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Cfa1 3 Economics Notes

Finance Notes > CFA Level 1 Notes

This is an extract of our Cfa1 3 Economics document, which we sell as part of our CFA Level 1 Notes collection written by the top tier of University Of London (examined By LSE) students.

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CFA Level 1

Economics

Elasticity
Price Elasticity of Demand (PED)
 A measure of the responsiveness of quantity demanded to changes in price
 % Change = (New Amount - Old Amount) / Old Amount
 PED = % Change in QD / % Change in P
Inelastic and Elastic Demand
Perfectly Elastic Demand (PED = )
 Horizontal D: QD becomes infinite in response to a tiny change in P
Elastic Demand ( > PED > 1)
 Gentle D: Change in QD > Change in P
Unit Elastic Demand (PED = 1)
 45o D: Change in QD = Change in P
Inelastic Demand (0 < PED < 1)
 Steep D: Change in QD < Change in P
Perfectly Inelastic Demand (PED = 0)
 Vertical D: QD remains constant no matter how P changes
Total Revenue and Elasticity
 Total Revenue (TR) = Total Q sold  P
Price Cut and Elasticity
 Elastic Demand: P, QD, TR
 Inelastic: P, QD, TR
 Unit Elastic: P, QD, TR (No Change)
Price Increase and Elasticity
 Elastic Demand: P, QD, TR
 Inelastic: P, QD, TR
 Unit Elastic: P, QD, TR (No Change)
Factors Affecting PED
 Closeness of Substitutes
 Closeness, Elasticity
1 CFA Level 1

Economics

Proportion of Income Spent on the Good
 Proportion, Elasticity
Time Elapsed since a Price Change
 Time Elapsed, Elasticity
Type of Goods
 Necessities, Inelastic
 Luxuries, Elastic
Gross Elasticity of Demand (CED)
 A measure of responsiveness of demand for Good X to change in the price of Good Y.
 CED = % Change in QD of X / % Change in P of Y
Substitute and Complement
Close Substitute (Large CED)
 P of Y, then QD of X
Substitute (CED > 0)
 P of Y, then QD of X
Unrelated Goods (CED = 0)
 P of Y (Changed), then QD of X (Unchanged)
Complements (CED < 0)
 P of Y, then QD of X
Income Elasticity of Demand (IED)
 A measure of the responsiveness of demand for a good / service to a change in income
 IED = % Change in QD / % Change in Income
Normal and Inferior Goods
Income Elastic (Normal Goods) (IED > 1)
 % Change in QD > % Change in Income
Income Inelastic (Normal Goods) (0 < IED < 1)
2 CFA Level 1

Economics

 % Change in QD < % Change in Income
Negative Income Elastic (Inferior Good) (IED < 0)
 Income, QD
Price Elasticity of Supply (PES)
 A measure of the responsiveness of Q supplied to a change in P
 PES = % Change in QS / % Change in P
Inelastic and Elastic Supply
Perfectly Elastic Supply (PES = )
 Horizontal S: QS becomes infinite in response to a tiny increase in P
Elastic Supply ( > PES > 1)
 Gentle S: Change in QS > Change in P
Unit Elastic Supply (PES = 1)
 45o S: Change in QS = Change in P
Inelastic Supply (0 < PES < 1)
 Steep S: Change in QS < Change in P
Perfectly Inelastic Supply (PES = 0)
 Vertical S: QS remains constant no matter how P changes

 Factors Affecting PES
 Resource Substitution Possibilities
 Substitution Possibility, PES  Close to 0
Rarity of Resources
 Rarity, Substitution Possibility, PES  Close to 0
Time frame for the Supply Decision
 Momentary Supply
 Long-run Supply
 Short-run Supply
Momentary Supply Curve 3 CFA Level 1

Economics

 The response of QS immediately following a change in P.
Long-run Supply Curve
 The response of QS to a change in P after incorporating all available technologies
Short-run Supply Curve
 The response of QS to a change in P after incorporating some available technologies
Calculation Considerations
 Use Average P and Q
 Average = (New Value - Old Value) / 2
Absolute Value of PED
 Measuring magnitude
 Ignore minus sign
Units-free Measure
 Due to the ratio of two percentages
Percentages and Proportions
 Proportionate Change in Q = Change in Q / Average Q
 Proportionate Change in P = Change in P / Average P
 PED = % Change in QD / % Change in P
 PED = (Change in QD / Average Q) / (Change in P / Average P)
Elasticity and Slope
 Elasticity, Slope
Efficiency
Resource Allocation Methods
 Market Price
 People who can pay get the resources
Command System
 By order of someone in authority

Majority Rule 4 CFA Level 1








Economics

Contest
Winner(s) get the resources
First-come First-served (Queue)
Lottery (Luck)
Personal Characteristics (Discrimination)
People with the right characteristics get the resources
Force
War or Legal power enforced by courts

Marginal Benefit (MB) (Demand)
 The value of one more unit of a good or service
 The max price consumers are willing to pay for another unit of the good
 Demand Curve = MB Curve
 Value = what a consumer receives
 Price = what a consumer pays
Marginal Cost (MC) (Supply)
 The cost of producing one more unit of a good / service
 The min. price producers must receive to induce them to sell another unit of good
 Supply Curve = MC Curve
 Cost = what a producer gives up
 Price = what a producer receives
Equilibrium
 Marginal Benefit = Marginal Cost
 Efficient price
 Efficiency Quantity
Consumer Surplus
 The amount consumers benefit from buying a good at a lower price
 = Value (MB) of a good - price paid for the good
Producer Surplus
 The amount producers benefit by selling a good at a higher price
 = Price received for a good - min supply price (MC)
Marginal Social Benefit (MSB)
 Incremental marginal benefit as viewed by the society
 Sum of all marginal external benefit and marginal private benefit

5 CFA Level 1

Economics

Marginal Social Cost (MSC)
 Incremental marginal cost as viewed by the society
 Sum of all marginal external cost and marginal private cost
Inefficiency (MSB ≠ MSC)
 Underproduction: Produce less than can be consumed by society
 Overproduction: Produce more than can be consumed by society
 Both result in deadweight loss
Obstacles to Efficiency
 Price Regulations
 Price Ceiling, Price Floor, Min Wage
Quantity Regulations
 Ration Limit (Demand), Quota Limit (Supply)
Taxes
 QS, Underproduction
Subsidies
 QS, Overproduction
Externalities
 A cost / benefit that affects someone other than the seller / buyer
Public Goods
 Free-rider problem
Common Resources
 Tragedy of commons (exploitation of resources)
Monopoly
 Produce too little and charge too high a price for profit max
High Transactions Costs
 Underproduction
Fairness in Resource Allocation
 It is not fair if the result is considered unfair
 It is not fair if the rules are considered unfair 6 CFA Level 1

Economics

 Fairness is the one that benefits the less well off
Utilitarianism
 To achieve the greatest happiness for the greatest no. of people
 Income must be transferred from the rich to the poor until all are equally rich
Tradeoff between Efficiency and Fairness
 Taxing the rich
 Subsidizing the poor
 The rich work less to reduce the amount being taxed
 Q produced is less than efficient
Symmetry Principle (Moral Principle)
 A requirement that people in similar situations be treated similarly
 Behave toward other people in the way you expect them to behave toward you
Fairness of Rules
 The state must enforce laws that establish and protect private property
 Private property may be transferred only by voluntary exchange
 Anything that blocks voluntary exchange is unfair
Markets in Action
Housing Markets and Rent Ceilings
 Short-run Supply of Housing (SSH)
 Long-run Supply of Housing (LSH)
 Short-run Demand of Housing (SDH)
 Long-run Demand of Housing (LDH)
Perfectly Elastic Short-run Supply of Housing
 Rent > MC, Developers will keep on building
 Rent = MC, Developers will build according to the market demand
 Rent < MC, Developers will stop building
Short-run Effects of Natural Disasters
 Case 1: Damages to Buildings: SSH, Rent
 Case 2: Death of People: SDH, Rent
Long-run Adjustment
 Case 1: Constructions of Buildings: SH, then LSH (Original), Rent (Original)
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