IAI CB2 common mistakes
IAI CB2 · Understand the traps and how to avoid them.
Treating a change in the price of the good itself as a shift of the demand or supply curve, then drawing a whole new curve instead of moving along the existing one.
Candidates memorise 'demand increases' and 'quantity demanded increases' as synonyms, and exam wording ('a rise in price leads to...') invites a curve shift reflex. The distinction between a movement along and a shift is tested in almost every paper, so the habit is over-applied.
What to do instead
Before drawing anything, write down which variable changed. If it is the own price of the good, move a point along the curve and label the axes P and Q. Only shift when a non-price determinant changes (income, tastes, prices of related goods, expectations, number of buyers for demand; input costs, technology, taxes/subsidies, expectations, number of sellers for supply). Practise by sorting ten scenarios into 'move' versus 'shift' in under two minutes.
Analysing a simultaneous demand and supply change and asserting a definite direction for both price and quantity, instead of stating which one is indeterminate.
Candidates handle one-curve shifts well but default to 'price rises, quantity rises' when both curves move, forgetting that the combined effect on one variable depends on the relative size of the shifts. Under time pressure they report a single outcome rather than a range.
What to do instead
Use a two-step routine: shift one curve, note the effect; then shift the second curve from that new equilibrium and note whether it reinforces or opposes each variable. State explicitly 'price is indeterminate without knowing the magnitude of the shifts; quantity unambiguously rises'. Sketch both a small-shift and large-shift version to prove the ambiguity.
Computing price elasticity of demand with the simple percentage-change formula and getting a different answer depending on direction, or misclassifying elastic versus inelastic because the coefficient is negative.
Candidates plug into (change in Q / Q) / (change in P / P) using the initial values, which gives asymmetric results for a price rise versus fall. They also panic at a negative sign and call a coefficient of -0.4 'elastic' because 0.4 looks small or the sign confuses comparison.
What to do instead
Default to the midpoint (arc) formula: change in Q divided by average Q, over change in P divided by average P. Report the absolute value and state the classification in words: greater than 1 elastic, equal to 1 unit elastic, less than 1 inelastic. Sanity-check with the total-revenue test: if price rises and revenue falls, demand is elastic.
Confusing income elasticity with cross-price elasticity, or ignoring the sign when interpreting either, so a normal good is mislabelled inferior or complements are called substitutes.
Both formulas look identical apart from which price or income sits in the denominator, and candidates rush the denominator. The sign carries all the meaning (positive income elasticity = normal, negative = inferior; positive cross elasticity = substitutes, negative = complements), and candidates treat the number as the answer.
What to do instead
Write the denominator explicitly before calculating: 'change in quantity demanded of good X divided by change in income' versus 'divided by change in price of good Y'. Then always add the interpretation sentence with the sign spelled out. Memorise the four sign cases as a table and rehearse them until the sign, not the magnitude, triggers the label.
Stating that total utility is maximised where marginal utility is maximised, rather than where marginal utility per unit of spending is equalised across goods and marginal utility is zero at the peak of total utility.
The words 'utility' and 'maximise' pull candidates toward the marginal curve's peak. Many also never internalise that total utility peaks exactly where marginal utility crosses zero, so they misread the relationship between the two curves on a diagram.
What to do instead
Learn the two anchor points: total utility is maximised where marginal utility equals zero; consumer equilibrium across goods requires MU of X divided by price of X equals MU of Y divided by price of Y. When a question gives a table, compute MU per currency unit for each good and allocate spending to the highest ratio first, then recheck.
Describing diminishing returns and diseconomies of scale as the same phenomenon, and placing the average cost curves' turning points at the wrong output level.
Both produce rising costs, so candidates merge them. They also assume marginal cost cuts average cost at its minimum in every case, without checking whether the question is short-run (fixed capital, diminishing marginal returns) or long-run (all inputs variable, economies then diseconomies of scale).
What to do instead
Separate the concepts by cause: diminishing returns arise from a fixed input in the short run and drive up marginal then average variable cost; diseconomies of scale arise from management and coordination problems when all inputs expand. Draw the standard short-run family (MC crossing AVC and ATC at their minimum points) and the long-run average cost envelope separately, and label which is which before answering.
Assuming a profit-maximising firm always sets price equal to marginal cost, and applying perfect-competition reasoning to monopoly or monopolistic competition questions.
The marginal cost equals marginal revenue rule is learned, but candidates collapse it into 'price equals marginal cost' or 'price equals marginal revenue'. In monopoly questions they then compute the competitive output and price and lose the marks on mark-up and deadweight loss.
What to do instead
Apply a fixed sequence: find output where MR equals MC, then read the price off the demand curve at that output, never off the MR or MC curve. Note that price equals marginal cost only under perfect competition in long-run equilibrium. For monopoly, also identify the mark-up and the deadweight-loss triangle between the monopoly and competitive quantities.
Adding up all transactions or all sales to compute GDP, or counting transfer payments, intermediate goods and second-hand sales as part of national income.
Candidates see the word 'total' and sum everything in the data. They also miss that GDP measures value added and only current production, so resales of houses or shares and pension payments look like income and get included.
What to do instead
Apply the three exclusion tests every time: is it current production, is it a final good or service, is it produced domestically within the period? Exclude intermediate goods (double counting), transfers, second-hand sales and purely financial transactions. When data are given, prefer the expenditure approach (C plus I plus G plus net exports) and reconcile with the income approach to check.
Treating the money multiplier and the deposit multiplier as identical, or assuming banks lend out all reserves, so the calculated change in the money supply is overstated.
Textbook formulas like 1 divided by the reserve ratio are memorised without the assumptions. Candidates forget that banks hold excess reserves and that the public holds currency, both of which shrink the real multiplier, and they conflate the narrow money base with broad money.
What to do instead
State the assumptions before applying any multiplier: no excess reserves, no currency drain, and a single reserve ratio. Compute the deposit multiplier as 1 divided by the reserve ratio, then adjust downward in words if the question mentions excess reserves or cash holdings. Distinguish the monetary base (currency plus bank reserves) from broad money (base times the money multiplier).
Classifying inflation and unemployment linkages backwards, for example calling cost-push inflation demand-pull, or claiming the Phillips curve implies inflation and unemployment rise together.
The labels sound interchangeable and candidates answer from intuition about 'too much money chasing too few goods'. The short-run Phillips curve's inverse relationship is memorised as a phrase rather than a mechanism, so direction errors survive into the exam.
What to do instead
Anchor each term to its cause: demand-pull is excess aggregate demand (inflation and falling unemployment move together along the curve); cost-push is a rise in input costs or wages, which can raise inflation and unemployment simultaneously (stagflation, shifting the curve). For any scenario, name the shock first, then trace its effect on the aggregate demand and aggregate supply diagram before writing the conclusion.
Recommending the same policy for every macroeconomic problem, or ignoring the lag, crowding-out and exchange-rate side effects that exam questions award marks for.
Candidates learn 'recession means expansionary policy' as a rule and stop there. They miss that the instrument depends on whether the problem is demand-deficient or supply-side, and on the state of the output gap, and they rarely mention implementation and impact lags.
What to do instead
Use a four-line template for every policy question: diagnose the shock and output gap; choose the instrument (fiscal or monetary) and its direction; state the transmission mechanism step by step; then give one limitation (crowding out for fiscal, liquidity trap or lag for monetary, exchange-rate effects in an open economy). Always tie the recommendation to the diagnosed cause rather than to the word 'recession'.