The Testing Effect refers to the improvement of students' performance when students are tested repeatedly of their knowledge. See previous blog entry. Frequent testing using multiple choice questions has also been shown to be effective not just for recall but for higher Bloom level of learning. So the testing effect is not limited to memory recall of facts only, but also to application type of learning. However, the presence of incorrect answers (also known as "lures") in multiple choice questions may cause the students to acquire incorrect concepts via faulty reasoning. Even then, repeated testings produce more positive benefits than negative side-effects.
One way to compensate the negatives of multiple-choice testing is to provide immediate feedback to correct learner's misconceptions and avoid their construction of incorrect knowledge. Another way is to offer a "don't know" option or a penalty for selecting a wrong answer. This can also reduce the amount of guessing. Lastly, a different way of testing may be used, such as short answer questions, which seem to have even more positive benefits than multiple choice questions.
Marsh, E., Roediger III, H., Bjork, R., Bjork, E. (2007). The Memorial Consequences of Multiple-Choice Testing. Psychonomic Bulletin & Review. 14(2), 194-199.