Economics Notes for CFA Level 1: Unraveling the World of Supply, Demand, and Everything In-Between

In this article, we’ll delve into the Economics topic of the CFA Level 1 exam, walking you through each reading to help you master the art of supply and demand. So, buckle up and get ready to navigate the fascinating landscape of economics!

1. Topics in Demand and Supply Analysis

Welcome to the engaging world of demand and supply analysis, where you’ll delve into the intricacies of price elasticity, the influence of income and substitution effects, the concept of marginal returns, and the dynamics of breakeven and shutdown conditions. You’ll also explore the implications of economies and diseconomies of scale. By the end of this journey, you’ll be able to navigate the complexities of economic behaviors with confidence.

  • Own-Price Elasticity of Demand: Dive into the concept of own-price elasticity, learning about elastic and inelastic demands, and how different factors like substitutes, income, and necessity impact demand.
  • Cross Price and Income Elasticity of Demand: Understand the dynamics of cross-price and income elasticities, and learn how related goods and income levels influence the demand for normal and inferior goods.
  • Substitution and Income Effects: Explore how substitution and income effects influence choices when prices change, familiarize yourself with normal and inferior goods, and learn about exceptions to the law of demand.
  • Marginal Returns and Productivity: Get a grasp on supply analysis, factors of production, and productivity measures, and learn about the three stages of marginal productivity and the concept of diminishing marginal productivity.
  • Breakeven and Shutdown Analysis: Uncover the nuances of breakeven and shutdown conditions, learn to differentiate fixed and variable costs, and apply these principles to real-world business scenarios.
  • Economies and Diseconomies of Scale: Discover the benefits of business expansion, understand the limits of economies of scale, and explore the implications of diseconomies of scale.

2. The Firm and Market Structures

Dive into the captivating world of market structures, their unique characteristics, and their profound impacts on firms. Traverse the terrain of perfect competition, monopolistic competition, oligopoly, and monopoly, while also gaining insights into pricing strategies and methods for measuring market concentration.

  • Characteristics of Market Structure: Learn about the different market structures, their unique characteristics, and their impact on a firm’s strategic decisions.
  • Perfect Competition: Explore the dynamics of perfectly competitive markets, including optimal price and output determination, as well as short-run and long-run equilibrium scenarios.
  • Monopolistic Competition: Understand the world of monopolistic competition, focusing on pricing, production, and the battle among firms with differentiated products.
  • Oligopoly: Delve into the fascinating world of oligopolies, studying their distinct attributes, the interdependence of firms, and key pricing and quantity models.
  • Monopoly: Explore the realm of monopolies, learning about their unique features, pricing methods, criticisms, and the role of government regulation.
  • Pricing Strategy: Gain insights into the pricing strategies employed by different market structures and comprehend the rule for profit maximization.
  • Measuring Market Concentration: Become proficient in calculating market concentration using various methods such as econometric approaches, the N-firm concentration ratio, and the Herfindahl-Hirschman Index.

3. PRE: Aggregate Output, Prices, and Economic Growth

Gather insights into the intriguing world of macroeconomics, focusing on aggregate output, prices, and economic growth. You’ll get to grips with GDP, its components, aggregate demand and supply, macroeconomic equilibrium, and the fundamentals of economic growth.

  • Understanding GDP: Learn the ropes of GDP, including its calculation methods and the distinction between nominal and real GDP, along with the significance of the GDP deflator.
  • Components of GDP: Unearth the core components of GDP, examining the flows of output, income, and expenditure in the economy, and uncovering the correlation among savings, investment, fiscal balance, and trade balance.
  • Aggregate Demand and Aggregate Supply: Gain proficiency in the realm of aggregate demand and supply curves, focusing on different supply curve slopes in varying timeframes.
  • Shifts in Aggregate Demand and Supply: Understand what causes shifts in aggregate demand and supply, and the impact of household, business, monetary, fiscal, and international factors on these dynamics.
  • Macroeconomic Equilibrium: Discover how aggregate demand and supply interact to reach short-run and long-run macroeconomic equilibrium, and the types of fluctuations that can disrupt the economy.
  • Economic Growth and Sustainability: Learn about the key sources of economic growth and the role of labor supply, physical capital stock, human capital, technology, and natural resources in fostering long-term growth and sustainability.

4. Understanding Business Cycles

Embark on a comprehensive journey through the world of business cycles, understanding their phases, theories, and relationship with credit cycles. Further, demystify the concepts of unemployment and inflation, their measurement techniques, and the significance of economic indicators in deciphering business cycle patterns.

  • Overview of the Business Cycle: Gain an understanding of the different phases of business cycles and their influence on various sectors of the economy.
  • Effects on Housing Sector and External Trade: Peek into how housing sector swings and external trade dynamics shift with the business cycle, impacting everything from home buying to global trade flows. 
  • Unemployment: Dive into the realm of unemployment, learning about its various types, how it’s measured, and the impact of discouraged workers on the economy.
  • Inflation: Get to grips with the distinctions between cost-push and demand-pull inflation, and their effects on the wider economy.
  • Measuring Inflation: Familiarize yourself with the diverse methods of measuring inflation, their limitations, and how to navigate these potential biases.
  • Credit Cycles: Unearth the intricate ties between credit and business cycles and their implications for economic expansions, contractions, and investments.
  • Economic Indicators: Explore the world of economic indicators, understanding their types and how they can be used to predict and navigate business cycles.

5. Fiscal Policy

Navigate through the intricate world of fiscal policy, uncovering how these policies shape the economy. Dive into the process of money creation, the dynamics of money demand and supply, and the nuances of inflation.

  • Money and its Creation Process: Uncover the core functions of money, the birth of fractional reserve banking, and the process of money creation, with a look at narrow and broad money.
  • Demand and Supply of Money: Explore the reasons for transaction, precautionary, and speculative demand for money, and delve into the relationship between money supply, money demand, and short-term interest rates.
  • Expected and Unexpected Inflation: Understand the Fisher effect, the difference between expected and unexpected inflation, and their respective costs and effects on the economy.
  • Fiscal Policy: Learn about the objectives of fiscal policy, the concept of budget surpluses and deficits, automatic stabilizers, discretionary fiscal policy, and the lags and limitations associated with implementing fiscal policy.
  • Fiscal Policy Tools: Learn about the tools of fiscal policy including spending tools, direct and indirect taxes, their effects on aggregate demand, and the significance of the fiscal multiplier and balanced budget multiplier.

6. Monetary Policy

Dive into the dynamics of money demand and supply, the roles and tools of central banks, and the practical applications and limitations of monetary and fiscal policies.

  • Roles and Desirable Qualities of the Central Bank: Gain insights into the central bank’s key roles, primary objectives, and essential qualities for maintaining economic stability and controlling inflation.
  • Monetary Policy Tools: Discover the tools used by central banks to implement expansionary and contractionary policies, understand the monetary transmission mechanism, and learn about the limitations of monetary policy.
  • Limitations of Monetary Policy: Unearth the limitations of monetary policy, from long-term market interest rates to liquidity traps, and understand the challenges of addressing deflation and the role of quantitative easing.
  • Interaction Between Monetary and Fiscal Policy: Explore the relationship between monetary and fiscal policies, their impact on aggregate demand, and possible scenarios when they work in tandem.

7. Introduction to Geopolitics

Navigate the intriguing world of geopolitics, its profound impact on the global economy, and its ripple effects on financial markets. Understand the dynamics of geopolitical interactions, globalization, and the various tools and risks associated with geopolitics.

  • Geopolitical Interactions and Globalisation: Learn about the dynamics of geopolitics, including the roles of state and non-state actors, the influence of cultural factors, and the connection to globalization, as well as its pros and cons.
  • Trade Organisations: Learn about the roles and objectives of prominent trade organizations such as the IMF, World Bank, and WTO, and their influence on global trade and economic development.
  • Geopolitics: Tools and Risks: Understand the range of geopolitical tools at a nation’s disposal, how to analyze different types of geopolitical risks, and their significance in investment decision-making.

8. International Trade and Capital Flows

Venture into the compelling world of international trade and capital flows, learning about the dynamics of imports, exports, trade and capital restrictions, and agreements. Also, get acquainted with the balance of payments system and the role of major trade organizations in the global economic landscape.

  • International Trade: Delve into the mechanics of international trade, including protection measures, the principles of absolute and comparative advantage, and key trade models.
  • Benefits and Costs of Trade: Uncover the double-edged sword of international trade, exploring how it fosters economic growth and innovation while posing risks of income inequality and industry upheaval.
  • Trade Restrictions and Trade Agreements: Explore the realm of trade restrictions and agreements, and understand their economic effects and the rationale behind their use.
  • Balance of Payments: Dive into the balance of payments system, understanding its components, its connection with national economic accounts, and the significance of trade deficits and surpluses.

9. Capital Flows and the FX Market, Exchange Rate Calculations

Exchange rates form the backbone of international financial transactions, from basic forex trading to complex policy implications. This comprehensive guide breaks down the intricacies of foreign and forward exchange rates, various regimes, and the interplay with international trade and capital flows.

  • Foreign Exchange Rates: Unpack the complexities of currency exchange rates, covering the essentials through to nuanced concepts such as direct and indirect quotes, and the calculation of cross rates.
  • Exchange Rate Regimes: Explore the spectrum of exchange rate regimes, including the mechanisms of formal dollarization and monetary unions, and their implications on a country’s monetary policy execution.
  • Exchange Rates, International Trade, and Capital Flows: Examine the impact of exchange rates on international trade and capital flows, encompassing theories like the elasticities and absorption approaches, and key concepts like the Marshall-Lerner condition and J-curve effect.
  • Capital Restrictions: Discover the concept of capital restrictions, their economic implications, and the reasons behind their enforcement.
  • Forward Exchange Rates: Delve into the specifics of spot and forward rates, including premiums, discounts, and the interplay of arbitrage, while getting familiar with the foreign exchange market’s dynamics.

Wrapping Up: Conquering Economics for CFA Level 1

And there you have it – a comprehensive overview of the Economics topic in the CFA Level 1 exam! Remember to stay curious, practice plenty of questions, and embrace the fascinating world of economics. After all, who said economics couldn’t be a thrilling rollercoaster ride? Good luck, and may your newfound economic prowess pave the way to CFA success!