Economics
Economics tests microeconomic reasoning (scarcity, demand and supply, elasticity, costs and market structures) and macroeconomic measurement and policy (GDP, inflation, unemployment, fiscal and monetary policy). You must be able to explain a diagram or calculation, not merely state a definition.
Core rules
- A demand curve slopes downward and a supply curve upward, other things equal.
- A change in price causes movement along a curve; a change in income, tastes or related prices shifts the curve.
- Price elasticity of demand (PED) = percentage change in quantity demanded / percentage change in price.
- Total cost = fixed cost + variable cost. Marginal cost is the change in total cost from one extra unit.
- GDP by expenditure = C + I + G + (X - M). Real GDP removes the effect of price changes.
Worked example
A price fall from 10 to 8 raises quantity demanded from 100 to 130. Percentage change in quantity = 30/100 = 30%. Percentage change in price = -2/10 = -20%. PED = 30 / -20 = -1.5. Demand is elastic because the absolute value exceeds 1. Total revenue rises from 10 x 100 = 1,000 to 8 x 130 = 1,040. The firm gains revenue from extra units despite the lower price because the quantity response is proportionately larger.
Traps
- Ignoring the negative sign when interpreting PED, or calling -0.4 elastic.
- Confusing a shift of a curve with a movement along it.
- Treating nominal GDP growth as real growth when prices have risen.
- Assuming inflation means every price is rising; it is a sustained rise in the general price level.