Economics and Business Environment
Economics and Business Environment tests the external forces that shape demand, costs, prices and policy risk. Expect elasticity, market structure, macroeconomic indicators, monetary and fiscal policy, exchange rates and the regulatory environment.
Microeconomics
Price elasticity of demand is the percentage change in quantity divided by the percentage change in price; demand is elastic when the absolute value exceeds 1. With elastic demand a price cut raises total revenue; with inelastic demand it lowers it. Income elasticity separates normal from inferior goods; cross elasticity is positive for substitutes and negative for complements. Market structure runs from perfect competition, where firms are price takers and long-run economic profit is zero, through monopolistic competition and oligopoly to monopoly, where output is restricted and price exceeds marginal cost.
Macroeconomics
GDP measures output, not welfare. Nominal figures must be deflated to real terms before comparing periods. Demand-pull inflation raises prices through spending; cost-push inflation raises unit costs. Monetary policy works through interest rates, credit, asset prices and expectations; fiscal policy works through spending and tax. A multiplier above one means an initial injection raises income by more than itself, but leakages through saving, tax and imports reduce it.
Worked example
A firm cuts price from 10 to 9 and demand rises from 1,000 to 1,200 units. Percentage change in quantity is +20%; percentage change in price is −10%; elasticity = 20 / −10 = −2.0, so demand is elastic. Revenue rises from 10,000 to 10,800. The firm should not conclude that further cuts always help: elasticity changes along a linear demand curve, and at some point demand becomes inelastic.
Exchange rates and regulation
A depreciation of the home currency makes exports cheaper and imports dearer, improving the trade balance only if demand for exports and imports is sufficiently elastic (the Marshall–Lerner condition). Regulation raises compliance costs but can also raise barriers to entry and protect incumbents.
Traps
Confusing a movement along a demand curve with a shift in the curve. Reporting elasticity without the sign convention. Mixing real and nominal growth. Assuming a currency depreciation always improves the trade balance. Confusing monetary and fiscal tools. Treating accounting profit as economic profit, which must deduct opportunity cost.