Economics for Investment Decision Makers: Micro, Macro, and International Economics

802 Pages·2013·4.81 MB·English

by  Jerald E. Pinto

ECONOMICS FOR
INVESTMENT
DECISION
MAKERS
CFAInstituteisthepremierassociation forinvestmentprofessionals aroundtheworld, with
over 117,000 members in 134 countries. Since 1963 the organization has developed and
s
administered the renowned Chartered Financial Analyst Program. With a rich history of
leading the investment profession, CFA Institute has set the highest standards in ethics,
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foremost authority on investment profession conduct and practice.
EachbookintheCFAInstituteInvestmentSeriesisgearedtowardindustrypractitioners
along with graduate-level finance students and covers the most important topics in the
industry. The authors of these cutting-edge books are themselves industry professionals and
academics and bring their wealth of knowledge and expertise to this series.
ECONOMICS FOR
INVESTMENT
DECISION
MAKERS
Micro, Macro, and International Economics
Christopher D. Piros, CFA
Jerald E. Pinto, CFA
CoverDesign:Leiva-Sposato
CoverImage:ªMaciejNoskowski/iStockphoto
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LibraryofCongressCataloging-in-PublicationData:
Economicsforinvestmentdecisionmakers:micro,macro,andinternationaleconomics/Christopher
D.PirosandJeraldE.Pinto,editors.
p.cm.—(CFAinstituteinvestmentseries)
Includesbibliographicalreferencesandindex.
ISBN978-1-118-10536-8(cloth); ISBN978-1-118-41880-2(ebk);
ISBN978-1-118-53316-1(ebk); ISBN978-1-118-41624-2(ebk)
1. Supplyanddemand. 2. Microeconomics. 3. Macroeconomics. 4. Investments.
I. Piros,ChristopherDixon.II.Pinto,JeraldE.
HB171.5.E3356 2013
330—dc23
2012034395
PrintedintheUnitedStatesofAmerica
10 9 8 7 6 5 4 3 2 1
CONTENTS
Foreword xiii
Acknowledgments xvii
About the CFA Institute Investment Series xix
CHAPTER 1
Demand and Supply Analysis: Introduction 1
Learning Outcomes 1
1. Introduction 2
2. Types of Markets 3
3. Basic Principles and Concepts 4
3.1. The Demand Function and the Demand Curve 5
3.2. Changes in Demand versus Movements along the Demand Curve 7
3.3. The Supply Function and the Supply Curve 10
3.4. Changes in Supply versus Movements along the Supply Curve 11
3.5. Aggregating the Demand and Supply Functions 13
3.6. Market Equilibrium 17
3.7. The Market Mechanism: Iterating toward Equilibrium—or Not 19
3.8. Auctions as a Way to Find Equilibrium Price 24
3.9. Consumer Surplus—Value minus Expenditure 28
3.10. Producer Surplus—Revenue minus Variable Cost 30
3.11. Total Surplus—Total Value minus Total Variable Cost 32
3.12. Markets Maximize Society’s Total Surplus 32
3.13. Market Interference: The Negative Impact on Total Surplus 34
4. Demand Elasticities 40
4.1. Own-Price Elasticity of Demand 41
4.2. Own-Price Elasticity of Demand: Impact on Total Expenditure 46
4.3. Income Elasticity of Demand: Normal and Inferior Goods 47
4.4. Cross-Price Elasticity of Demand: Substitutes and Complements 48
4.5. Calculating Demand Elasticities from Demand Functions 49
5. Summary 51
Practice Problems 53
v
vi Contents
CHAPTER 2
Demand and Supply Analysis: Consumer Demand 59
Learning Outcomes 59
1. Introduction 59
2. Consumer Theory: From Preferences to Demand Functions 60
3. Utility Theory: Modeling Preferences and Tastes 60
3.1. Axioms of the Theory of Consumer Choice 61
3.2. Representing the Preference of a Consumer: The Utility Function 62
3.3. Indifference Curves: The Graphical Portrayal of the Utility Function 63
3.4. Indifference Curve Maps 66
3.5. Gains from Voluntary Exchange: Creating Wealth through Trade 66
4. The Opportunity Set: Consumption, Production, and Investment Choice 70
4.1. The Budget Constraint 70
4.2. The Production Opportunity Set 72
4.3. The Investment Opportunity Set 74
5. Consumer Equilibrium: Maximizing Utility Subject to the Budget Constraint 75
5.1. Determining the Consumer’s Equilibrium Bundle of Goods 75
5.2. Consumer Response to Changes in Income: Normal and
Inferior Goods 76
5.3. How the Consumer Responds to Changes in Price 77
6. Revisiting the Consumer’s Demand Function 78
6.1. Consumer’s Demand Curve from Preferences and Budget Constraints 78
6.2. Substitution and Income Effects for a Normal Good 79
6.3. Income and Substitution Effects for an Inferior Good 82
6.4. Negative Income Effect Larger than Substitution Effect:
Giffen Goods 83
6.5. Veblen Goods: Another Possibility for a Positively Sloped
Demand Curve 85
7. Summary 86
Practice Problems 87
CHAPTER 3
Demand and Supply Analysis: The Firm 89
Learning Outcomes 89
1. Introduction 89
2. Objectives of the Firm 90
2.1. Types of Profit Measures 91
2.2. Comparison of Profit Measures 95
3. Analysis of Revenue, Costs, and Profits 96
3.1. Profit Maximization 97
3.2. Productivity 127
4. Summary 135
Practice Problems 136
Contents vii
CHAPTER 4
The Firm and Market Structures 143
Learning Outcomes 143
1. Introduction 143
2. Analysis of Market Structures 144
2.1. Economists’ Four Types of Structure 144
2.2. Factors That Determine Market Structure 146
3. Perfect Competition 149
3.1. Demand Analysis in Perfectly Competitive Markets 149
3.2. Supply Analysis in Perfectly Competitive Markets 158
3.3. Optimal Price and Output in Perfectly Competitive Markets 159
3.4. Factors Affecting Long-Run Equilibrium in Perfectly
Competitive Markets 161
4. Monopolistic Competition 163
4.1. Demand Analysis in Monopolistically Competitive Markets 166
4.2. Supply Analysis in Monopolistically Competitive Markets 166
4.3. Optimal Price and Output in Monopolistically Competitive Markets 167
4.4. Factors Affecting Long-Run Equilibrium in Monopolistically
Competitive Markets 168
5. Oligopoly 169
5.1. Demand Analysis and Pricing Strategies in Oligopoly Markets 169
5.2. Supply Analysis in Oligopoly Markets 176
5.3. Optimal Price and Output in Oligopoly Markets 178
5.4. Factors Affecting Long-Run Equilibrium in Oligopoly Markets 178
6. Monopoly 179
6.1. Demand Analysis in Monopoly Markets 181
6.2. Supply Analysis in Monopoly Markets 182
6.3. Optimal Price and Output in Monopoly Markets 184
6.4. Price Discrimination and Consumer Surplus 185
6.5. Factors Affecting Long-Run Equilibrium in Monopoly Markets 187
7. Identification of Market Structure 188
7.1. Econometric Approaches 189
7.2. Simpler Measures 189
8. Summary 191
Practice Problems 192
CHAPTER 5
Aggregate Output, Prices, and Economic Growth 197
Learning Outcomes 197
1. Introduction 198
2. Aggregate Output and Income 198
2.1. Gross Domestic Product 200
2.2. The Components of GDP 208
viii Contents
2.3. GDP, National Income, Personal Income, and Personal
Disposable Income 211
3. Aggregate Demand, Aggregate Supply, and Equilibrium 217
3.1. Aggregate Demand 217
3.2. Aggregate Supply 230
3.3. Shifts in Aggregate Demand and Supply 232
3.4. Equilibrium GDP and Prices 245
4. Economic Growth and Sustainability 256
4.1. The Production Function and Potential GDP 257
4.2. Sources of Economic Growth 259
4.3. Measures of Sustainable Growth 264
5. Summary 270
Practice Problems 273
CHAPTER 6
Understanding Business Cycles 279
Learning Outcomes 279
1. Introduction 279
2. Overview of the Business Cycle 280
2.1. Phases of the Business Cycle 280
2.2. Resource Use through the Business Cycle 284
2.3. Housing Sector Behavior 292
2.4. External Trade Sector Behavior 293
3. Theories of the Business Cycle 294
3.1. Neoclassical and Austrian Schools 295
3.2. Keynesian and Monetarist Schools 296
3.3. The New Classical School 299
4. Unemployment and Inflation 303
4.1. Unemployment 304
4.2. Inflation 307
5. Economic Indicators 319
5.1. Popular Economic Indicators 320
5.2. Other Variables Used as Economic Indicators 325
6. Summary 327
Practice Problems 328
CHAPTER 7
Monetary and Fiscal Policy 333
Learning Outcomes 333
1. Introduction 334
2. Monetary Policy 335
2.1. Money 336
2.2. Roles of Central Banks 348