CFA (Chartered Financial Analyst) Economics Syllabus

Explain the kinked demand curve model of oligopoly.

It assumes rivals match price cuts but not price increases. So above the prevailing price demand is elastic (raising price loses many customers) and below it demand is inelastic. The kink creates a discontinuity in marginal revenue, so prices tend to be rigid (sticky) even when costs change.

Define a Nash equilibrium in the context of oligopoly.

A Nash equilibrium is a set of strategies in which no firm can improve its payoff by unilaterally changing its own strategy, given the strategies of the other firms. It is the standard solution concept for strategic interaction such as the prisoner's-dilemma pricing game among oligopolists.

What are the defining characteristics of a monopoly?

A single seller of a product with no close substitutes, high barriers to entry (e.g. control of resources, patents, network effects, natural monopoly cost structure), and the firm is a price maker facing the market (downward-sloping) demand curve.

How does a monopolist choose price and output, and how does it relate to demand elasticity?

A monopolist produces where $MR = MC$, then sets price from the demand curve above that quantity, so $P > MR = MC$. A profit-maximizing monopolist always operates on the elastic portion of demand ($|E_{p}| > 1$), since $MR = P\left(1 - \frac{1}{|E_{p}|}\right)$.

Define price discrimination and the conditions required for it.

Price discrimination is charging different prices to different customers for the same good. It requires (1) a downward-sloping demand curve / market power, (2) at least two consumer groups with different price elasticities that can be identified, and (3) the ability to prevent resale (no arbitrage). First-degree discrimination captures all consumer surplus.

How are the Concentration Ratio and the Herfindahl-Hirschman Index (HHI) computed, and what do they measure?

Both measure market concentration. The N-firm concentration ratio sums the market shares of the largest N firms (e.g. CR4). The HHI sums the squared market shares: $$HHI = \sum_{i=1}^{N} s_{i}^{2}$$ where $s_i$ is each firm's percentage share. HHI better reflects market power because it weights larger firms more heavily; a monopoly gives $HHI = 10{,}000$.

What is the Lerner Index and what does it measure?

The Lerner Index measures monopoly (market) power as the markup of price over marginal cost relative to price: $$L = \frac{P - MC}{P} = \frac{1}{|E_{p}|}$$ It ranges from 0 (perfect competition) toward 1 (greater market power).

Define GDP and state the two main approaches to measuring it.

GDP is the total market value of all final goods and services produced within a country in a given period. It can be measured by the expenditure approach (summing spending on final output) or the income approach (summing incomes earned in production); both yield the same total.

State the expenditure-approach equation for GDP.

$$GDP = C + I + G + (X - M)$$ where $C$ is consumption, $I$ is gross private investment, $G$ is government spending, $X$ is exports and $M$ is imports, so $(X-M)$ is net exports.

Distinguish nominal GDP, real GDP, and the GDP deflator.

Nominal GDP values output at current prices; real GDP values output at base-year (constant) prices, removing inflation. The GDP deflator links them: $$\text{GDP deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$$

Write the Cobb-Douglas production function and the equation for the sources of economic growth (growth accounting).

Cobb-Douglas: $Y = A\,K^{\alpha} L^{1-\alpha}$, where $A$ is total factor productivity, $K$ capital, $L$ labor. Growth accounting: $$\frac{\Delta Y}{Y} = \frac{\Delta A}{A} + \alpha\frac{\Delta K}{K} + (1-\alpha)\frac{\Delta L}{L}$$

What is potential GDP and what is the output gap?

Potential GDP is the maximum sustainable output of an economy at full employment without accelerating inflation. The output gap = actual GDP $-$ potential GDP. A positive gap signals inflationary pressure; a negative gap signals an underperforming economy with unemployment above the natural rate.

Name the four phases of the business cycle.

Expansion (rising activity, output growth, falling unemployment), peak (the top of the cycle), contraction/recession (falling output, rising unemployment), and trough (the bottom, before recovery begins). A common definition of recession is two consecutive quarters of declining real GDP.

How do inventories and unemployment behave across the business cycle?

In an early downturn, unplanned inventories rise as sales fall; firms then cut production. Near a trough, inventories fall to low levels before production recovers. Unemployment is a lagging indicator: it keeps rising after a trough and keeps falling after a peak. The inventory-sales ratio is watched as a cycle signal.

What is the credit cycle and how does it interact with the business cycle?

The credit cycle describes the expansion and contraction of credit availability and cost over time. Credit tends to expand during economic upswings (easy lending, rising asset prices) and contract sharply in downturns (tighter lending, defaults), amplifying business-cycle swings. Credit cycles are typically longer and larger in amplitude than business cycles.

Define the three main types of unemployment.

Frictional: short-term unemployment from people transitioning between jobs. Structural: a mismatch between workers' skills/locations and available jobs (longer-lasting). Cyclical: unemployment caused by the business cycle (rises in recessions, falls in expansions). Frictional + structural make up the natural rate of unemployment.

Define the labor force participation rate and the unemployment rate.

$$\text{Participation rate} = \frac{\text{Labor force}}{\text{Working-age population}}, \quad \text{Unemployment rate} = \frac{\text{Unemployed}}{\text{Labor force}}$$ The labor force = employed + unemployed (actively seeking work). Discouraged workers are excluded, so the official rate can understate joblessness.

Distinguish the CPI and the GDP deflator as inflation measures.

The CPI measures the price of a fixed basket of consumer goods (a Laspeyres-type index, so it can overstate inflation due to substitution bias). The GDP deflator covers all domestically produced goods and uses current-period quantities. CPI includes imported consumer goods; the deflator does not.

Distinguish cost-push from demand-pull inflation.

Demand-pull inflation arises from excess aggregate demand pulling prices up (too much money chasing too few goods). Cost-push inflation arises from rising input costs (e.g. wages or commodity prices) pushing up the price level, often with falling output (stagflation).

What are headline versus core inflation, and what are leading, coincident, and lagging indicators?

Headline inflation includes all items; core inflation excludes volatile food and energy prices to reveal the underlying trend. Leading indicators (e.g. stock prices, building permits, yield curve) change before the economy; coincident indicators (e.g. industrial production) move with it; lagging indicators (e.g. unemployment rate, CPI) change after it.

Explain the Phillips curve and the role of expectations.

The short-run Phillips curve shows an inverse relationship between unemployment and inflation. In the long run there is no trade-off: the curve is vertical at the natural rate of unemployment (NAIRU), because inflation expectations adjust. Attempts to push unemployment below the natural rate only accelerate inflation.

Distinguish monetary policy from fiscal policy.

Monetary policy is conducted by the central bank and manages the money supply and interest rates to influence the economy. Fiscal policy is conducted by the government and uses taxation and government spending. Monetary policy has short implementation lags but long impact lags; fiscal policy has the reverse.

State the Quantity Theory of Money equation and its implication.

$$M \times V = P \times Y$$ where $M$ is money supply, $V$ velocity, $P$ the price level, and $Y$ real output. If $V$ and $Y$ are stable, growth in $M$ translates directly into inflation ($P$) — the monetarist view that inflation is a monetary phenomenon.

What are the main tools of monetary policy?

(1) Open market operations (buying/selling government securities), (2) the policy/discount rate (the rate at which banks borrow from the central bank), and (3) reserve requirements (the fraction of deposits banks must hold). Buying securities, cutting rates, or lowering reserve requirements are expansionary.

List the primary roles of a central bank.

A central bank typically: issues currency (monopoly on supply), acts as banker to the government and to commercial banks, serves as lender of last resort, regulates and supervises the banking/payment system, manages foreign-exchange and gold reserves, and conducts monetary policy to achieve price stability (and often full employment).

How does the money multiplier create money, and what is its formula?

When a central bank adds reserves, banks lend out excess reserves, which are redeposited and re-lent, multiplying the money supply. With reserve requirement $r$, the simple money multiplier is $$\text{Money multiplier} = \frac{1}{r}$$ so total deposits can expand by (new reserves) $\times \frac{1}{r}$.

What is the neutral (equilibrium) real interest rate, and what makes policy expansionary or contractionary?

The neutral real rate is the rate that neither stimulates nor restrains the economy when output is at potential. Policy is expansionary when the real policy rate is below neutral and contractionary when above. Some central banks follow a Taylor-rule-type guideline linking the target rate to inflation and the output gap.

What are the limitations of monetary policy, including the liquidity trap?

Monetary policy can fail when interest rates approach zero (a liquidity trap), where further easing does not stimulate spending. It also relies on bank willingness to lend and on stable money demand/velocity. Long and variable lags, and the risk of deflationary expectations becoming entrenched, further limit effectiveness.

Distinguish automatic stabilizers from discretionary fiscal policy.

Automatic stabilizers (progressive taxes, unemployment benefits) adjust without new legislation, cushioning the cycle automatically. Discretionary fiscal policy requires deliberate government action to change spending or taxes. Stabilizers act quickly; discretionary policy suffers recognition, action, and impact lags.

Explain how monetary and fiscal policy interact, including crowding out.

Policies can reinforce or offset each other. Expansionary fiscal policy financed by borrowing can raise interest rates and crowd out private investment, partly offsetting the stimulus. Coordinated easy money plus loose fiscal policy is most expansionary; tight money plus loose fiscal favors high rates with large deficits. The Ricardian equivalence hypothesis argues deficit-financed spending may be offset by increased private saving.

State the gains-from-trade principle and the difference between absolute and comparative advantage.

Absolute advantage: a country can produce a good using fewer resources than another. Comparative advantage: a country can produce a good at a lower opportunity cost than another. Trade benefits both partners when each specializes according to comparative advantage, even if one has an absolute advantage in everything (Ricardian model).

Distinguish tariffs, quotas, and voluntary export restraints, and their welfare effects.

A tariff is a tax on imports (raises government revenue, raises domestic price). A quota is a quantity limit on imports (the quota rent accrues to license holders/foreign exporters). A voluntary export restraint (VER) is a self-imposed export limit by the exporting country. All restrict trade, raise domestic prices, and create deadweight losses.

What is the difference between a free trade area, a customs union, and a common market?

A free trade area removes tariffs among members but each keeps its own external tariffs (e.g. NAFTA/USMCA). A customs union adds a common external tariff. A common market further allows free movement of labor and capital. Deeper still are an economic union (common economic policy) and monetary union (common currency).

What are the three main accounts of the balance of payments?

(1) The current account (trade in goods and services, income, and current transfers), (2) the capital account (capital transfers and non-produced/non-financial assets), and (3) the financial account (cross-border investment flows). In principle the accounts sum to zero: a current account deficit is financed by a financial account surplus.

Name the major international trade and financial organizations and their roles.

The World Trade Organization (WTO) administers trade agreements and resolves disputes. The International Monetary Fund (IMF) promotes monetary cooperation, exchange-rate stability, and provides balance-of-payments support. The World Bank provides development financing and technical assistance to lower-income countries.

Distinguish a direct from an indirect exchange-rate quote and a nominal from a real exchange rate.

A direct quote gives domestic currency per unit of foreign currency (price currency = domestic); an indirect quote is the reciprocal. The real exchange rate adjusts the nominal rate for relative price levels: $$\text{Real rate} = \text{Nominal rate} \times \frac{P_{foreign}}{P_{domestic}}$$ measuring relative purchasing power and competitiveness.

Distinguish currency appreciation/depreciation under floating regimes from revaluation/devaluation under fixed regimes.

Under a floating regime, market forces cause appreciation (a rise) or depreciation (a fall) in a currency's value. Under a fixed/pegged regime, the authorities deliberately change the peg: revaluation raises the official value, devaluation lowers it. A depreciating domestic currency makes exports cheaper and imports dearer.

Define spot and forward exchange rates, and explain a forward premium or discount.

The spot rate is for immediate (T+2) delivery; the forward rate is agreed today for settlement on a future date. If the forward rate exceeds the spot rate, the base currency trades at a forward premium; if below, at a forward discount. Forward points are quoted as adjustments to the spot rate.

State the covered interest rate parity formula for the forward rate.

Covered interest rate parity (no-arbitrage) gives the forward rate (price/base) as $$F = S \times \frac{1 + i_{price}}{1 + i_{base}}$$ where $S$ is the spot rate and $i_{price}, i_{base}$ are the interest rates of the price and base currencies for the period. The higher-yielding currency trades at a forward discount.

How do you compute a cross rate from two exchange rates with a common currency?

A cross rate is an exchange rate between two currencies derived through a common third currency (often USD). For example, to get GBP/EUR from USD/GBP and USD/EUR: $$\frac{\text{EUR}}{\text{GBP}} = \frac{\text{USD/GBP}}{\text{USD/EUR}}$$ Align the quotes so the common currency cancels, multiplying or dividing as needed.