# Level 1. Economics (ECO) If you can handle the following items from SS 4, you should be in good shape for the exam.

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1 Level 1 SS4 Economics (ECO) Expect to see 24 questions that relate to ECO SS 4, SS 5 and SS 6 Only 8 questions from each study session! If you can handle the following items from SS 4, you should be in good shape for the exam. 1. Calculate and interpret various elasticity measures 2. Calculate and interpret consumer surplus, producer surplus and total surplus 3. Differentiate between a shift of a curve and a movement along a curve 4. Calculate and interpret surplus and shortage 5. Be able to describe the effect of a price ceiling and price floor on price and quantity 6. Be able to describe consumer choice theory and utility theory 7. Calculate and interpret a budget constraint 8. Differentiate between normal, inferior, Giffen and Veblen goods 9. Differentiate between accounting profit and economic profit 10. Be able to identify increasing vs. decreasing marginal productivity 11. Be able to explain economies and diseconomies of scale 12. Know the characteristics of the various cost curves 13. Know the characteristics of the various market structures 14. Know the profit maximizing output level for various market structures Exam Preparation & Investment Sales Training 1

2 Demand and Supply Analysis: Introduction Factor Markets markets for raw materials used to make finished goods Goods Markets markets for final goods and services Capital Markets users and suppliers of financial capital (Stock and Bond Markets) Shifts and Movements Along Curves 1) Change in Quantity Demanded ( Qd) movement along the curve 2) Change in Demand ( D) shift of the curve Inverse Demand and Supply Functions 1. An analyst is working with the following equation, Qd = Px. If she rearranges it to solve for Px in terms of Qx, she would most likely produce: A. Px = Qx B. Px = Qx C. Px = Qx Equilibrium Example: Given: I = 2,300, W = 10, Py = 21.4 Qd = 2, Px + 0.5I + 150Py Qs = Px 60W Price Qd Exam Preparation & Investment Sales Training 2

3 Government Intervention: Surplus and Shortage 2. A rent ceiling that is effective results in: A. an increase in the supply of housing B. a shortage of housing C. helping the poor D. more housing supplied than demanded Consumer Surplus, Producer Surplus and Total Surplus 3. People receive a consumer surplus in a market transaction if the good's: A. marginal social cost exceeds its price. B. value exceeds its price. C. price exceeds its value. D. price exceeds its marginal social cost. Price (P) Given: Qd = 180 2P and Qs = P S D 50 Quantity (Q) Exam Preparation & Investment Sales Training 3

4 Elasticities: 1) Own Price: e = % Qd / P = ( Qd / P) (P/Qd) 2) Income: e = % Qd / I = ( Qd / I) (I/Qd) Income elasticity will be positive for normal goods Income elasticity will be negative for inferior goods 3) Cross Price: e = % Qdx / Py = ( Qdx / Py) (Py/Qdx) cross price elasticity will be positive for substitute goods cross price elasticity will be negative for complementary goods Use the following information to answer the next 3 questions. An analyst is working with the following equation, Qd = Px + 0.8I + 0.9Py. Assume Px = 38, I = 100 and Py = Based on the information given above, the price elasticity of demand is closest to: A B C. 0.6 D Based on the information given above, the income elasticity is closest to: A. 0.5 B. 0.8 C. 1.3 D Based on the information given above, the cross price elasticity for good X with respects to good Y is closest to: A. 0.3 B C. 3.9 D Exam Preparation & Investment Sales Training 4

5 Consumer Choice Theory and Utility Theory Demand and Supply Analysis: Consumer Demand Consumer choice theory relationship between consumer demand curves and consumer preferences Utility theory quantitative model of consumer preferences Assumptions: 1. complete preferences able to make a choice 2. transitive preferences preference follows logic! 3. non-satiation always want more Good b Budget Constraint: I = (Pa)(Qa) + (Pb)(Qb) or Qb = (I/Pb) (Pa/Pb)(Qa) Good a Marginal Rate of Substitution amount of good a you are willing to give up, to get more good b If MRSab > Pa/Pb, we have positive consumer surplus, buy more of good a If MRSab < Pa/Pb, we have negative consumer surplus, buy less of good a (don t buy a, buy good b) When MRSab = Pa/Pb, we are at the consumer s equilibrium bundle of goods Exam Preparation & Investment Sales Training 5

6 Law of Demand The Demand curve slopes downward due to the income and substitution effects Normal Good income and substitution reinforce each other Inferior Good income effect offsets part or all of the substitution effect Giffen Good Inferior good, the income effect is so overwhelming that the demand curve is positively sloped Veblen Good Not an inferior good, but demand curve is positively sloped ultra luxury item Good b BC 1 BC 2 Good a Exam Preparation & Investment Sales Training 6

7 7. A consumer s income is \$500, the price of food (F) is \$2 per unit, and the price of shelter (S) is \$100. Which of the following represents the consumer s budget constraint? A. 500 = 100Q F + 2Q S B. 500 = 2Q F + 100Q S C. Q S = 500 2Q F 8. A consumer s income is \$500, the price of food (F) is \$2 per unit, and the price of shelter (S) is \$100. Which of the following represents the consumer s marginal rate of substitution of food for shelter (MRS FS )? A. 5 B. 50 C An analyst would be most likely to conclude that a Giffen good has: A. a positive substitution effect. B. a negative income effect. C. a larger income effect than substitution effect. D. all of the above characteristics. 10. You have been asked to analyze the following statements: I. regarding normal goods, demand curves always slope downward. II. regarding normal goods, the income effect and substitution effect are in the same direction. Based on this information, you would most likely conclude that: A. only statement I is correct B. both statements are incorrect C. both statements are correct Exam Preparation & Investment Sales Training 7

8 Solutions: 1. X Solutions to the questions can be found on our Level 1 Test Bank. The Level 1 Test Bank contains over 1,000 CFA exam style questions. The cost of the Test Bank is only \$99 (+tax) To gain access, simply click on the Buy Now below and you will be taken to our ecommerce/paypal site where you can complete the transaction. Thank you. Best of luck with your studies! Exam Success Buy Now Exam Preparation & Investment Sales Training 8

9 Accounting Profit vs. Economic Profit Economic Profit Example: Demand and Supply Analysis: The Firm Sheila s Sports Shop is a very popular sporting goods store, which has annual revenue of \$600,000. Sheila runs the business herself. Her alternative employment options are to be a College swimming coach for \$50,000 per year or a construction worker for \$40,000 per year. Sheila spends \$230,000 purchasing goods for resale to her customers. She also has four employees, who each earn \$25,000 per year. Sheila owns the building that her Sports Shop is housed in, after remodeling it she could have rented it out for \$20,000 per year. Calculate Sheila s economic profit. Economic Rent amount required by the owner of a resource to give up that resource for use Factors of Production 1. Land 2. Labour 3. Capital 4. Raw Materials Total Revenue (TR), Average Revenue and Marginal Revenue (MR) Maximum TR occurs at the point where MR = 0 Average revenue is equal to price and is represented by the Demand curve! Total Cost (TC), Average Cost (ATC), Marginal Cost (MC), Fixed Cost and Variable Cost Marginal cost curve crosses the ATC and AVC curves at their minimum points Breakeven Price occurs at the minimum of the ATC curve Shutdown Price occurs at the minimum of the AVC curve Price MC ATC Breakeven AVC Shutdown Quantity Exam Preparation & Investment Sales Training 9

10 Total Product (TP), Average Product (AP) and Marginal Product (MP) TP AP MP Labour Labour Short Run a time period in which at least one input factor of production is held constant (fixed) Long Run a time period in which all input factors can change Diminishing (Marginal) Returns a short run concept Decreasing Return to Scale a long run concept Economies of Scale the percentage increase in output is greater than the percentage increase in Cost Diseconomies of Scale the percentage increase in output is less than the percentage increase in Cost Profit Maximizing Level of Output occurs at the point where marginal revenue is equal to marginal cost Marginal Revenue Product (MRP) the marginal product of an input multiplied by the price of that input Profit Maximization occurs when the MRP equates to the price of the input for each type of resource: MRP 1 /P 1 = MRP 2 /P 2 =.. = MRP n /P n Rule: If MRP > Cost, profit will increase, therefore use more of that resource If MRP < Cost, profit will decrease, therefore use less of that resource Exam Preparation & Investment Sales Training 10

11 This is a placeholder for practice questions included in the weekly study program notes. These questions can be found on our Level 1 Test Bank. The Level 1 Test Bank contains over 1,000 CFA exam style questions. The cost of the Test Bank is only \$99 (+tax) To gain access, simply click on the Buy Now below and you will be taken to our ecommerce/paypal site where you can complete the transaction. Thank you. Best of luck with your studies! Exam Success Buy Now Exam Preparation & Investment Sales Training 11

12 The Firm and Market Structures Pure Competition Monopolistic Competition Exam Preparation & Investment Sales Training 12

13 Monopoly Oligopoly Exam Preparation & Investment Sales Training 13