Course Content
TOPICS IN DEMAND AND SUPPLY ANALYSIS
This chapter is covered under Reading 12 of Study Session 4. After reading this chapter, a student shall be able to: a. calculate and interpret price, income, and cross-price elasticities of demand and describe factors that affect each measure; b. compare substitution and income effects; c. distinguish between normal goods and inferior goods; d. describe the phenomenon of diminishing marginal returns; e. determine and describe break-even and shutdown points of production; f. describe how economies of scale and diseconomies of scale affect costs.
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THE FIRM AND MARKET STRUCTURES
This chapter is covered in reading 13 of study session 4 of the material provided by the Institute. After reading this chapter, a student shall be able to: a. describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly; b. explain relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure; c. describe a firm’s supply function under each market structure; d. describe and determine the optimal price and output for firms under each market structure; e. explain factors affecting long-run equilibrium under each market structure; f. describe pricing strategy under each market structure; g. describe the use and limitations of concentration measures in identifying market structure; h. identify the type of market structure within which a firm operates.
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AGGREGATE OUTPUT, PRICES, AND ECONOMIC GROWTH
This chapter is covered in reading 14 of study session 4 of the material provided by the Institute. After reading this chapter, a student shall be able to: a. calculate and explain gross domestic product (GDP) using expenditure and income approaches; b. compare the sum-of-value-added and value-of-final-output methods of calculating GDP; c. compare nominal and real GDP and calculate and interpret the GDP deflator; d. compare GDP, national income, personal income, and personal disposable income; e. explain the fundamental relationship among saving, investment, the fiscal balance, and the trade balance; f. explain the IS and LM curves and how they combine to generate the aggregate demand curve; g. explain the aggregate supply curve in the short run and long run; h. explain causes of movements along and shifts in aggregate demand and supply curves; i. describe how fluctuations in aggregate demand and aggregate supply cause short-run changes in the economy and the business cycle; j. distinguish between the following types of macroeconomic equilibria: long-run full employment, short-run recessionary gap, short-run inflationary gap, and short-run stagflation; k. explain how a short-run macroeconomic equilibrium may occur at a level above or below full employment; l. analyze the effect of combined changes in aggregate supply and demand on the economy; m. describe sources, measurement, and sustainability of economic growth; n. describe the production function approach to analyzing the sources of economic growth; o. distinguish between input growth and growth of total factor productivity as components of economic growth.
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UNDERSTANDING BUSINESS CYCLES
This chapter is covered in reading 15 of study session 4 of the material provided by the Institute. After reading this chapter, a student shall be able to: a. describe the business cycle and its phases; b. describe how resource use, housing sector activity, and external trade sector activity vary as an economy moves through the business cycle; c. describe theories of the business cycle; d. describe types of unemployment and compare measures of unemployment; e. explain inflation, hyperinflation, disinflation, and deflation; f. explain the construction of indexes used to measure inflation; g. compare inflation measures, including their uses and limitations; h. distinguish between cost-push and demand-pull inflation; i. interpret a set of economic indicators and describe their uses and limitations.
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MONETARY AND FISCAL POLICY
This chapter is covered in reading 16 of study session 5 of the material provided by the Institute. After reading this chapter, a student shall be able to: a. compare monetary and fiscal policy; b. describe functions and definitions of money; c. explain the money creation process; d. describe theories of the demand for and supply of money; e. describe the Fisher effect; f. describe roles and objectives of central banks; g. contrast the costs of expected and unexpected inflation; h. describe tools used to implement monetary policy; i. describe the monetary transmission mechanism; j. describe qualities of effective central banks; k. explain the relationships between monetary policy and economic growth, inflation, interest, and exchange rates; l. contrast the use of inflation, interest rate, and exchange rate targeting by central banks; m. determine whether a monetary policy is expansionary or contractionary; n. describe limitations of monetary policy; o. describe roles and objectives of fiscal policy; p. describe tools of fiscal policy, including their advantages and disadvantages; q. describe the arguments about whether the size of a national debt relative to GDP matters; r. explain the implementation of fiscal policy and difficulties of implementation; s. determine whether a fiscal policy is expansionary or contractionary; t. explain the interaction of monetary and fiscal policy.
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INTERNATIONAL TRADE AND CAPITAL FLOWS
This topic is covered under Reading 17 of the study session 5 provided by the institute. The candidate should be able to: a compare gross domestic product and gross national product; b describe benefits and costs of international trade; c distinguish between comparative advantage and absolute advantage; d compare the Ricardian and Heckscher–Ohlin models of trade and the source(s) of comparative advantage in each model; e compare types of trade and capital restrictions and their economic implications; f explain motivations for and advantages of trading blocs, common markets, and economic unions; g describe common objectives of capital restrictions imposed by governments; h describe the balance of payments accounts including their components; i explain how decisions by consumers, firms, and governments affect the balance of payments; j describe functions and objectives of the international organizations that facilitate trade, including the World Bank, the International Monetary Fund, and the World Trade Organization.
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CURRENCY EXCHANGE RATES
This chapter is covered in Reading 18 of the study material provided by the institute. After reading this chapter, the student should be able to: a. define an exchange rate and distinguish between nominal and real exchange rates and spot and forward exchange rates; b. describe functions of and participants in the foreign exchange market; c. calculate and interpret the percentage change in a currency relative to another currency; d. calculate and interpret currency cross-rates; e. convert forward quotations expressed on a points basis or in percentage terms into an outright forward quotation; f. explain the arbitrage relationship between spot rates, forward rates, and interest rates; g. calculate and interpret a forward discount or premium; h. calculate and interpret the forward rate consistent with the spot rate and the interest rate in each currency; i. describe exchange rate regimes; j. explain the effects of exchange rates on countries’ international trade and capital flows.
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Economics
About Lesson

a.  An absolute advantage exists if the country is able to produce a good at a lower cost or use fewer resources.

b.   A comparative advantage exists if the country’s opportunity cost of producing a good is less than its trading partner.

c.  The mechanism through which the concept of comparative advantage works, can be explained with the help of the following example:

     i.  Suppose there are two countries A and B, producing two goods X and Y.

    ii.  The production structure at the given resource level of the two goods in each of the countries is as follows:

 

X

Y

A

4

8

B

2

16

  iii.  We can see that country A can produce more of product X and country B can produce more of product Y.

Therefore, countries A and B have an absolute advantage in the production of product X and Y respectively.

    ivThis means that to produce one unit of product X country A has to give up producing 2 units of product Y. In other words, for country A the opportunity cost of producing one unit of product X is 2 units of product Y.

    v.  Similarly, the opportunity cost of the two products for both the countries is:

 

X

Y

A

2 Y

1/2 X

B

8 X

1/8 Y

    vi.  Here we can see that since countries A and B have the lesser opportunity cost of product X and Y respectively, they have a comparative advantage over the overproduction of these products.

   vii.  In such a situation, if country A can sell one unit of product X for more than two units of product Y, and country B can buy one unit of product X for less than 8 units of product Y, both the countries are at the profit.

  viii.  So a trade-off of product X within the range of 2-8 units of product Y is a win-win situation for both countries.

d.  Consider another example, where one country has the absolute advantage in respect of both the products.

    i.  Suppose there are two countries A and B, producing two goods X and Y.

    ii.  The production structure at the given resource level of the two goods in each of the countries is as follows:

 

X

Y

A

4

8

B

2

6

   iii.  We can see that country A has an absolute advantage in respect of both the goods X and Y, as it can produce more of both of them.

   iv.  The opportunity cost of the two products for both the countries is:

 

X

Y

A

2 Y

1/2 X

B

3 X

1/3 Y

    v.  Here we can see that since countries A and B have the lesser opportunity cost of product X and Y respectively, they have a comparative advantage over the production of these products.

    vi.  In such a situation, if country A can sell one unit of product X for more than two units of product Y, and country B can buy one unit of product X for less than 3 units of product Y, both the countries are at the profit.

   vii.  Thus, it is possible to have a comparative advantage while not having an absolute advantage in producing a good.

e.  The greater the difference between the world price of a good and its autarkic price, the more potential to gain from trade.

f.  A country’s comparative advantage can change over time.

1.1.         Gains from Trade

a.  Considering the same example of country A and B producing products X and Y, the autarkic production and consumption of the two countries and the world is:

Country A

 

PA

PA

X

200

200

Y

400

400

Country B

 

PA

PA

X

100

100

Y

800

800

World

 

PA

PA

X

300

300

Y

1200

1200

b.  Now if the two countries start making use of the comparative advantage and start producing only the product in which it has a comparative advantage then:

     i.  Country A can produce 400 units of product X, and

    ii.  Country B can produce 1600 units of product Y.

   iii.  This will increase the world production and consumption to 400 units of product X, and 1600 units of product Y.

c.  This can be plotted on a graph as follows:

Gains From Trade CFA Level 1 Economics Study Notes

d.  Thus we can see that the production possibility frontier (PPF) has shifted outside after opening up trade opportunities. A higher indifference curve can be attained at this level of PPF.