IAI CB1 flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Production possibility frontier

A curve showing the maximum combinations of two goods an economy can produce with given resources and technology; its slope equals the marginal rate of transformation.

Opportunity cost

The value of the next best alternative forgone when a resource is used in a particular way; it underpins all economic choice under scarcity.

Ceteris paribus

A modelling assumption that all variables other than those under analysis are held constant, allowing the effect of a single change to be isolated.

Positive versus normative statements

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

Circular flow of income

A model in which household spending flows to firms and factor incomes flow back; equilibrium requires injections (investment, government spending, exports) to equal withdrawals (saving, taxes, imports).

Equimarginal principle

Consumers maximise utility when marginal utility per unit of money is equal across all goods: MUx/Px = MUy/Py, subject to the budget constraint.

Indifference curve properties

Curves are downward sloping and convex to the origin, never intersect, and higher curves represent higher utility; the slope is the marginal rate of substitution.

Price elasticity of demand

Percentage change in quantity demanded divided by percentage change in price. Demand is elastic if the absolute value exceeds one and inelastic if it is below one.

Profit-maximising output rule

A firm maximises profit where marginal revenue equals marginal cost and marginal cost is rising, so that MC crosses MR from below at that output.

Shutdown condition

In the short run a firm should shut down if price falls below minimum average variable cost, since it cannot then cover even its variable costs.

Economies of scale

Reductions in long-run average cost as output rises, arising from specialisation, indivisibilities and bulk purchasing; they make the long-run average cost curve fall.

Perfect competition long-run equilibrium

Free entry and exit drive price to minimum long-run average cost, so firms earn only normal profit and produce where price equals marginal cost.

Deadweight loss of monopoly

The loss of consumer and producer surplus from output below the allocatively efficient level where price equals marginal cost; it forms a triangle between demand and marginal cost.

Third-degree price discrimination

Charging different prices in separate markets according to differing elasticities; it requires market separation, no resale and differing price sensitivities among buyers.

Kinked demand curve

An oligopoly model in which rivals are assumed to match price cuts but not price rises, making price rigid around the prevailing level.

Herfindahl-Hirschman Index

The sum of the squared market shares of all firms in a market, used as a concentration measure; it ranges up to 10,000 for a pure monopoly.

Expenditure measure of GDP

GDP equals consumption plus investment plus government spending plus exports minus imports, measured over a period, usually a year.

Simple Keynesian multiplier

The ratio of a change in equilibrium output to the initial change in autonomous spending, equal to 1/(1 − marginal propensity to consume).

Output gap

The difference between actual and potential output as a percentage of potential output; a negative gap indicates spare capacity and downward pressure on inflation.

Automatic stabilisers

Features such as progressive taxes and unemployment benefits that dampen fluctuations in disposable income without deliberate government action, reducing the multiplier's amplitude.

Crowding out

A fall in private investment or consumption caused by government borrowing raising interest rates or absorbing scarce real resources, weakening expansionary fiscal policy.

Natural rate of unemployment

The unemployment rate consistent with stable inflation, comprising frictional and structural unemployment once cyclical unemployment has fallen to zero.

Comparative advantage

A country gains from specialising where its opportunity cost of production is lower than a trading partner's, even if it has no absolute advantage.

Balance of payments identity

The current account plus the capital and financial account plus errors and omissions must sum to zero, because every international transaction is recorded twice.

Marshall-Lerner condition

A currency depreciation improves the trade balance only if the sum of the absolute price elasticities of export and import demand exceeds one.

Terms of trade

The ratio of a country's export price index to its import price index, multiplied by 100; a rise means each unit of exports buys more imports.

J-curve effect

After a depreciation the trade balance initially worsens before improving, because traded volumes adjust more slowly than the relative prices that drive them.

Modified duration

Duration divided by one plus the yield to maturity; it approximates the percentage change in a bond's price for a one percentage point change in yield.

Dividend discount model

Equity value equals the present value of expected future dividends; with constant growth, price equals next year's dividend divided by required return minus growth.

Capital asset pricing model

Expected return equals the risk-free rate plus beta times the market risk premium, so only non-diversifiable systematic risk is priced.

Semi-strong market efficiency

Prices reflect all publicly available information, so trading on published accounts or news releases cannot earn abnormal returns consistently.

Adverse selection in banking

Lenders cannot distinguish good from bad borrowers before lending, so prudent borrowers may be charged too much or rationed out of the market.