Overview
Economics on the CFA Level I exam spans microeconomic foundations, macroeconomic aggregates, and international trade and exchange rates. Questions test both conceptual understanding and numerical application — expect to calculate elasticities, interpret GDP data, and reason about central bank policy effects.
Microeconomics
Demand, Supply, and Elasticity
Price elasticity of demand measures the responsiveness of quantity demanded to a price change: PED = %ΔQ / %ΔP. Demand is elastic when |PED| > 1 (revenue falls as price rises) and inelastic when |PED| < 1 (revenue rises as price rises). Cross-price elasticity distinguishes substitutes (positive) from complements (negative). Income elasticity separates normal goods (positive) from inferior goods (negative).
Market Structures
- Perfect competition: Price takers, zero economic profit in the long run, P = MC
- Monopolistic competition: Differentiated products, some pricing power, zero long-run profit
- Oligopoly: Few firms, interdependence, kinked demand curve or game theory models
- Monopoly: Single seller, P > MC, deadweight loss
Macroeconomics
GDP and Business Cycles
GDP measures the market value of all final goods and services produced in an economy in a period. The expenditure approach: GDP = C + I + G + (X − M). Nominal GDP uses current prices; real GDP adjusts for inflation. The output gap measures actual GDP relative to potential GDP.
Business cycles move through expansion, peak, contraction, and trough. Leading indicators (stock prices, building permits) signal turning points before they occur; lagging indicators (unemployment, CPI) confirm trends after the fact.
Monetary and Fiscal Policy
Central banks use the policy rate, reserve requirements, and open-market operations to influence credit conditions. Expansionary monetary policy lowers rates to stimulate demand; contractionary policy raises rates to reduce inflation. The quantity theory of money: MV = PQ.
Fiscal policy uses government spending and taxation. Expansionary fiscal policy increases the deficit; the fiscal multiplier measures the ultimate impact on GDP. Ricardian equivalence argues that deficit spending is offset by forward-looking saving behavior, reducing multiplier effects.
Exchange Rates
The nominal exchange rate is the price of one currency in terms of another. The real exchange rate adjusts for relative price levels. Purchasing power parity (PPP) predicts that exchange rates adjust so that identical goods cost the same across countries. Covered and uncovered interest rate parity link interest rate differentials to expected exchange rate changes.