Economics - Definitions and Formulas - CFA L1

Short Run

the time period over which some factors of production are fixed

Long Run

the time period over which all factors of production are variable

Breakeven Point

average revenue is just equal to average total cost, total revenue is just equal to total (economic) cost

Perfect Competition

a market in which many firms produce identical products, barriers to entry into the market are very low, and firms compete for sales only on the basis of price

Monopolistic Competition

products are not identical. Each firm differentiates its product(s) from those of other firms through some combination of differences in product quality, product features, and marketing. Prices are also not identical.

Oligopoly

only a few firms are in the industry. In such a market, each firm must consider the actions and responses of other firms in setting price and business strategy

Monopoly

a market is characterized by a single seller of a product with no good substitutes

Kinked Demand Curve Model

Oligopoy model - based on the assumption that competitors are unlikely to match a price increase by a competitor, but very likely to match a price decrease by a competitor. at the current market price. Each firm believes that it faces a demand curve that is more elastic (flatter) above the current price (the kink in the demand curve) than it is below the given price

Cournot Model

Oligopoly pricing - two firms with identical MC curves each choose their preferred selling price based on the price the other firm chose in the previous period

Stackelberg Model

assumes pricing decisions are made sequentially. One firm, the "leader," chooses its price first, and the other firm chooses a price based on the leader's price

Nash Equilibrium

A Nash equilibrium is reached when the choices of all firms are such that there is no other choice that makes any firm better off (increases profits or decreases losses)

Collusion

competitors making a joint agreement to charge a given price—or, alternatively, to agree to specific levels of output

Dominant Firm Model

Oligopoly model - a single firm has a significantly large market share because of its greater scale and lower cost structure—the dominant firm (DF). In such a model, the market price is essentially determined by the DF, and the other competitive firms (CFs) take this market price as given

N-Firm Concentration ration

the sum of the percentage market shares of the largest N firms in a market

Herfindahl-Hirschman Index (HHI)

the sum of the squares of the market shares of the largest firms in the market

Expansion

real GDP is increasing

Peak

real GDP stops increasing and begins decreasing

Contraction/Recession

real GDP is decreasing

Trough

real GDP stops decreasing and begins increasing

Classical Business Cycle

based on real GDP relative to a beginning value

Growth Cycle

changes in the percentage difference between real GDP and its longer-term trend or potential value.

Growth Rate Cycle

refers to changes in the annualized percentage growth rate from one period to the next and tends to show both peaks and troughs earlier than the other two measures

Credit Cycles

cyclical fluctuations in interest rates and the availability of loans (credit)

Inventory-Sales Ratio

An important indicator to a business cycle. During steady economic growth the ratio trends toward a normal level

Consumer Spending

largest component of GDP. Increases during expansions and decreases during contractions

Durable Goods

Appliances, Furniture, etc. Spending on these items are highly cyclical

Leading Indicators

change direction before peaks or troughs in the business cycle,

Coincident Indicators

change direction at roughly the same time as peaks or troughs

Lagging Indicators

tend not to change direction until after expansions or contractions are already underway

Fiscal Policy

a government's use of spending and taxation to influence economic activity

Budget Surplus

when government tax revenues exceed expenditures

Budget Deficit

when government expenditures exceed tax revenues

Monetary Policy

the central bank's actions that affect the quantity of money and credit in an economy to influence economic activity

Discretionary Fiscal Policy

the spending and taxing decisions of a national government that are intended to stabilize the economy

Automatic Stabilizers

built-in fiscal devices triggered by the state of the economy

Debt Ratio

ratio of aggregate debt to GDP

Crowding-Out Effect

Increased government borrowing will tend to increase interest rates, and firms may reduce their borrowing and investment spending as a result, thus decreasing the impact on aggregate demand of deficit spending

Ricardian Equivalence

private-sector savings in anticipation of future tax liabilities just offset the government deficit

Transfer Payments

redistribute wealth, taxing some and making payments to others

Current Spending

government purchases of goods and services on an ongoing and routine basis

Capital Spending

government spending on infrastructure, such as roads, schools, bridges, and hospitals

Direct Taxes

levied on income or wealth

Indirect Taxes

levied on goods and services

Marginal Propensity to Consume

Tax reductions for those with low incomes will be more effective in increasing aggregate demand, as those with lower incomes tend to spend a larger proportion of income on consumption

Disposable Income

income after taxes

Fiscal Multiplier

determines the potential increase in aggregate demand resulting from an increase in government spending

Recognition Lag

Discretionary fiscal policy decisions are made by a political process. The state of the economy is complex, and it may take policymakers time to recognize the nature and extent of the economic problems

Action Lag

Governments take time to discuss, vote on, and enact fiscal policy changes

Impact Lag

Time elapses between the enactment of fiscal policy changes and when the impact of the changes on the economy actually takes place. It takes time for corporations and individuals to act on the fiscal policy changes, and fiscal multiplier effects occur only over time as well

Structural Budget Deficit/Cyclically Adjusted Budget Deficit

the deficit that would occur based on current policies if the economy were at full employment

Legal Tender

money supplied by the central bank

Fiat Money

money not backed by any tangible value

Menu Costs

cost to businesses of constantly having to change their prices

Shoe Leather Costs

costs to individuals of making frequent trips to the bank so as to minimize their holdings of cash that are depreciating in value due to inflation

Pegging

choosing a target level for the exchange rate of their currency with that of another country, primarily the U.S. dollar

Monetary Transmission Mechanism

the ways in which a change in monetary policy, specifically the central bank's policy rate, affects the price level and inflation

Operational Independence

the central bank is allowed to independently determine the policy rate

Target Independence

the central bank also defines how inflation is computed, sets the target inflation level, and determines the horizon over which the target is to be achieved

Bond Market Vigilantes

If money supply growth is seen as inflationary, higher expected future asset prices will make long-term bonds relatively less attractive and will increase long-term interest rates

Liquidity Trap

if demand for money becomes very elastic and individuals willingly hold more money, even without a decrease in short-term rates

Quantitative Easing

a central bank purchases predetermined amounts of government bonds, company shares, or other financial assets (liquidity) in order to artificially stimulate economic activity

Geopolitics

interactions among nations, including the actions of state actors (national governments) and nonstate actors (corporations, nongovernment organizations, and individuals)

State Actors

national governments

Non-States Actors

corporations, nongovernment organizations and individuals

Soft Power

the ability to influence other countries without using or threatening force

Globalization

the long-term trend toward worldwide integration of economic activity and cultures

Nationalism

a nation pursuing its own economic interests independently of, or in competition with, the economic interests of other countries

Autarky

a goal of national self-reliance, including producing most or all necessary goods and services domestically. Autarky is often associated with a state-dominated society in general, with attributes such as government control of industry and media (noncooperation and nationalism)

Hegemony

countries that are open to globalization but have the size and scale to influence other countries without necessarily cooperating (noncooperation and globalization)

Bilateralism

cooperation between two countries. A country that engages in bilateralism may have many such relationships with other countries while tending not to involve itself in multicountry arrangements (cooperation and nationalism)

Multilateralism

countries that engage extensively in international trade and other forms of cooperation with many other countries (cooperation and globalization)

Regionalism

cooperating multilaterally with nearby countries but less so with the world at large

Geopolitical Risk

the possibility of events that interrupt peaceful international relations

Event Risk

A type of geopolitical risk. Events about which we know the timing but not the outcome, such as national elections

Exogenous Risk

A type of geopolitical risk. Refers to unanticipated events, such as outbreaks of war or rebellion

Thematic Risk

A type of geopolitical risk. Known factors that have effects over long periods, such as human migration patterns or cyber risks

Velocity of Geopolitical Risk

high velocity (short term), medium velocity, or low velocity (long term)

Black Swan Risk

the risk of low-likelihood exogenous events that have substantial short-term effects