incentive based policies.

79. Two incentive based programs that might be considered to control GHG are
A) emissions standards; technology based standards.
B) cap and trade programs; emission taxes/charges.
C) bag and tag programs; cap and trade programs.
D) shifting away from meat consumption; CAFÉ standards.

80. A price-based policy, where a monetary fee on emissions is set and the quantity of emissions
is adjusted as polluters react to that fee, is called _____.
A) bag and tag program
B) cap and trade
C) emission tax
D) emissions standard
Answer Keys:
71. C
72. D
73. B
74. C
75. A
76. B
77. D
78. C
79. B
80. C