IAI CB1 cheat sheet

Scarcity forces choice: the three fundamental questions are what to produce, how to produce it and for whom; every answer carries an opportunity cost.

Production possibility frontier: points on the curve are productively efficient, points inside are inefficient, points outside are unattainable with current resources and technology; the slope is the marginal rate of transformation.

Opportunity cost of an extra unit of X equals ΔY/ΔX along the PPF; increasing opportunity cost produces a concave (bowed-out) frontier.

Ceteris paribus is the standard modelling device for isolating one variable's effect; models are judged by predictive usefulness rather than literal realism.

Positive statements are testable claims about what is; normative statements rest on value judgements and cannot be refuted by data.

Circular flow equilibrium: injections J = I + G + X equal withdrawals W = S + T + M; if J exceeds W, national income rises until equality is restored.

Allocation systems: market (price mechanism), command (state direction) and mixed; prices simultaneously ration, signal and provide incentives.

Marginal decision rule: expand an activity while marginal benefit exceeds marginal cost and stop where MB = MC.

Diminishing marginal returns: adding successive units of a variable input to a fixed factor eventually lowers marginal product, holding technology constant.

Budget constraint: PxX + PyY = M with slope −Px/Py; a price change pivots the line, an income change shifts it parallel.

Utility maximisation: MUx/Px = MUy/Py, where the indifference curve is tangent to the budget line and MRS = Px/Py.

Substitution effect moves consumption along an indifference curve as relative prices change; the income effect moves to a different curve; a Giffen good has a negative income effect that dominates.

PED = %ΔQd/%ΔP; |PED| > 1 elastic, = 1 unit elastic, < 1 inelastic; demand is more elastic with close substitutes, a longer time horizon and a larger budget share.

With elastic demand a price cut raises total revenue; with inelastic demand a price rise raises total revenue; revenue is maximised where PED = −1.

Income elasticity > 0 normal (>1 luxury, 0–1 necessity) and < 0 inferior; cross elasticity > 0 substitutes, < 0 complements.

Short-run costs: TC = FC + VC and MC = dTC/dQ; MC cuts AVC and AC at their minimum points, and AC falls whenever MC < AC.

Profit maximisation: MR = MC with MC rising; for a price taker P = MR so P = MC. Shut down in the short run if P < minimum AVC, exit in the long run if P < minimum AC.

LRAC is the envelope of short-run AC curves; economies of scale give a falling LRAC and minimum efficient scale is the lowest output at which LRAC is minimised.

Perfect competition assumptions: many buyers and sellers, homogeneous product, perfect information, free entry and exit; each firm is a price taker with P = MR = AR.

Perfect competition long run: entry and exit drive price to minimum LRAC, firms earn only normal profit, and both allocative (P = MC) and productive (min AC) efficiency hold.

Monopoly: demand slopes down, MR lies below AR and is twice as steep for linear demand; profit maximisation at MR = MC gives P > MC and a deadweight loss triangle.

Price discrimination requires market power, separable segments with different elasticities and no resale; the higher price is charged to the less elastic segment.

Monopolistic competition: many firms with differentiated products and free entry; short-run supernormal profit attracts entry until AR is tangent to AC, leaving normal profit and excess capacity.

Oligopoly: few firms, recognised interdependence and strategic behaviour; standard models are kinked demand, Cournot quantity competition, Bertrand price competition and cartels.

Nash equilibrium: each firm's strategy is optimal given the other's; in a prisoner's dilemma both defect and reach a jointly worse outcome than cooperation.

Concentration measures: n-firm concentration ratio and HHI = Σs², ranging to 10,000 for pure monopoly; contestable markets can deliver efficient outcomes if entry and exit are costless.

Efficiency tests: allocative P = MC, productive minimum AC, dynamic innovation; monopoly may gain dynamic efficiency while losing allocative and X-efficiency.

GDP = C + I + G + (X − M); real GDP uses constant prices and nominal GDP current prices, with the GDP deflator = nominal/real × 100.

AD = C + I + G + X − M slopes downward through wealth, interest rate, exchange rate and trade effects; any change in an autonomous component shifts the curve.

SRAS slopes upward because of sticky wages and prices; LRAS is vertical at potential output, so sustainable growth requires more or better factors of production.

Simple multiplier k = 1/(1 − c); with a proportional tax rate t and import propensity m, k = 1/(1 − c(1 − t) + m).

Inflation is measured by the CPI or RPI; demand-pull arises from AD shifting along SRAS, cost-push from SRAS shifting up, and expectations feed into wage and price setting.

Unemployment types: frictional, structural, cyclical and seasonal; the natural rate equals frictional plus structural, and cyclical unemployment is the deviation from it.

Fiscal policy: automatic stabilisers act without legislation; discretionary policy changes tax rates or spending; crowding out and Ricardian equivalence weaken the demand effect.

Monetary transmission: policy rate → market rates, asset prices, exchange rate and expectations → output and inflation; the zero lower bound and liquidity trap limit this, prompting quantitative easing.

Okun's law links unemployment to growth relative to trend; the Phillips curve shows a short-run inflation–unemployment trade-off that disappears at the natural rate.

Balance of payments: current account (goods, services, primary and secondary income) + capital account + financial account + errors and omissions = 0.

A current account deficit must be matched by a financial account surplus; it may reflect strong domestic demand, a real exchange rate that is too high, or weak competitiveness.

Comparative advantage: specialise where opportunity cost is lowest; gains from trade exist even if one country has an absolute advantage in both goods.

Terms of trade = (export price index / import price index) × 100; a rise means a given volume of exports buys more imports.

A tariff raises the domestic price, cuts imports, transfers surplus from consumers to producers and government, and creates deadweight loss from distorted consumption and production.

Marshall-Lerner condition: depreciation improves the trade balance only if |PEDx| + |PEDm| > 1; the J-curve implies it may deteriorate first.

Purchasing power parity predicts exchange rates adjust to equalise price levels; interest rate parity links forward rates to interest differentials; both hold only loosely in the short run.

Fixed rates require reserves or capital controls; floating rates adjust through markets; the trilemma permits only two of a fixed rate, free capital mobility and independent monetary policy.

Integration stages: free trade area, customs union, common market, monetary union; deeper integration brings more trade creation but potentially more trade diversion.

Financial markets provide price discovery, liquidity, risk transfer and mobilisation of savings; money markets trade short-term instruments (T-bills, CDs, commercial paper), capital markets long-term bonds and equities.

Bond price = Σ C/(1+y)^t + F/(1+y)^n; price and yield move inversely, and the longer the duration the greater the price sensitivity.

Duration is the weighted average time to cash flows; modified duration = D/(1+y) approximates the percentage price change for a one percentage point yield change, with convexity correcting the error.

Term structure theories: expectations (forward rates reflect expected spot rates), liquidity preference (long maturities carry a premium) and segmentation; inverted curves often precede recessions.

CAPM: E(R) = rf + β(E(Rm) − rf); beta measures non-diversifiable systematic risk, and diversifiable risk earns no premium.

EMH forms: weak (past prices), semi-strong (all public information), strong (all information including private); anomalies such as momentum challenge semi-strong efficiency.

Intermediation exists because of scale economies, maturity transformation and information advantages; asymmetric information creates adverse selection before lending and moral hazard afterwards.

Fisher equation: (1 + i) = (1 + r)(1 + π), approximately i ≈ r + π; the real return drives saving and investment decisions.

Macroprudential policy targets system-wide risk through capital buffers, loan-to-value limits and countercyclical tools; central banks act as lender of last resort to stop bank runs.