Cambridge IAL Economics cheat sheet

Demand curve slopes downward: as price falls, quantity demanded rises (income and substitution effects); supply slopes upward because higher prices cover rising marginal cost.

Movement along a curve is caused only by a change in the good's own price; a shift is caused by non-price determinants (income, tastes, prices of substitutes/complements, expectations, number of buyers; for supply: costs, technology, taxes/subsidies, weather, number of sellers).

Equilibrium: Qd = Qs. A price above equilibrium creates a surplus (excess supply) that pushes price down; a price below creates a shortage (excess demand) that pushes price up.

Price elasticity of demand PED = %ΔQd / %ΔP; use the midpoint formula to avoid direction bias. |PED| > 1 elastic (total revenue falls when price rises), |PED| < 1 inelastic (revenue rises when price rises), |PED| = 1 unit elastic (revenue maximised).

Determinants of PED: availability of substitutes, proportion of income spent, necessity vs luxury, time horizon, habit/addiction.

Income elasticity YED = %ΔQd / %ΔY: positive for normal goods, > 1 for luxury, between 0 and 1 for necessity, negative for inferior goods. Cross elasticity XED = %ΔQd(A) / %ΔP(B): positive for substitutes, negative for complements.

Price elasticity of supply PES = %ΔQs / %ΔP; larger when spare capacity exists, when stocks are available, when the time period is longer, and when factors are mobile.

Consumer surplus = area below demand and above price; producer surplus = area above supply and below price; total surplus is maximised at free-market equilibrium. Deadweight loss is the welfare lost when quantity deviates from the equilibrium quantity.

Indirect tax on producers shifts supply up/left by the tax per unit; incidence depends on relative elasticities - the more inelastic side bears the larger share. A specific (unit) tax shifts supply parallel; an ad valorem tax pivots the supply curve.

Subsidy shifts supply down/right; consumer benefit exceeds producer benefit when demand is relatively more elastic than supply.

Price ceiling (maximum price) below equilibrium causes shortage, queues, rationing, black markets, and quality erosion; price floor (minimum price) above equilibrium causes surplus, requiring government purchase or storage.

Minimum wage is a price floor in the labour market: it raises wages for those employed but can create unemployment when demand for labour is elastic.

Buffer stock schemes stabilise price by buying at a floor and selling at a ceiling; they need storage, finance, and correct target prices, and fail with perishables or persistent surpluses.

Absolute advantage: producing more output with the same inputs. Comparative advantage: lower opportunity cost - the basis for mutually beneficial specialisation and trade.

Opportunity cost of good X = loss of good Y / gain of good X. A country should specialise where its opportunity cost ratio is lower than the trading partner's.

Terms of trade = (index of export prices / index of import prices) × 100; a rise means each unit of exports buys more imports (favourable), but competitiveness may fall.

Free trade gains: increased consumer choice, lower prices via competition, exploitation of economies of scale, technology transfer, and higher world output.

Protectionist tools: tariffs (tax on imports), quotas (quantity limit), subsidies to domestic producers, embargoes, administrative/technical barriers, and voluntary export restraints.

Tariff effects on a small open economy: price rises to world price plus tariff, imports fall, consumer surplus falls, producer surplus rises, government gains tariff revenue, and deadweight loss arises from lost consumption and inefficient domestic production.

Arguments for protection: infant industry, strategic/sunset industry, national security, protect employment during structural change, prevent dumping, and raise government revenue. Counterarguments: retaliation, higher consumer prices, inefficiency, and slowed structural adjustment.

Floating exchange rate is determined by demand for and supply of the currency: exports, inward investment, and higher interest rates raise demand (appreciation); imports and capital outflow raise supply (depreciation).

Appreciation makes exports dearer and imports cheaper, worsening the trade balance if Marshall–Lerner condition (|PEDx| + |PEDm| > 1) is not met; J-curve describes the short-run worsening before improvement.

Fixed exchange rate requires reserves or interest-rate policy to defend the peg; devaluation lowers the currency's official value, revaluation raises it.

Purchasing power parity compares currencies by the basket of goods each can buy; it is a long-run anchor, not a short-run predictor.

Balance of payments: current account (goods, services, income, transfers) plus capital and financial accounts must sum to zero; a current account deficit is financed by capital inflows or reserve depletion.

Unemployment rate = (unemployed / labour force) × 100, where labour force = employed + unemployed.

Activity (participation) rate = labour force / working-age population × 100. Employment rate = employed / working-age population × 100.

Claimant count measures those receiving unemployment benefits; the ILO/LFS measure counts people without work, available to start within two weeks, and actively seeking work in the past four weeks.

Types of unemployment: frictional (search), structural (skills/regional mismatch, deindustrialisation), cyclical (demand-deficient), seasonal, and real-wage (wages held above equilibrium).

Full employment exists when unemployment equals the natural rate (frictional plus structural); it is not zero unemployment.

Inflation rate = [(CPI this year − CPI last year) / CPI last year] × 100.

CPI is a weighted price index of a representative basket; weights reflect household spending shares and are updated periodically. RPI uses an arithmetic averaging formula and includes housing costs, so it usually differs from CPI.

Real values = nominal values adjusted for inflation: real interest rate ≈ nominal rate − inflation rate (Fisher approximation).

Deflation is a sustained fall in the price level; disinflation is a fall in the inflation rate; both differ from a slower rise in prices.

Inflation redistributes income: borrowers and holders of real assets gain; savers, lenders, and those on fixed nominal incomes lose.

Costs of inflation: menu costs, shoe-leather costs, uncertainty reducing investment, erosion of export competitiveness, and fiscal drag.

Costs of unemployment: lost output (below potential GDP), lost tax revenue, higher benefit spending, hysteresis (skills decay), and social costs.

Nominal GDP vs real GDP: real GDP is valued at constant base-year prices, removing the effect of price changes; GDP per capita = real GDP / population.

Demand-pull inflation: aggregate demand grows faster than productive capacity; the economy operates beyond potential output, and the output gap becomes positive.

Cost-push inflation: rising input costs (wages above productivity, energy, imported raw materials) shift short-run aggregate supply left, raising prices and lowering output simultaneously (stagflation).

Monetarist view: inflation is 'too much money chasing too few goods'; sustained inflation requires growth in the money supply exceeding growth in real output (MV = PY).

Quantity theory of money: MV = PY; if velocity V and real output Y are constant, growth in M translates one-for-one into inflation.

Expectations matter: wage-setting based on expected inflation can create a wage–price spiral; inflation targeting aims to anchor expectations.

Imported inflation arises from a depreciation of the currency or higher world commodity prices, raising the domestic price of imports.

Phillips curve: short-run trade-off between inflation and unemployment; a shift in expectations or supply shocks moves the short-run curve, and the long-run curve is vertical at the natural rate.

Costs of high inflation: uncertainty discourages long-term investment, relative prices become distorted, exports lose competitiveness, and inflation acts as a regressive tax on cash holders.

Benefits/limited costs of low, stable inflation: it allows real wage adjustment without nominal cuts and reduces the risk of deflation.

Deflation risks: deferred consumption raises real debt burdens, can trigger debt-deflation spirals, and limits monetary policy because nominal interest rates cannot fall far below zero.

Short-run costs: TC = FC + VC; AC = TC/Q; MC = ΔTC/ΔQ. MC cuts AC at its minimum point.

Law of diminishing returns: adding a variable factor to fixed factors eventually lowers marginal product, so MC rises and the short-run supply curve slopes upward.

Long-run economies of scale: technical (specialisation, indivisible equipment), managerial, financial, marketing, and risk-bearing. Diseconomies arise from coordination and control problems.

Revenue: TR = P × Q; MR = ΔTR/ΔQ. Profit maximised where MR = MC; for a price taker P = AR = MR.

Perfect competition: many buyers and sellers, homogeneous product, free entry and exit, perfect information; in long-run equilibrium firms earn only normal profit (P = minimum AC).

Monopoly: single seller, high barriers to entry; profit maximising at MR = MC with price above MC, causing allocative inefficiency and deadweight loss. Natural monopoly occurs where economies of scale persist over the whole market.

Monopolistic competition: many firms, differentiated products, low barriers; short-run supernormal profit attracts entry, eroding profit to normal in the long run.

Oligopoly: few large firms, interdependence, kinked demand curve explains price rigidity; collusion (cartels) raises prices, while non-collusive rivalry may involve price wars.

Market failure occurs when the free market fails to allocate resources efficiently (MSB ≠ MSC). Types: externalities, public goods, merit/demerit goods, information failure, and monopoly power.

Negative externality of production: MSC > MPC; the free market overproduces. Pigouvian tax equal to marginal external cost internalises the externality; tradable permits cap total pollution.

Positive externality: MSB > MPB (e.g. education, vaccination); the free market underproduces. Subsidies or state provision can raise output to the social optimum.

Public goods are non-rival and non-excludable, so they are underprovided by markets (free-rider problem); quasi-public goods are partially rival or excludable.

Government failure: intervention creates inefficiency through poor information, administrative costs, unintended consequences, and regulatory capture.

AD = C + I + G + (X − M). AD slopes downward because of wealth, interest-rate, and net-export effects.

SRAS slopes upward because of sticky wages and prices; LRAS is vertical at potential output (monetarist) or may bend upward (Keynesian range).

Expansionary fiscal policy: raise G or cut T. Contractionary: cut G or raise T. Multiplier = 1 / (1 − MPC) = 1 / MPS + MPT + MPM.

Automatic stabilisers (progressive taxes, unemployment benefits) dampen the cycle without discretionary action.

Discretionary fiscal policy faces time lags, crowding out, and political constraints; the balanced-budget multiplier equals 1 for a matched change in G and T.

Monetary policy tools: policy interest rate, reserve requirements, open-market operations, quantitative easing, and forward guidance.

Transmission mechanism: lower interest rates raise consumption and investment, lower the exchange rate (raising net exports), and raise asset prices.

Liquidity trap: nominal interest rates near zero and money demand perfectly elastic, so further monetary expansion is ineffective; fiscal policy becomes more powerful.

Crowding out: government borrowing raises interest rates and displaces private investment; full crowding out occurs when the economy is at capacity.

Supply-side policies: deregulation, labour-market reform, education and training, infrastructure, and lower marginal tax rates to raise LRAS and potential output.

Policy conflicts: reducing inflation may raise unemployment (short-run Phillips curve); tightening fiscal policy may worsen inequality; higher interest rates may appreciate the currency and harm exporters.

Keynesian vs monetarist: Keynesians favour active fiscal intervention to close output gaps; monetarists emphasise rules, money supply control, and the vertical long-run Phillips curve.

Economic growth = increase in real GDP (or real GDP per capita); development is broader, covering living standards, health, education, and freedom.

Growth rate = [(real GDP_t − real GDP_{t−1}) / real GDP_{t−1}] × 100. Rule of 70: doubling time ≈ 70 / annual growth rate.

Sources of growth: increases in quantity and quality of factors of production (land, labour, capital, enterprise) and technological progress (total factor productivity).

Production possibility curve shifts outward with growth in factor endowments or technology; points inside the curve indicate inefficiency.

Sustainable development meets present needs without compromising future generations; includes environmental limits and intergenerational equity.

HDI = simple average of three dimension indices: life expectancy (health), mean and expected years of schooling (education), and GNI per capita at PPP (income). Each dimension index = (actual − minimum) / (maximum − minimum).

Limitations of GDP as a welfare measure: ignores income distribution, unpaid work, environmental damage, leisure, and the informal economy.

Causes of inequality and poverty: unequal land ownership, unequal access to education and credit, urban–rural gaps, discrimination, and regressive tax systems.

Policies for development: investment in education and health, infrastructure, microfinance, property rights, trade liberalisation with safeguards, foreign direct investment, and overseas aid.

Aid can be effective where governance is sound and aid is targeted; it can also create dependency, be tied to donor interests, and be diverted by corruption.

Foreign direct investment brings capital, technology transfer, and jobs but may cause profit repatriation, environmental damage, and enclave development.

Terms of trade and commodity dependence: countries exporting primary products face volatile and often declining relative prices (Prebisch–Singer thesis), encouraging diversification.