In a previous article, we introduced the CFA Institute
Investment Foundation Program (Read
more here). It is a free program
designed for anyone who wants to enter or advance within the investment
management industry, including IT, operations, accounting, administration, and
marketing. Candidates who successfully
pass the online exam earn the CFA Institute Investment Foundations Certificate.
There are total of 20 Chapters in 7 modules, covering all
the essential topics in finance, economics, ethics and regulations. This series of articles will highlight the
core knowledge of each chapter.
Chapter 4 provides an overview of microeconomics. The
learning outcome of chapter 4 is as follows:
·
Define economics;
·
Define microeconomics and macroeconomics;
·
Describe factors that affect quantity demanded;
·
Describe how demand for a product or service is
affected by substitute and complementary products and services;
·
Describe factors that affect quantity supplied;
·
Describe market equilibrium;
·
Describe and interpret price and income
elasticities of demand and their effects on quantity and revenue;
·
Distinguish between accounting profit and
economic profit;
·
Describe production levels and costs, including
fixed and variable costs, and describe the effect of fixed costs on
profitability;
·
Identify factors that affect pricing;
·
Compare types of market environment: perfect
competition, pure monopoly, monopolistic competition, and oligopoly.
Every time you buy or sell a product, or try to assess the
value of a product or service, you are effectively applying microeconomics. You
may directly use microeconomics in your everyday work. Even if you do not, it
is very likely to be used by others in your workplace to make business and
investment decisions. Microeconomics is an important concept in investing, so
knowing about it will help you better understand the industry in which you
work.
Some important points to remember about microeconomics
include the following:
·
Economics is the study of production,
distribution, and consumption.
·
Microeconomics is the study of how individuals
and companies make decisions to allocate scarce resources.
·
The law of demand states that the quantity
demanded and price of a product are usually inversely related.
·
The law of supply states that when the price of
a product increases, the quantity supplied increases too. Thus, the supply
curve is upward sloping from left to right.
·
Elasticity refers to how the quantity demanded
or supplied changes in response to small changes in a related factor, such as
price, income, or the price of a substitute or complementary product. If a
product’s quantity demanded or supplied is responsive to changes in a factor,
its demand or supply is said to be elastic. Demand or supply is said to be
inelastic if a product’s quantity demanded or supplied does not change
significantly in response to a change in the factor.
·
According to the income effect, if consumers
have more purchasing power, the quantity of products purchased may increase.
Increases in income lead to an increase in demand for normal products and a
decrease in demand for inferior products.
·
Profit is the difference between the revenue
generated from selling products and services and the cost of producing them.
Accounting profit considers only the explicit costs, whereas economic profit
takes into account both explicit costs and the implicit opportunity costs.
Opportunity costs capture the value forgone by choosing a particular course of
action relative to the best alternative that is not chosen.
·
The market environment in which a company
operates influences its pricing, supply, and efficiency. It may be categorised
according to the degree of competition. A perfectly competitive market is one
extreme, a monopoly is the other extreme, and most markets lie between these
two extremes.
·
In a perfectly competitive market, buyers and
sellers trade a uniform non-differentiated product, and no single buyer or
seller can affect the market price. Barriers to entry are low, the degree of
competition is high, and companies usually earn normal profits.
·
In a pure monopoly, a single company produces a
product for which there are no close substitutes. There are significant
barriers to entry that prevent other companies from entering the industry. A
monopolistic company is likely to charge higher prices, have a lower total
volume of products and services, and may earn higher profits.
·
In monopolistic competition, there are many
buyers and sellers who are able to differentiate their products to buyers. Each
company may have a limited monopoly because of the differentiation of its
products. Thus, products trade over a range of prices rather than a single
market price. There are typically no major barriers to entry.
·
An oligopoly is a market dominated by a small
number of large companies because the barriers to entry are high. As a
consequence, companies are able to make abnormal profits for long periods. A
cartel is a special case of oligopoly.
Sample Question:
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