CFA Economics

Macro and Micro

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Inflation & Unemployment

Inflation rate is the change in the CPI over a given period of time

inflation rate (i) = (current CPI - last period CPI) / last period CPI

Unemployment:

Frictional: economic changes prevent matching qualified workers with job openings

Structural: unemployed workers do not have the skills necessary to match newly created jobs.

Cyclical: recession phase of a business cycle, economy producing at less than capacity.

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Labour Demand & Supply

A firm's demand for labour is increased by:

  • increases in the price of the firm's output
  • increase in the price of productive input that is a substitute for labour
  • decrease in price of a productive input that is a complement to labour

supply of labour is influenced by:

  • substitution effect: increase in wage rate causes workers to substitute labour hours for leisure hours
  • income effect: increases in income increase workers' demand for leisure.
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Schools of Macroeconomic Thought

Classical: shifts in AD and AS driven by technological changes; money wages adjust rapidly to restore equilibrium.

Keynesian: shifts in AD caused by changes in expectations; wages are 'downward sticky', use fiscal and monetary policy to increase AD and restore equilibrium

Monetarist: monetary policy is the main factor leading to business cycles; central bank should increase money supply at a predictable rate

Timing of fiscal policy:

Time lags: (1) Recognition (2) Administrative (3) Impact

Automatic Stabilizers: (1) Induced taxes (2) needs-tested spending

Central banks control money supply in 3 ways:

(1) reserve requirements (2) open market operations (most used) (3) discount rate

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Elasticity of Demand

Price Elasticity of Demand (PED) =

(% change in quantity demanded / % change in price)

If absolute value is GREATER THAN 1.0, demand is ELASTIC

If absolute value is LESS THAN 1.0, demand is INELASTIC

If absolute = 1, demand is UNIT ELASTIC

Two main determinants of price elasticity:

1. availablity of substitutes (demand more elastic if substitutes available)

2. share of budget spent on product (demand less elastic for pricier items)

Elasticity of demand and supply is greater in the long run.

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