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2015 INTRODUCTION TO ECONOMICS AND FINANCE STUDY TEXT CAF-02 P P A C I Introduction to economics and finance Second edition published by Emile Woolf International Bracknell Enterprise & Innovation Hub Ocean House, 12th Floor, The Ring Bracknell, Berkshire, RG12 1AX United Kingdom Email: [email protected] www.emilewoolf.com © Emile Woolf International, January 2015 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, without the prior permission in writing of Emile Woolf International, or as expressly permitted by law, or under the terms agreed with the appropriate reprographics rights organisation. You must not circulate this book in any other binding or cover and you must impose the same condition on any acquirer. Notice Emile Woolf International has made every effort to ensure that at the time of writing the contents of this study text are accurate, but neither Emile Woolf International nor its directors or employees shall be under any liability whatsoever for any inaccurate or misleading information this work could contain. © Emile Woolf International ii The Institute of Chartered Accountants of Pakistan Certificate in Accounting and Finance Introduction to economics and finance C Contents Page Syllabus objective and learning outcomes v Chapter 1 Economic concepts 1 2 Microeconomics 25 3 Demand and supply: elasticities 51 4 Utility analysis 83 5 Costs, revenues and firms 109 6 Macroeconomics: An introduction 151 7 Consumption, savings and investment 181 8 Multiplier and accelerator 197 9 Money 217 10 Growth and taxes 245 11 Monetary policy 259 12 Credit 273 13 Balance of payments and trade 285 14 Financial markets 303 Index xxx © Emile Woolf International iii The Institute of Chartered Accountants of Pakistan Introduction to economics and finance © Emile Woolf International iv The Institute of Chartered Accountants of Pakistan Certificate in Accounting and Finance Introduction to economics and finance S Syllabus objectives and learning outcomes ASSESSMENT OF FUNDAMENTAL COMPETENCIES INTRODUCTION TO ECONOMICS AND FINANCE Objective To enable candidates to equip themselves with the fundamental concepts of economics and finance needed as foundation for higher studies of finance. Learning Outcome The candidate will be able to: 1 understand the nature of micro-economics and its basic concepts understand the nature of macro-economics and its relation with the measurement 2 of economic growth 3 understand how the balance of payments of a country is worked out 4 understand the nature of banking systems 5 understand the basic function of financial markets. © Emile Woolf International v The Institute of Chartered Accountants of Pakistan Introduction to economics and finance Grid Weighting Concepts of economics 5-10 Microeconomics 25-35 Macroeconomics 25-35 Introduction to banking system, financial markets and international trade 25-35 Total 100 Syllabus Contents Level Learning Outcome Ref A Concepts of economics 1 The economic problem - 1 LO1.1.1: Understand the fundamental wants, resources, scarcity nature of economics LO1.1.2: Describe the scope and objectives of economics. LO1.1.3: Describe, with examples, the concept of economic problem and its implications for an economy. LO1.1.4: Explain with examples the four factors of production. LO1.1.5: Discuss the production possibility curve and its relevance to the concept of opportunity cost 2 Economic systems - 1 LO1.2.1: Describe the major functions planned, market and mixed of an economic system economies LO1.2.2: Explain the salient features of planned, mixed and market economies LO1.2.3: Provide examples of mixed, planned and market economies LO1.2.4: Describe the shortfalls of a market economy 3 Islamic economic system 1 LO1.3.1: Describe the main features of the Islamic economic system LO1.3.2: Compare the Islamic economic system with other economic systems. © Emile Woolf International vi The Institute of Chartered Accountants of Pakistan Syllabus and study guide B Microeconomics 1 Microeconomics – nature 2 LO2.1.1: Define micro economics and discuss its scope and limitations. 2 Demand and supply 2 LO2.2.1: Define law of demand and explain its assumptions, limitations and exceptions LO2.2.2: Define law of supply and explain its assumptions. 3 Equilibrium of demand and 2 LO2.3.1: Explain the determination of supply price by equilibrium of demand and supply LO2.3.2: Explain the effect of changes in demand and supply LO2.3.3: Discuss the determination of price of perishable and durable goods. 4 Elasticity of demand and 2 LO2.4.1: Describe the concept of supply elasticity of demand and its practical application LO2.4.2: Explain the determinants of the elasticity of demand LO2.4.3: Demonstrate the measurement of price, income, point, arc and cross elasticity of demand LO2.4.4: Describe the concept of elasticity of supply and explain the percentage and graphical methods of measurement of elasticity of supply LO2.4.5: Describe the determinants of supply elasticity. 5 Utility analysis and 2 LO2.5.1: Explain the law of diminishing indifference curve marginal utility and discuss its assumptions and limitations LO2.5.2: Explain the law of equi- marginal utility LO2.5.3: Discuss the meaning and characteristics of indifference curves LO2.5.4: Explain consumers’ equilibrium through indifference curve analysis. © Emile Woolf International vii The Institute of Chartered Accountants of Pakistan Introduction to economics and finance B Microeconomics (continued) 6 Cost and revenue curves 2 LO2.6.1: Discuss short run curves of total cost, total fixed cost, total variable cost, average cost and marginal cost LO2.6.2: Derive a long run average cost curve from a short run average cost curve LO2.6.3: Derive a long run marginal cost curve LO2.6.4: Discuss revenue curves under perfect and imperfect competition LO2.6.5: Discuss the concept of economies and diseconomies of scale. 7 Equilibrium of firm in the 2 LO2.7.1: State the features of perfect short and long term under and imperfect competition perfect competition, LO2.7.2: Discuss the short and long monopoly, oligopoly and run equilibrium of firms under perfect monopolistic conditions and imperfect competition. 8 Laws of increasing and 2 LO2.8.1: Explain the law of increasing diminishing returns returns and its application and assumptions LO2.8.2: Explain the law of diminishing returns and its application and assumptions C Macroeconomics 1 Measurement of national 2 LO3.1.1: Define macroeconomics and income including knowledge discuss its scope and limitations of basic concepts like GDP, LO3.1.2: Define gross national product, GNP, NNP gross domestic product and net national product LO3.1.3: Explain the product approach, income approach and expenditure approach to the measurement of national income LO3.1.4: Explain circular flow of Income LO3.1.5: State the difficulties usually faced in measuring National Income. © Emile Woolf International viii The Institute of Chartered Accountants of Pakistan Syllabus and study guide C Macroeconomics (continued) 2 Consumption, saving and 2 LO3.2.1: Understand the meaning of investment functions; consumption and saving and its relationship with the income LO3.2.2: Identify how Keynes’ Psychological law of consumption explains the relationship between consumption and income with the help of average propensity to consume and marginal propensity to consume curves LO3.2.3: Understand the determinants of the consumption function LO3.2.4: Understand the stability of consumption and saving functions in the short run and discuss the reasons thereof LO3.2.5: Understand the meaning of investment, induced investment and autonomous investment LO3.2.6: Explain the relationship of investment with marginal efficiency of capital and interest rate. 3 Marginal propensity to 2 LO3.3.1: Discuss the marginal consume and save propensity to consume and save 4 Multiplier and accelerator; 2 LO3.4.1: Comprehend the effect of the multiplier on the level of national income LO3.4.2: Understand the assumptions and limitations of the multiplier concepts LO3.4.3: Comprehend the principle of acceleration of derived demand LO3.4.4: Understand how the multiplier and accelerator interact © Emile Woolf International ix The Institute of Chartered Accountants of Pakistan