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CFA1: Economics

  • Elasticity: %change in quantity / %change in price
    • also affected by substitutes, proportion of income spent, time passed since last price change
    • If income elasticity > 1, price increase -> total expenditure increase
    • labor demand elasticity // product price, labor intensiveness, substitute capital, lower wage rate
    • demand/supply elasticity detemines proportion of producer/consumer supply loss from higher tax
  • Law of diminishing returns: more resources in production -> increases output at a decreasing rate
  • Price discrimination: two or more identifiable customer groups that have different price elasticities of demand; more gains from the group with inelastic demand(pays higher price)
  • Crowding out effect: reduction in private borrowing and spending as a result of higher interest rates
  • Accounting profit usually overstated because lack of opportunity cost consideration
  • Production decision
    • short-run fixed costs fixed, based on AVC
    • long-run variable costs for different size plants
  • economically efficient = lowest production cost
  • which must be technologically efficient = least input
  • demand of final goods/services ↑ -> price ↑ -> demand for resources(labor) ↑

Industrial organization

MarketNumber of firmsBarriers to entryProduct variationDemand curveProduction levelElasticity
Perfect competitionLotsnonehomogeneoushorizontal(flat)until MC=MR=P, as long as P=MR>MC & P>AVCperfectly elastic
Monopolistic competitionFairly highlowdifferentiateddownwardMR=MC?highly elastic
  • Natural monopoly - when economies of scale are great



  • Unemployed = actively seeking employment
  • minimum wage > equilibrium wage -> excess supply of workers
    • substitutes for labor -> unemployment rises, economic efficiency
  • aggregate hours: total number of hours worked in a year by all employed people

Fiscal policy

  • Laffer curve: higher tax rates can reduce tax revenue
  • unannounced policy: in effect in short-run, no in long-run
    • unannounced decrease in growth rate of money supply -> decrease in output in short-run, lower inflation, but no change in output in the long run

Monetary policy

  • open market operations: most often used, sale/purchase of treasury bonds
  • Automatic stabilizers: built-in features that tend to automatically promote a budget deficit during a recession and a budget surplus during an inflationary boom, without a change in policy
  • Available money supply = bank reserve / reserve requirement
    • Potential deposit expansion multiplier = 1 / reserve ratio
    • required reserves = demand deposits * reserve requirement
    • excess reserves = actual reserves - required reserves
  • money supply ↑ -> aggregate demand ↑ in short term -> new equilibrium at higher price & GDP
  • Quantity theory of money
    • money supply * velocity = price * employment level
    • money supply proportional to price