CFA Economics Syllabus

Compare the four market structures on number of firms, product type, and pricing power.

Perfect competition: many firms, identical product, no pricing power (price taker). Monopolistic competition: many firms, differentiated product, some pricing power. Oligopoly: few firms, identical or differentiated product, considerable interdependent pricing power. Monopoly: one firm, unique product with no close substitutes, significant pricing power.

Why does a monopolist's marginal revenue lie below its price, and what is the MR expression?

To sell more, a monopolist (single-price) must lower price on all units, so $MR < P$. With inverse demand $P = a - bQ$, total revenue is $TR = aQ - bQ^2$ and $MR = \frac{dTR}{dQ} = a - 2bQ$, twice as steep as demand.

Give the profit-maximizing markup relationship (Lerner index) for a firm with pricing power.

$\frac{P - MC}{P} = -\frac{1}{E_p}$, so the optimal price is $P = \frac{MC}{1 + \frac{1}{E_p}}$. More elastic demand (larger $|E_p|$) implies a smaller markup over marginal cost.

What is the defining short-run vs long-run outcome of monopolistic competition?

In the short run a firm can earn economic profit or loss. In the long run, free entry and exit drive economic profit to zero, so demand is tangent to $ATC$; the firm produces where $P = ATC > MC$, leaving excess capacity and producing below minimum-ATC output.

Describe the kinked-demand-curve model of oligopoly.

It assumes rivals match price cuts but ignore price increases, so demand is elastic above the current price and inelastic below it, producing a kink. The MR curve has a vertical gap at the kink, so marginal cost can shift within that gap without changing the profit-maximizing price, explaining price rigidity.

In the Cournot duopoly model, what is being chosen and what characterizes equilibrium?

Firms simultaneously choose quantities, treating the rival's output as fixed. Cournot (Nash) equilibrium occurs where each firm's output is a best response to the other's, yielding total output and price between the perfectly competitive and monopoly outcomes.

Define a Nash equilibrium in the context of oligopoly strategy.

A Nash equilibrium is a set of strategies, one per firm, in which no firm can increase its payoff by unilaterally changing its own strategy given the strategies of the others; each player's choice is a best response to the others'.

Name three common measures of market concentration and one weakness of the simplest one.

The N-firm concentration ratio, the Herfindahl-Hirschman Index (HHI), and (broadly) elasticity-based measures. Weakness of the concentration ratio: it ignores mergers among firms already in the top N and is insensitive to the size distribution outside the top N.

How is the Herfindahl-Hirschman Index (HHI) calculated and interpreted?

$HHI = \sum_{i=1}^{N} s_i^{2}$, where $s_i$ is each firm's market share expressed in percent (or as a fraction). Higher values indicate greater concentration; a monopoly gives $HHI = 10{,}000$ (percent basis) or $1$ (fraction basis).

State the components of aggregate expenditure (GDP by the expenditure approach).

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

Why does the aggregate demand curve slope downward?

A lower price level raises real wealth (real balance/wealth effect), lowers interest rates raising investment (interest rate effect), and makes domestic goods cheaper abroad raising net exports (real exchange rate effect); together these raise real output demanded as the price level falls.

Distinguish movements along AD from shifts of AD.

A change in the price level causes a movement along the AD curve. AD shifts when a non-price determinant changes: consumer/business confidence, wealth, fiscal policy ($G$, taxes), monetary policy/interest rates, exchange rates, or foreign income affecting net exports.

Contrast the shape of the short-run and long-run aggregate supply curves.

Short-run aggregate supply (SRAS) slopes upward because some input prices (especially wages) are sticky, so higher output prices raise profits and output. Long-run aggregate supply (LRAS) is vertical at potential (full-employment) real GDP, because all prices adjust and output is set by resources and technology.

What distinguishes demand-pull from cost-push inflation in the AD-AS framework?

Demand-pull inflation arises from a rightward shift of AD (excess demand) pushing the price level and output up. Cost-push inflation arises from a leftward shift of SRAS (rising input costs), raising the price level while lowering output (stagflation).

Describe the self-correcting mechanism that returns an economy from a recessionary gap to long-run equilibrium.

In a recessionary gap (real GDP below potential), high unemployment eventually lowers wages and other input costs, shifting SRAS rightward until output returns to potential ($LRAS$) at a lower price level. An inflationary gap corrects in reverse as costs rise and SRAS shifts left.

Define the spending (expenditure) multiplier for a closed economy with lump-sum taxes.

The multiplier is $\frac{1}{1 - MPC} = \frac{1}{MPS}$, where $MPC$ is the marginal propensity to consume and $MPS = 1 - MPC$ is the marginal propensity to save. An autonomous spending change $\Delta A$ changes equilibrium output by $\frac{1}{1-MPC}\Delta A$.

What is the tax multiplier and how does it compare to the spending multiplier?

$\text{Tax multiplier} = \frac{-MPC}{1 - MPC}$. It is negative (a tax cut raises output) and smaller in absolute value than the spending multiplier $\frac{1}{1-MPC}$, because part of a tax change is absorbed by saving rather than spent.

State the equation of exchange and what the quantity theory of money assumes.

$M \cdot V = P \cdot Y$, where $M$ is money supply, $V$ is velocity, $P$ is the price level, and $Y$ is real output. The quantity theory assumes $V$ and $Y$ are relatively stable in the long run, so changes in $M$ map directly into changes in $P$ (money is neutral in the long run).

List the three traditional tools of monetary policy and how a central bank uses them to ease policy.

(1) Open market operations (buy securities to inject reserves), (2) the policy/discount rate (lower it to encourage borrowing), and (3) reserve requirements (lower them to expand lending capacity). All three increase the money supply and lower short-term interest rates when easing.

How is the simple money multiplier defined and what is the deposit expansion it implies?

With reserve requirement $r$, the money multiplier is $\frac{1}{r}$, so an increase in reserves of $\Delta R$ can expand the money supply by $\frac{1}{r}\,\Delta R$ under full lending and no cash leakage.

State the Fisher equation linking nominal and real interest rates.

$(1 + i) = (1 + r)(1 + \pi^{e})$, approximated as $i \approx r + \pi^{e}$, where $i$ is the nominal rate, $r$ the real rate, and $\pi^{e}$ expected inflation. The nominal rate also embeds a risk premium in practice.

Define the neutral (natural) policy rate and what it implies for a central bank's stance.

The neutral rate is the policy rate consistent with stable inflation and output at potential; approximately $r_{neutral} = r_{real,trend} + \pi_{target}$. Setting the policy rate below neutral is expansionary; above neutral is contractionary/restrictive.

What conditions limit the effectiveness of monetary policy?

Effectiveness is limited by the liquidity trap (rates near the zero bound so further easing has little effect), banks unwilling to lend or firms/households unwilling to borrow, unstable money demand/velocity, and long and variable policy lags. Deflation with rate expectations can also blunt policy.

Distinguish automatic stabilizers from discretionary fiscal policy.

Automatic stabilizers (progressive taxes, unemployment benefits) adjust with the business cycle without new legislation, dampening fluctuations. Discretionary fiscal policy is deliberate legislated change in spending or taxes to influence the economy.

Contrast recognition, action, and impact lags for fiscal versus monetary policy.

Fiscal policy typically has long recognition and action (implementation) lags due to the legislative process but works relatively directly once enacted. Monetary policy can be decided quickly (short action lag) but has a longer, more uncertain impact lag as rate changes filter through the economy.

State the theory of comparative advantage and its basis.

A country should specialize in and export goods it can produce at a lower opportunity cost than trading partners, even if it has no absolute advantage. Trade based on comparative advantage allows both countries to consume beyond their production possibilities, raising total output.

Differentiate absolute advantage from comparative advantage.

Absolute advantage means producing a good using fewer resources (higher productivity) than another country. Comparative advantage means producing a good at a lower opportunity cost. Gains from trade depend on comparative, not absolute, advantage.

Compare a tariff and a quota in their effects on a domestic market.

A tariff is a tax on imports that raises the domestic price, reduces imports, generates government revenue, and creates deadweight loss. A quota is a quantity limit on imports with similar price/quantity effects but the extra rent (quota rents) accrues to license holders or foreign exporters rather than to government revenue.

List the main components of the balance of payments and their sign conventions.

The current account (trade in goods and services, net income, net transfers), the capital account (capital transfers, non-produced assets), and the financial account (cross-border investment flows). Under ideal accounting, $\text{Current account} + \text{Capital account} + \text{Financial account} = 0$.

State how a nominal exchange rate quote is read and how to compute the real exchange rate.

A quote of $P/B$ means the price of one unit of the base currency $B$ in terms of the price currency $P$; a rise means $B$ appreciates. The real exchange rate adjusts for relative price levels: $S_{real} = S_{nominal}\cdot\frac{P_{foreign}}{P_{domestic}}$, measuring relative purchasing power/competitiveness.