CPA Foundation Level
Economics flashcards
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What is opportunity cost, and how does the production possibility curve show it?
Opportunity cost is the value of the next best alternative given up, not the money spent. Moving along the production possibility curve gains one good only by giving up some of the other: the amount given up is the opportunity cost, and the slope of the curve measures it. The curve bows outward because opportunity cost rises as more of one good is produced.
What is the difference between a change in quantity demanded and a change in demand?
Change in quantity demanded: a movement along the demand curve, caused only by a change in the good's own price (an extension when price falls, a contraction when it rises). Change in demand: a shift of the whole curve, caused by any other determinant, such as income, the prices of related goods, tastes, expectations or population. Name the cause first: own price, move along; anything else, shift.
How does price elasticity of demand decide whether a price cut raises total revenue?
Elastic demand (PED > 1): a price cut raises quantity by a larger percentage, so total revenue rises. Inelastic demand (PED < 1): a price cut raises quantity by a smaller percentage, so total revenue falls, and a price rise raises it. Unit elastic (PED = 1): total revenue is unchanged. On a straight demand curve revenue peaks at the midpoint, where demand is unit elastic.
Who bears a per-unit tax levied on sellers?
The tax shifts supply up by the amount of the tax. Consumers pay a higher price, producers keep a lower one, and quantity falls. The side of the market that is less elastic bears more of the tax, because it can escape less, whoever hands the money over. Consumers' share = PES / (PES + PED).
What condition holds at consumer equilibrium, in cardinal and in ordinal terms?
Cardinal (utility) approach: the equi-marginal principle, MUx / Px = MUy / Py, so the last shilling spent on each good gives the same satisfaction. Ordinal (indifference curve) approach: the budget line is tangent to the highest attainable indifference curve, so MRSxy = Px / Py.
What does the law of diminishing returns state, and what are the three stages of production?
As successive units of a variable factor are added to a fixed factor, the marginal product of the variable factor eventually declines. Stage I: MP and AP rising, up to AP's maximum; the fixed factor is under-used. Stage II: MP falling but positive, AP falling; this is where a firm produces. Stage III: MP negative and TP falling; no firm operates here. It is a short-run law.
What are the necessary and sufficient conditions for profit maximisation?
Necessary (first-order): marginal revenue equals marginal cost, MR = MC. Sufficient (second-order): MC cuts MR from below, so MC is rising through the intersection. The firm must also check that price covers average variable cost in the short run and average total cost in the long run, or the best output is zero.
What is the multiplier, and how is it calculated?
The ratio of the change in equilibrium income to the change in autonomous spending that caused it. Closed economy without government: k = 1 / (1 - MPC) = 1 / MPS. In general: k = 1 / (MPS + MPT + MPM), the reciprocal of the marginal propensity to withdraw. Example: MPC = 0.8 gives k = 5, so KES 10 billion of extra spending raises income by KES 50 billion. Kenya's multiplier is modest because its marginal propensity to import is high.
What instruments does the Central Bank of Kenya use for monetary policy, and how does it tighten?
Instruments: the Central Bank Rate, set by the Monetary Policy Committee every two months; open market operations; the cash reserve ratio; the discount window; moral suasion; foreign exchange operations. To tighten: raise the CBR, sell securities to drain liquidity, raise the cash reserve ratio, raise the discount window rate, ask banks to restrain credit, and sell dollars to support the shilling.
What is the difference between absolute and comparative advantage?
Absolute advantage (Adam Smith): producing a good with fewer resources than the trading partner. Comparative advantage (David Ricardo): producing a good at a lower opportunity cost. A country gains by specialising in the good with its lowest opportunity cost, even if it is worse at producing everything. Both countries gain if the terms of trade lie between their opportunity cost ratios.
What is the difference between positive and normative economics?
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What are the four factors of production, and what is each one's reward?
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Which goods appear to break the law of demand?
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What shifts the supply curve?
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What do a maximum price and a minimum price do, and when do they bind?
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Why do agricultural prices fluctuate more than the prices of manufactured goods?
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How are income elasticity and cross elasticity of demand interpreted?
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What determines the price elasticity of demand for a good?
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What is the law of diminishing marginal utility, and how does marginal utility relate to total utility?
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How does a fall in the price of a good split into substitution and income effects?
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What is consumer surplus, and how is it calculated on a straight demand curve?
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What are returns to scale, and how do they differ from diminishing returns?
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What shapes do the short-run cost curves take, and why?
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What is the long-run average cost curve, and what is the minimum efficient scale?
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What are internal and external economies of scale?
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How many workers does a profit-maximising firm hire?
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What is the difference between transfer earnings and economic rent?
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What are the features of perfect competition, and what is its long-run outcome?
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How does a monopolist set output and price, and why is the outcome inefficient?
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How does the kinked demand curve explain rigid prices in oligopoly?
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What are the three methods of measuring national income, and the double-counting trap in each?
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How do you get from GDP at market prices to national income?
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What are inflationary and deflationary gaps, and how are they closed?
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What is the accelerator principle?
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What is the difference between economic growth and economic development?
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What is the vicious circle of poverty, and how can a country break it?
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What are Kenya's short, medium and long-term planning tools?
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What are the four functions of money?
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What are Keynes's three motives for holding money?
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How do commercial banks create credit, and why is the multiplier smaller in practice?
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What does the quantity theory of money state?
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What does the IS-LM model show about a rise in government spending?
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What is the difference between demand-pull and cost-push inflation, and how is each controlled?
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What are the main types of unemployment, and a remedy for each?
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What does the Phillips curve claim, and why is the long-run curve vertical?
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How are the terms of trade calculated, and what does a rise mean?
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What are the parts of the balance of payments, and how is a persistent deficit corrected?
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What is the Marshall-Lerner condition, and what is the J-curve?
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What are the stages of regional economic integration, and how far has the EAC gone?
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How do the roles of the IMF and the World Bank differ?
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On a production possibility curve, what do a point inside the curve, a point beyond it and an outward shift of the whole curve each show?
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What three questions must every economy answer, and how do planned, free market and mixed economies answer them?
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What is consumers' sovereignty, and why is it limited in practice?
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Why does the supply curve normally slope upward?
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How does the point where a straight-line supply curve starts tell you its elasticity, and what is PES for Qs = -20 + 2P at P = 35?
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What determines the price elasticity of supply?
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Why does a surge in demand raise rents in Nairobi but raise sales of mobile phones?
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What does a per-unit subsidy to producers do to the market equilibrium?
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When demand and supply both increase, what happens to equilibrium price and quantity?
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What is a firm's total cost at zero output, and why does a firm that shuts down in the short run still make a loss?
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Why does marginal cost cut average variable cost and average total cost at their lowest points?
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What is the difference between actual and potential economic growth?
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Why do developing countries need development planning, and what kind of planning does Kenya use?
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Who gains and who loses from inflation, and how does it affect the balance of payments?
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Who counts as unemployed on the ILO definition, and why does the rate understate Kenya's problem?
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