IAI CB2 cheat sheet

Law of demand: quantity demanded falls as price rises, ceteris paribus; the demand curve slopes downward.

Demand shifters: income, tastes, prices of substitutes and complements, expectations, number of buyers. A price change moves along the curve, not the curve itself.

Supply shifters: input costs, technology, taxes and subsidies, expectations, number of sellers, weather for agricultural goods.

Equilibrium: quantity demanded equals quantity supplied; above it a surplus pushes price down, below it a shortage pushes price up.

Movement to a new equilibrium: demand rise raises both price and quantity; supply rise lowers price and raises quantity.

Simultaneous shifts: if demand and supply both rise, quantity rises unambiguously but the price change is indeterminate without magnitude data.

Price ceiling below equilibrium creates shortage and rationing; price floor above equilibrium creates surplus, e.g. agricultural support prices.

Normal good: income rise increases demand; inferior good: income rise decreases demand.

Price elasticity of demand PED = %ΔQd / %ΔP; use midpoint formula (Q2−Q1)/((Q1+Q2)/2) ÷ (P2−P1)/((P1+P2)/2).

|PED| > 1 elastic, = 1 unit elastic, < 1 inelastic; demand is more elastic when substitutes exist, the good is a luxury, or the time horizon is long.

Total revenue test: price rise raises revenue if demand is inelastic, lowers it if elastic, leaves it unchanged if unit elastic.

Income elasticity YED = %ΔQd / %ΔY; positive for normal goods, negative for inferior goods, >1 for luxuries.

Cross elasticity XED = %ΔQd of A / %ΔP of B; positive for substitutes, negative for complements, near zero for unrelated goods.

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

Perfectly inelastic demand is vertical (PED = 0); perfectly elastic is horizontal (PED = ∞).

Tax incidence: the side of the market with lower elasticity bears more of the tax burden.

Total utility TU rises while marginal utility MU is positive; TU peaks where MU = 0; MU = ΔTU/ΔQ.

Law of diminishing marginal utility: successive units consumed in a period yield smaller additions to satisfaction.

Utility maximisation rule: MUx/Px = MUy/Py, with the budget fully spent; equal marginal utility per unit of money across goods.

Marginal rate of substitution MRS = MUx/MUy equals the slope magnitude of the indifference curve and falls along a convex curve.

Budget line: Px·X + Py·Y = income; slope = −Px/Py; a price change rotates the line, an income change shifts it parallel.

Consumer optimum: indifference curve tangent to the budget line, so MRS = Px/Py.

Income effect and substitution effect explain the downward-sloping demand curve; Giffen goods are the rare exception.

Indifference curves cannot cross, are convex to the origin, and higher curves represent higher utility.

Short run: at least one input fixed; long run: all inputs variable.

Law of diminishing returns: adding variable input to fixed capacity eventually lowers marginal product MP.

AP and MP relation: MP > AP raises AP, MP < AP lowers AP, and MP cuts AP at AP's maximum.

Total cost TC = TFC + TVC; average cost AC = TC/Q; marginal cost MC = ΔTC/ΔQ.

MC cuts AC at AC's minimum; when MC < AC, AC falls, and when MC > AC, AC rises.

Long-run average cost LRAC shows economies of scale (falling), constant returns (flat), and diseconomies of scale (rising).

Profit maximisation: MR = MC with MC rising; in perfect competition P = MR, so P = MC.

Shutdown rule short run: shut down if price < minimum AVC; exit long run if price < minimum AC.

Normal profit is included in economic cost; economic profit = revenue − explicit − implicit costs.

Perfect competition: many firms, homogeneous product, free entry, price taker, horizontal firm demand, zero long-run economic profit.

Monopoly: single seller, barriers to entry, downward-sloping demand, MR below price, profit maximised where MR = MC.

Monopoly has no supply curve; it sets price from the demand curve at the profit-maximising quantity.

Monopolistic competition: many firms, differentiated products, downward-sloping demand, free entry drives long-run economic profit to zero.

Oligopoly: few firms, interdependence, kinked demand curve, price rigidity, game theory and collusion analysis.

Price discrimination requires market separation and different elasticities; charge more in the inelastic market.

Allocative efficiency requires P = MC; perfect competition achieves it long run, monopoly does not.

Natural monopoly: declining LRAC over relevant output, so one firm is cheapest; usually regulated on price or rate of return.

GDP = C + I + G + (X − M) by expenditure; GDP is output within borders, GNP is output by nationals.

Nominal vs real GDP: real GDP values output at constant base-year prices; GDP deflator = nominal/real × 100.

National income identity: Y = C + I + G + NX; income approach sums wages, rent, interest and profit.

Avoid double counting: count only final goods or sum value added at each stage.

GNP = GDP + net factor income from abroad; NNP = GNP − depreciation.

Personal disposable income = personal income − personal taxes; used for consumption analysis.

Consumption function C = a + bY, where b is the marginal propensity to consume; MPC + MPS = 1.

Multiplier k = 1/(1 − MPC) = 1/MPS for a closed economy without proportional taxes.

Functions of money: medium of exchange, unit of account, store of value, standard of deferred payment.

Money supply measures: M1 = currency in circulation plus demand deposits; broader measures add time and savings deposits.

Commercial bank credit creation: maximum deposit expansion = initial deposit × 1/reserve ratio.

Central bank functions: issue currency, banker to government and banks, lender of last resort, monetary policy, reserve management.

Money demand motives: transactions, precautionary, speculative; speculative demand is inversely related to interest rates.

Interest rate is the opportunity cost of holding money; bond prices and interest rates move inversely.

Quantity theory MV = PY; if V and Y are constant, money growth translates into inflation.

Real interest rate ≈ nominal interest rate − expected inflation (Fisher equation).

Demand-pull inflation: excess aggregate demand; cost-push inflation: rising input costs or wages.

CPI measures the cost of a fixed basket; inflation rate = (CPI this period − CPI last period)/CPI last period × 100.

Phillips curve: short-run inverse trade-off between inflation and unemployment; long-run curve is vertical at the natural rate.

Unemployment types: frictional, structural, cyclical, seasonal; unemployment rate = unemployed/labour force × 100.

Real wage unemployment arises when wages are held above equilibrium; structural unemployment from skills or geographic mismatch.

Business cycle phases: expansion, peak, contraction/recession, trough; leading indicators turn before output.

Okun's law links unemployment above the natural rate to negative output gap.

Deflation raises real debt burdens; disinflation is a fall in the inflation rate, not a fall in prices.

Expansionary fiscal policy: raise government spending or cut taxes; contractionary is the reverse.

Fiscal multipliers: spending multiplier 1/(1 − MPC); tax multiplier = −MPC/(1 − MPC).

Automatic stabilisers: progressive taxes and unemployment benefits dampen the cycle without new legislation.

Discretionary fiscal policy faces recognition, implementation and response lags.

Expansionary monetary policy: cut policy rate, buy securities (open market operations), lower reserve requirements.

Contractionary monetary policy: raise rates, sell securities, raise reserve requirements to reduce money supply.

Monetary transmission: interest rate changes affect investment, consumption and the exchange rate.

Crowding out: government borrowing raises interest rates and can reduce private investment.

Policy mix: fiscal and monetary policy can reinforce or offset each other; central bank independence supports inflation targeting.

Fiscal policy instruments: government expenditure, taxation, transfer payments, borrowing; budget deficit = G + transfers − T.

Monetary policy instruments: policy interest rate, open market operations, reserve requirements, quantitative easing.

Expansionary gap: increase G or cut T to shift aggregate demand right; contractionary gap: reverse.

Multiplier formula for closed economy: k = 1/(1 − MPC); with proportional tax rate t, k = 1/(1 − MPC(1 − t)).

Liquidity trap: nominal rates near zero, so conventional monetary policy loses traction; use fiscal policy.

Inflation targeting: central bank sets a target and adjusts the policy rate in response to forecast inflation.

Crowding out: bond-financed spending raises interest rates and displaces private investment.

Automatic stabilisers operate without discretionary action; discretionary policy carries recognition and implementation lags.

Policy coordination matters: fiscal expansion with tight money raises interest rates more and crowds out more investment.