CFA Level 1 - Economics
Labor Force Participation Rate Formula
(Labor Force) / (Working-Age Population(16 or older) ) x 100
Employment to Population Ratio Formula
(Number of Employed) / (Working-Age Population) x 100
Unemployment Rate Formula
(Number of Unemployed) / (Labor Force) x 100
Obstacles to efficient allocation of productive resources
1) Price Control (ceilings & floors); 2) Taxes and trade restricitions (subsidies & quotas); 3) Monopoly; 4) External Costs; 5) External Benefit; 6) Public goods and common resources
Equation of Exchange Formula
= (Money supply) x (Velocity) = GDP = (Price) x (Real Output)
Two ways that firms can organize production
CI 1) Command System, 2) Incentive System
HHI less than 1,000
Competitive
Four-Firm Concentration Ratio less than 40%
Competitve
Small Price Increase = Large Demand Decrease
Elastic
What does it mean if Price Elasticity of Demand is greater than one in absolute value?
Elastic
When demand is less elastic than supply- consumers bear higher or lower burden
HIGHER
Elasticity of demand and total expenditure/revenue
If prices are reduced to stimulate sales, total revenue will only increase if the percentage increase in demand is greater than the percentage decrease in price. -If demand is relatively elastic >1, a % decrease in price will result in an increase in quantity demanded that is higher, so total expenditure will increase -If demand is relatively inelastic <1, a % decrease in price will result in an increase in quantity demanded that is lower, so total expenditure will decrease -If demand is unit elastic, a % decrease in price will result in an increase in quantity demanded that is the same and total expenditure will not change Therefore, -If a price cut increases total revenue, demand is elastic -If a price cut decreases total revenue, demand is inelastic -If a price cut does not change total revenue, demand is unit elastic -If the demand curve facing a producer is elastic, an increase in price will decrease total revenue -If the demand curve facing a producer is inelastic, an increase in price will increase total revenue -If the demand curve is unit elastic, an increase in price will not change total revenue. -If a producer is charging a price that lies on the inelastic region of the demand curve, increase prices to increase total revenue.
Implicit Costs
Implied Rental Rate + Normal Profit
Inelastic means more or less DWL
Less
HHI between 1,000-1,800
Moderately Competitive
Command Systems
Organization according to a managerial chain of command, eg US Military [Told what to do]
Economic Efficiency
Output from least cost
Technological Efficiency
Output from least inputs
Four Types of Economic Markets
PMOM 1) Perfect Competition, 2) Monopolitic Competition, 3) Oligopoly, 4) Monopoly
Three Types of Business Organizations
PPC 1) Proprietorships, 2) Partnerships, 3) Corporations
Three Constraints to Profit Maximization
TMI 1) Technological, 2) Informational, 3) Market Constraints
Tax burden and deadweight loss
Tax incidence refers to how the burden of tax is shared by consumers and producers in terms of reduction in surplus. Burden doesn't fall entirely on group for which it is imposed
Inflation Rate Formula
% change in CPI (Current CPI- Year Ago CPI)/ (Year Ago CPI) X 100
Price Elasticity of Supply Formula
(% Change in Quantity Supplied) / (% Change in Price)
Money Multiplier for a change in monetary base Formula
(1+c) / (d+c) c = currency as a % of deposits d = desired reserve ratio
Change in Quantity of Money Formula
(Change in Quantity of Money) = (Change in Monetary Base) x (Money Multiplier)
Marginal Cost Formula
(Change in Total Cost) / (Change in Output)
CPI Formula
(Cost of Basket of Current Prices) / (Cost of Basket at Base Period Prices) x 100
Elasticity of Demand Factors
1) Availability of Substitute; 2) Relative amount of income spent on the good; 3) Time SINCE price change
Elasticity of Supply Factors
1) Available substitutes for resources (inputs) used to produce the goods; (2) the time that has elapsed since the price change
Two Concepts of Robert Nozick's Anarchy, State, and Utopia (Symmetry)
1) Governments must recognize and protect private property; 2) Private property must be given from one party to another only when it is voluntarily done
Three limitations to the HHI and Four-Firm Concentration Ratio
1) Problems with defining the geographical scope of the market; 2) Barriers to entry and firm turnover are NOT considered; 3) Weak link between market and an industry
Potential Increase In Money Supply Formula
= (Potential Deposit Expansion Multiplier) x (Increase in Excess Reserves)
Potential Deposit Expansion Multiplier Formula
= 1 / (required reserve ratio)
Average Total Cost Formula
= AFC + AVC
Total Cost Formula
= Total Fixed Cost + Total Variable Cost
Command System
A central authority determines resource allocation, is used in centrally planned economies and is also used within firms and in the military
Factors affecting elasticity of demand
Availability of close substitutes - if substitutes easily exist, demand is more elastic Proportion of income spent on the good - if good takes up a large portion of income, demand is more elastic Time elapsed since price change - the longer time has elapsed, the more elastic demand will be The extent to which the good is viewed as necessary or optional - the more a good is seen as being necessary, the less elastic it will be
Average Fixed Cost Formula
Average Fixed Cost = TFC/Q
Average Variable Cost Formula
Average Variable Cost= TVC/Q
Herfinhahl-Hirschman Index (HHI)
Calculated by summing the squared percentage market shares of the 50 largest firm in an industry (or all of the firms in the industry if there were less than 50). The HHI is very low in a highly competitive industry and increases to 10,000 (=100squared) for an industry with only one firm. An HHI between 1,000 and 1,800 is considered moderately competitive, while an HHI greater than 1,800 indicates that it is not competitive
Market Equilibrium
Can be defined in two ways: 1) occurs at the price at which quantity demanded equals quantity supplied 2) occurs at the quantity at which the highest price a buyer is willing and able to pay equals the lowest price that a producer is willing and able to accept It is the point of intersection between the market demand and supply curves. When we focus on one market and assume exogenous variables are constant, this is partial equilibrium analysis and it does not account for any feedback effects associated with other markets (versus general equilibrium analysis which includes all feedback).
Auctions as a way to find equilibrium prices
Common value auction: the value o fthe product is the same to each bidder and bidders estimate price before auction is settled, common value is revealed after. Private value auction: each bidder has subjective and different value of the product Ascending price auction: Typical auction where auctioneer starts at a low price and bidding increases in response to bidders reactions Sealed bid auction: for a common value item, buyers bid for the item with no knowledge of values bid by other potential buyers until after it is settled (first price sealed bid auction = sold to highest bidder (winner's curse), second price sealed bid auction/Vickery = highest bidder wins but the price paid is the second to highest bid) Descending price or Dutch auction: bidding begins at high price and lowers price in increments until the item is sold Modified dutch auction: commonly used for securities, each bidder puts in the number of shares and specify price, the company then qualifies bids starting with the lowest price and proceeds upwards until all shares have been qualified, lowest bidders get full quantity filled first -single price auction is used for treasuries where non-competitive bidders state total face value to purchase at final price/yield that clears the market (all securities offered are sold), competitive bidders specify total par value and exact price/yield they are willing to purchase that quantity
Economic Profit
Considers explicit and implicit costs
Search costs
Costs of matching buyers and sellers in the market. When search costs are significant, brokers can play a valuable role in the market by bringing buyers and sellers together. Brokers reduce search costs.
Elasticity of a linear demand curve
Downward sloping demand curve: -At high prices (low quantities), the ratio of price to quantity is high so demand is relatively elastic -At low prices (high quantities), the ratio of price to quantity is low so demand is relatively inelastic -Demand is unit elastic at the midpoint of the demand curve, elastic to the left and inelastic to the right
Economic Profit Formula
Economic Profit= Total Revenue - Opportunity Costs = Total Revenue - (Explicit + Implicit Costs)
Total Revenue Test
Estimate elasticity of demand: P Up-> R Up (Inelastic); P Up -> D Down (Elastic)
Deadweight loss
Externalities such as ceilings, floors, and taxes create a reduction in total surplus known as deadweight loss. It is borne by society as a hole.
Types of markets
Factor markets = markets for factors of production (land, labor, capital), firms purchase services of factors of production (labor) from households and transform those services into intermediate and final goods and services. Goods markets = markets for the output produced by firms (legal and medical services) using the services of factors of production, households and firms act as buyers (intermediate goods and services use inputs to produce other goods while final goods and services are in the final form purchased by households) Capital markets = markets for long-term financial capital (debt and equity), firms can use capital markets to raise funds for investing in business, household savings are the primary source of these funds Interactions between these markets are voluntary. Whenever the perceived value of a good exceeds the cost of producing it, there is potential for a trade that would make the buyer and the seller better off.
Price Elasticity of Demand
Firms revenue = quantity sold * price and since these are negatively related, a firm needs to know how sensitive quantity demanded is to changes in price. (% Change in Quantity Demanded) / (% Change in Price) OR (Change in quantity demanded/change in price) * (price/quantity demanded) Arc elasticity of demand is the picture included here. -Elasticity uses absolute value -if elasticity of demand = 1, demand is said to be unit elastic and demand curve forms an asymptotic curve (y axis & x axis) -if elasticity of demand = 0, demand is perfectly inelastic as quantity demanded does not change with price, and demand curve is perfect vertical line through quantity demanded -if elasticity of demand = infinity, demand is perfectly inelastic as quantity demanded changes infinitely large in response to a slight change in price, and demand curve is perfect horizontal line through price -if absolute value is between 0 and 1, demand is relatively inelastic -if absolute value is greater than 1, demand is relatively elastic
Total surplus: Total value (utility) minus total variable cost
For each unit up to and including the equilibrium unit, buys are able to purchase for less than they are willing and able to pay, while sellers are able to sell for more than they are willing to accept. Graphically, -total surplus is equal to the total value to buyers less the total variable cost to sell -It equals the triangle that goes from the y axis to the intersection of the supply and demand curves -it equals the sum of consumer surplus plus producer surplus = society's gain from the existence of a free market, it is maximized at equilibrium where supply and demand intersect Distribution between consumer and producer depends on slopes of the supply and demand curves: if supply curve is steeper, producers get more surplus and vice versa.
Price ceiling
Government imposes maximum price or limit that is below the equilibrium market price (rent ceiling). They only disrupt the market equilibrium if they are set below the equilibrium market price. No impact if set above the equilibrium market price. Graphically, -supply and demand curves stay the same but the P on the y axis intersects both curves lower than equilibrium -producer surplus is shifted to consumer surplus = rectangle from new forced price up to equilibrium price and from the y axis over to the line drawn down from the intersection of the new price and the supply curve -loss in consumer surplus = triangle from equilibrium price up to demand function and from line drawn down from the intersection of the new price and the supply curve to the demand curve -loss in producer surplus = triangle from equilibrium price down to supply curve and from the intersection of the new price and the supply curve to the supply curve -deadweight loss = sum of loss in consumer and producer surplus = triangle from the intersection of the new price and the supply curve to the intersection of equilibrium supply and demand
Price floors
Government imposes minimum price above the equilibrium market price (minimum wage). They only disrupt the market equilibrium if they are set above the equilibrium market price. No impact if set below the equilibrium market price. Graphically, -supply and demand curves stay the same but the horizontal P on the y axis intersects both curves higher than equilibrium -consumer surplus is shifted to producer surplus = rectangle from new forced price down to equilibrium price and from the y axis over to the line drawn down from the intersection of the new price and the demand curve -loss in consumer surplus = triangle from equilibrium price up to demand function and from line drawn down from the intersection of the new price and the demand curve to the demand curve -loss in producer surplus = triangle from equilibrium price down to supply curve and from the intersection of the new price and the demand curve to the supply curve -deadweight loss = sum of loss in consumer and producer surplus = triangle from the intersection of the new price and the demand curve to the intersection of equilibrium supply and demand
Majority Rule
Government policies such as taxation and transfer payments are an example of this type of resource allocation
Per-unit tax on selelrs
Graphically, -a tax on sellers shifts the supply curve up and to the left by the amount of the tax, the new price paid by consumers is now that amount more and a new quantity line is drawn from the intersection of the new supply curve and the demand curve -new consumer surplus is equal to the triangle from the actual price paid up to the demand curve and from the y axis over to the demand curve -new producer surplus is equal to the triangle from the actual price received down to the original supply curve and from the y axis over to the original supply curve -government tax revenue is equal to the rectangle from new price paid by consumers to new price received by producers and from the y axis over to the new quantity line that was drawn down from the intersection of the new supply curve and the demand curve -the deadweight loss is equal to the triangle from the new quantity line that was drawn down from the intersection of the new supply curve and the demand curve, over to the original supply and demand curve at equilibrium Deadweight loss occurs because the increase in government revenue from tax collection does not entirely offset the reduction in consumer and producer surplus. If the demand curve is steeper than the supply curve, then more consumer surplus will be transferred to the government.
Accounting Profits
Includes explicit costs
Aggregating supply and demand functions
Individual supply and demand curves are aggregated into market supply and demand curves. Multiply the individual supply/demand functions and not the individual inverse supply/demand functions. Then take the inverse to get the market supply/demand curves.
What does it mean if Price Elasticity of Demand is less than one in absolute value?
Inelastic
Income Elasticity of Demand < 0 = "negative"
Inferior Good
The market mechanism
Iterating toward equilibrium Excess supply = quantity supplied is greater than quantity demanded, it is the top triangle of the X in the supply and demand graph Excess demand = quantity demanded is greater than the quantity supplied, it is the bottom triangle of the X in the supply and demand graph If the demand curve is downward sloping and the supply curve is upward sloping, the market mechanism will always result in stable equilibrium. When the supply curve is steeper than the demand curve and intersects the demand curve from above (both have negative slopes), equilibrium is dynamically stable. Unstable equilibrium occurs when the market mechanism continues to drag the market away from equilibrium. When the demand curve is steeper than the supply curve and the supply curve intersects the demand curve from below (both have negative slopes), equilibrium is dynamically unstable. Can have multiple equilibria when there is nonlinear supply curves that intersect the demand curve more than once. The price where the supply curve intersects the demand curve from above is the stable equilibrium.
When supply is less elastic than demand- consumers bear higher or lower burden
LOWER, suppliers will bear a higher burden
Income Elasticity of Demand > 1
Luxury Good
Efficient allocation of resources
Marginal Benefit to society (Demand) = Marginal Cost for the "last" unit of each good and service to be produced (Supply). (MC = MB)
Allocation of Resources - Methods
Market Price, Command, Majority Rule, Contest, First-come, First-served, Lottery, Personal Characteristics, Force.
Income Elasticity of Demand
Measures the responsiveness of demand for a particular good to a change in income, all else constant (% Change in Quantity Demanded) / (% Change in Income) OR (change in quantity demanded/change in income) * (change in income/change in quantity demanded) If income elasticity of demand is greater than 1, demand income is elastic and it is a normal good because if income rises, the percentage increase in demand exceeds the percentage change in income and consumers spend a higher proportion on product. If income elasticity of demand is between 0 and 1, demand income is inelastic and it is still normal. As income rises, the percentage increase in demand is less than the percentage change in income and consumers spend a lower proportion on product. If income elasticity is less than 0, the product is an inferior good. As income rises, there is a negative change in demand and the amount spent on the good decreases. Demand curve shifts to the right for normal goods and to the left for inferior goods
Cross Elasticity of Demand
Measures the responsiveness of demand for a particular good to a change in price of another good, all else constant. (% Change in Quantity Demanded) / (% Change in Price of Substitute or Complement) OR (change in quantity demanded/change in price of other good) * (price of other good/change in quantity demanded) positive value => substitutes negative value => complements Substitutes => a high value indicates that products are close substitutes (small price change in one means big demand change in another), numerator and denominator go in same direction so it will always be positive for substitutes Complements => an increase in price of one reduces demand for the other (golf balls and golf course), numerator and denominator go in opposite directions and it will be negative, high negative means close substitutes as a small change in price for one results in significant reduction in demand for another Substitutes => demand curve shifts to the right Complements => demand curve shifts to the left
Four-Firm Concentration Ratio 100%
Monopoly
HHI greater than 1,800
NOT Competitive
0 < Income Elasticity of Demand < 1
Necessity
Income Elasticity for inferior goods- Positive or Negative
Negative
Income elasticity of an Inferior Good- Positive or Negative
Negative
Income Elasticity of Demand > 0 "positive"
Normal Good
Three Methods used to reduce Principal-Agent Problem
OIL 1) Ownership, 2) Incentive Pay, 3) Long-term contracts
Consumer surplus
Occurs when a consumer is able to purchase a good or service for less than the maximum price that a consumer is willing and able to pay for it. It equals the difference between the price that a consumer is willing to pay (indicated by demand curve) and what she actually pays (the market price). Graphically -total value or utility is the trapezoid under the demand curve between the y axis and the total units consumed (draw a line down to x axis where market price intersects demand curve). -total cost is the area of the rectangle that goes from y axis to vertical market price line and the x axis to market price line -consumer surplus is the difference between the two: the triangle above the market price line, between the y axis and the demand curve
Producer surplus
Occurs when a supplier is able to sell a good or service for more than the price she is willing to sell it for. It equals the difference between the market price and the price at which producers are willing to sell their product. Graphically -total revenue equals the area of the rectangle that goes from the x axis up to the market price line and from the y axis to the line drawn down from where the market price line intersects the supply curve -total variable cost (sum of marginal cost of producing each of the units) equals the area from the x-axis up to the supply curve (oddly shaped - not really trapezoid) and from the y axis over to the line drawn from supply curve at market price -producer surplus is the difference between the two, which is the triangle that goes from the market price line down to the supply curve and from the y axis over to the supply curve
Four-Firm Concentration Ratio greater than 60%
Oligopoly
Normal Profit
Opportunity cost of Owners' entrepreneurship expertise. It represents what owners could have earned if they used their organizational decision-making and other entreprenurial skills is another activity such as running another business.
Calculating demand elasticities from demand function
Plug in numbers into the demand function (not inverse) -coefficient of price in demand function = change in quantity demanded/change in price -price = price -quantity demanded at that price is the result of the demand function at that price -coefficient of income in demand function = change in quantity demanded/change in income -income = income -quantity demanded at that income is the result of the demand function at that income level (same answer as above) -coefficient of alternate product price in demand function = change in quantity demanded/change in price of alternate -price of alternate = price of alternate -quantity demanded at that alternate price is the result of the demand function at that alternate price level (same answer as above)
Cross Elasticity of Substitutes- Positive or Negative
Positive
Income Elasticity for normal goods- Positive or Negative
Positive
Normal Goods Elasticity
Positive Income Elasticity (greater than 1)
Quantity Theory of Money Formula
Price = M (V/Y)
On Straight-line Demand Curve - High Elasticity
Price Increase = Revenue Decrease E > 1 (absolute value) E > I -1 I
On Straight-line Demand Curve - Low Elasticity
Price Increase = Revenue Increase E < 1 (absolute value) E < I -1 I Price and Revenue move in the same direction
Principal- Agent Problem
Problems that arise when incentives and motivations or managers and workers (Agents) are not the same as the incentives and motivations of their firms.
Economic Efficiency
Producing a given output at the lowest possible cost
Supply
Refers to the willingness and ability of producers to sell a good or a service at a given price. Producers are willing to supply output as long as the price is at least equal to the cost of producing an additional unit of output (marginal cost). Law of supply states that price and quantity are positively related. Supply function for gasoline: QSg = -150 + 200Pg - 10W -for every 1$ increase in price, the quantity supplied would increase by 200 gallons -for every 1$ increase in the wage rate, the producer would be willing to sell 10 fewer gallons due to increase in marginal cost -P&Q are endogenous variables, W is exogenous Inverse supply function: QSg = -350 + 200Pg => Pg = 1.75 + 0.005QSg -graph of inverse supply function is called the supply curve or the MARGINAL COST CURVE with price on y axis and quantity on x axis -shows highest quantity the seller is willing and able to supply at each price and the lowest price the seller is will to supply at each quantity -slope of supply curve is change in price over change in quantity supplied -changes in price are movements along the supply curve or change in quantity supplied -change in labor costs are a shift in the supply curve or a change in supply Positively sloped
Large Price Increase = Smaller Demand Decrease
Relatively Inelastic, thus total expenditure on the good increases.
Incentive System
Senior mangement creates a system of rewards intended to motivate workers to perform in such a way as to maximize profits [Motivated to do]
Tax on buyers
Similar to tax on sellers, but demand curve is shifted to the left. Deadweight loss occurs because the increase in government revenue from tax collection does not entirely offset the reduction in consumer and producer surplus. If the demand curve is steeper than the supply curve, then more consumer surplus will be transferred to the government.
Implied Rental Rate
Term used to describe the opportunity cost to a firm for using its own capital. Sum of Economic Depreciation and Foregone Interest
Marginal cost
The cost of producing one more unit of output. A producer is willing to supply an additional unit of a product when the price she expects to receive for the unit exceeds its marginal cost, as the excess of price over marginal cost would serve to meet fixed costs and contribute to profits. Typically upward sloping due to law of diminishing marginal returns
Four-Firm Concentration Ratio
The percentage of total industry sales made by the four largest firms in the industry. A highly competitive industry may have a four-firm concentration ratio near zero, while the ratio for monopoly is 100%, < 40% = Competitive Market, >60% is Oiligopy
Demand
The willingness and ability of consumers to purchase a given amount of a good or service at a particular price. The quantity demanded depends primarily on price, but also on income levels, tastes, and preferences, and prices/availability of substitutes and complements. Law of demand states that as the price of a product increases (decreases), consumers will be able to purchase less (more) of it. Demand function for gasoline: QDg = 7.5 - 0.5Pg + 0.1I - 0.05Pa -an increase in price of gas results in a decrease in quantity demanded -an increase in income results in an increase in demand -an increase in the price of automobiles results in a decrease in demand (complements) -P&Q are endogenous variables, I and Pa are exogenous Inverse demand function assuming income and automobiles are constant: QDg = 12 - 0.5Pg => Pg = 24 - 2QDg -graph of the inverse demand function is called the demand curve or MARGINAL VALUE CURVE with Price on the y axis and Q on the x axis -shows maximum quantity of gas demanded at every given price/highest price willing to pay -slope of demand curve is the change in price/change in quantity demanded -change in quantity demanded is a movement along the demand curve in response to price change -change in income or automobile is a shift in the demand curve or a change in demand Negatively sloped
Marginal value (utility)
Total value is reduced when individuals consume quantities that do not yield equal marginal value to each of them. When all consumers face the same price, consumer surplus is maximized when each consumer purchases a quantity that equates her marginal value from the last unit consumed to the market price. Similarly, producer surplus is maximized when each producer supplies a quantity that equates the marginal cost from the last unit supplied to the market price.
What does it mean if Cross elasticity is positive
Two goods are reasonable substitutes for each other
On Straight-line Demand Curve - Greatest Revenue
Unitary Elasticity (E = -1)
Technological Efficiency
Using the least amount of inputs to produce a given output
Marginal Benefit
Utility derived from consumption of the last unit of a good or service, expressed through the price they are willing to pay. It is downward sloping because of the law of diminishing marginal utility, where the utility derived from consumption of the next unit will be lower than the utility derived from consumption of the last unit so pay a lower price. Utility is measured in terms of price that a customer is willing and able to pay for a unit. It also reflects the value of other goods and services that a consumer is willing to forego the consumption of in order to consume one more unit.
