© CFA Institute. For candidate use only. Not for distribution.

ECONOMICS
AND FINANCIAL
STATEMENT
ANALYSIS

CFAđ Program Curriculum
2022 ã LEVEL I ã VOLUME 2


© CFA Institute. For candidate use only. Not for distribution.

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ISBN 978-1-950157-43-3 (paper)
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CONTENTS
How to Use the CFA Program Curriculum  
Background on the CBOK  
Organization of the Curriculum  
Features of the Curriculum  
Designing Your Personal Study Program  
CFA Institute Learning Ecosystem (LES)  
Prep Providers  
Feedback  

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Economics
Study Session 3

Economics (1)  


Reading 8

Topics in Demand and Supply Analysis  
Introduction  
Demand Concepts  
Demand Concepts  
Price Elasticity of Demand  
Extremes of Price Elasticity  
Predicting Demand Elasticity, Price Elasticity and Total Expenditure  
Elasticity and Total Expenditure  
Income Elasticity of Demand, Cross-­Price Elasticity of Demand  
Cross-­Price Elasticity of Demand  
Substitution and Income Effects; Normal Goods, Inferior Goods and
Special Cases  
Normal and Inferior Goods  
Supply Analysis: Cost, Marginal Return, and Productivity  
Marginal Returns and Productivity  
Economc Profit Versus Accounting Profit  
Economic Cost vs. Accounting Cost  
Marginal Revenue, Marginal Cost and Profit Maximization; Short-­Run Cost
Curves: Total, Variable, Fixed, and Marginal Costs  
Understanding the Interaction between Total, Variable, Fixed, and
Marginal Cost and Output  
Perfect and Imperfect Competition, Profit Maximization  
Profit-­Maximization, Breakeven, and Shutdown Points of Production  
Breakeven Analysis and Shutdown Decision  
The Shutdown Decision  
Economies and Diseconomies of Scale with Short-­Run and Long-­Run Cost
Analysis  

Short- and Long-­Run Cost Curves  
Defining Economies of Scale and Diseconomies of Scale  
Summary  
Practice Problems  
Solutions  
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Reading 9

Reading 10

© CFA Institute. For candidate use only. Not for distribution.

Contents

The Firm and Market Structures  
Introduction & Analysis of Market Structures  
Analysis of Market Structures  
Perfect Competition & Demand Analysis in Perfectly Competitive Markets  
Demand Analysis in Perfectly Competitive Markets  
Elasticity of Demand  
Other Factors Affecting Demand  
Consumer Surplus: Value Minus Expenditure  
Supply Analysis & Optimal Price and Optimal Output In Perfectly
Competitive Markets  
Optimal Price and Output in Perfectly Competitive Markets  
Factors Affecting Long-­Run Equilibrium in Perfectly Competitive Markets  

Supply, Demand, Optimal Pricing, and Optimal Ouput under Monopolistic
Competition  
Demand Analysis in Monopolistically Competitive Markets  
Supply Analysis in Monopolistically Competitive Markets  
Optimal Price and Output in Monopolistically Competitive Markets  
Long-­Run Equilibrium for Monopolistically Competitive Firm  
Oligopoly & Demand Analysis and Pricing Strategies in Oligopoly Markets:
Pricing Independence Portion  
Demand Analysis and Pricing Strategies in Oligopoly Markets  
Oligopoly & Demand Analysis and Pricing Strategies in Oligopoly Markets:
The Cournot Assumption Part  
Oligopoly & Demand Analysis and Pricing Strategies in Oligopoly Markets:
The Nash Equilibrium part  
Supply Analysis & Optimal Price and Output & Long-­Run Equilibrium in
Oligopoly Markets  
Optimal Price and Output in Oligopoly Markets  
Factors Affecting Long-­Run Equilibrium in Oligopoly Markets  
Monopoly & Demand & Supply & Optimal Price and Output in Monopoly
Markets  
Demand Analysis in Monopoly Markets  
Supply Analysis in Monopoly Markets  
Optimal Price and Output in Monopoly Markets  
Price Discrimination and Consumer Surplus  
Factors Affecting Long-­Run Equilibrium in Monopoly Markets  
Identification of Market Structure  
Econometric Approaches  
Simpler Measures  
Summary  
Practice Problems  
Solutions  


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Aggregate Output, Prices, and Economic Growth  
Introduction  
Aggregate Output and Income  
Gross Domestic Product  
The Components of GDP  

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Contents

© CFA Institute. For candidate use only. Not for distribution.

GDP, National Income, Personal Income, and Personal Disposable
Income  
Relationship among Saving, Investment, the Fiscal Balance and the

Trade Balance  
Aggregate Demand and Aggregate Supply  
Aggregate Demand  
Aggregate Supply  
Shifts in the Aggregate Demand Curve  
Equilibrium GDP and Prices  
Economic Growth and Sustainability  
The Production Function and Potential GDP  
Sources of Economic Growth  
Measures of Sustainable Growth  
Measuring Sustainable Growth  
Summary  
Practice Problems  
Solutions  
Reading 11

Understanding Business Cycles  
Introduction  
Overview of the Business Cycle  
Phases of the Business Cycle  
Leads and Lags in Business and Consumer Decision Making  
Market Conditions and Investor Behavior  
Credit Cycles and Their Relationship to Business Cycles  
Applications of Credit Cycles  
Consequences for Policy  
Business Cycle Fluctuations from a Firm’s Perspective  
The Workforce and Company Costs  
Fluctuations in Capital Spending  
Fluctuations in Inventory Levels  
Consumer Behavior  

Consumer Confidence  
Measures of Consumption  
Income Growth  
Saving Rates  
Housing Sector Behavior  
Available Statistics  
Sensitivity to Interest Rates and Relationship to Credit Cycle  
The Role of Demographics  
Impact on the Economic Cycle  
External Trade Sector Behavior  
Cyclical Fluctuations of Imports and Exports  
The Role of the Exchange Rate  
Overall Effect on Exports and Imports  
Theoretical Considerations  
Historical Context  
Neoclassical Economics  
The Austrian School  
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© CFA Institute. For candidate use only. Not for distribution.

Contents

Monetarism  
Keynesianism  
Modern Approach to Business Cycles  
Economic Indicators  
Types of Indicators  
Composite Indicators  
Leading Indicators  
Using Economic Indicators  
Other Composite Leading Indicators  
Surveys  
The Use of Big Data in Economic Indicators  
Nowcasting  
GDPNow  
Unemployment  
Unemployment  

Inflation  
Deflation, Hyperinflation, and Disinflation  
Measuring Inflation: The Construction of Price Indexes  
Price Indexes and Their Usage  
Explaining Inflation  
Summary  
Practice Problems  
Solutions  

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Study Session 4

Economics (2)  

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Reading 12

Monetary and Fiscal Policy  
Introduction to Monetary and Fiscal Policy  
Monetary Policy  
Money: Functions, Creation, and Definition  
The Functions of Money  
Paper Money and the Money Creation Process  
Definitions of Money  
Money: Quantity Theory, Supply and Demand, Fisher Effect  
The Demand for Money  
The Supply and Demand for Money  
The Fisher Effect  
Roles of Central Banks & Objectives of Monetary Policy  
The Objectives of Monetary Policy  
The Costs of Inflation  
Monetary Policy Tools  
Open Market Operations  
The Central Bank’s Policy Rate  
Reserve Requirements  
The Transmission Mechanism  

Inflation Targeting  
Central Bank Independence   
Credibility  
Transparency  

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Contents

Reading 13

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Exchange Rate Targeting  
Monetary Policies: Contractionary, Expansionary, Limitations  
What’s the Source of the Shock to the Inflation Rate?  
Limitations of Monetary Policy  
Roles and Objectives of Fiscal Policy  
Roles and Objectives of Fiscal Policy  
Deficits and the National Debt  
Fiscal Policy Tools  
The Advantages and Disadvantages of Using the Different Tools of
Fiscal Policy  
Modeling the Impact of Taxes and Government Spending: The Fiscal
Multiplier  
The Balanced Budget Multiplier  
Fiscal Policy Implementation  
Deficits and the Fiscal Stance  
Difficulties in Executing Fiscal Policy  
The Relationship between Monetary and Fiscal Policy  
Factors Influencing the Mix of Fiscal and Monetary Policy  
Quantitative Easing and Policy Interaction  
The Importance of Credibility and Commitment  

Summary  
Practice Problems  
Solutions  

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International Trade and Capital Flows  
Introduction & International Trade-­Basic Terminology  
International Trade  
Patterns and Trends in International Trade and Capital Flows  
Benefits and Costs of International Trade  
Comparative Advantage and the Gains from Trade: Absolute and
Comparative Advantage  
Gains from Trade: Absolute and Comparative Advantage  
Ricardian and Heckscher–Ohlin Models of Comparative Advantage  
Trade and Capital Flows: Restrictions & Agreements- Tariffs, Quotas and
Export Subsidies  
Tariffs  
Quotas  
Export Subsidies  
Trading Blocs, Common Markets, and Economic Unions  
Capital Restrictions  
Balance of Payments- Accounts and Components  

Balance of Payments Accounts  
Balance of Payment Components  
Paired Transactions in the BOP Bookkeeping System  
Commercial Exports: Transactions (ia) and (ib)  
Commercial Imports: Transaction (ii)  
Loans to Borrowers Abroad: Transaction (iii)  
Purchases of Home-­Country Currency by Foreign Central Banks:
Transaction (iv)  

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Reading 14

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Contents

Receipts of Income from Foreign Investments: Transaction (v)  
Purchase of Non-­financial Assets: Transaction (vi)  

National Economic Accounts and the Balance of Payments  
Trade Organizations  
International Monetary Fund  
World Bank Group  
World Trade Organization  
Summary  
Practice Problems  
Solutions  

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Currency Exchange Rates  
Introduction & The Foreign Exchange Market  
The Foreign Exchange Market  
Market Functions  
Market Participants, Size and Composition  
Market Size and Composition  
Exchange Rate Quotations  
Exchange Rate Quotations  
Cross-­
Rate Calculations  

Forward Calculations  
Exchange Rate Regimes- Ideals and Historical Perspective  
The Ideal Currency Regime  
Historical Perspective on Currency Regimes  
A Taxonomy of Currency Regimes  
Arrangements with No Separate Legal Tender  
Currency Board System  
Fixed Parity  
Target Zone  
Active and Passive Crawling Pegs  
Fixed Parity with Crawling Bands  
Managed Float  
Independently Floating Rates  
Exchange Rates and the Trade Balance: Introduction  
Exchange Rates and the Trade Balance: The Elasticities Approach  
Exchange Rates and the Trade Balance: The Absorption Approach  
Summary  
Practice Problems  
Solutions  

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Financial Statement Analysis
Study Session 5

Financial Statement Analysis (1)  

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Reading 15

Introduction to Financial Statement Analysis  
Introduction  

Scope of Financial Statement Analysis  
Major Financial Statements - Balance Sheet  
Financial Statements and Supplementary Information  

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Contents

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Statement of Comprehensive Income  
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Income Statement  
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Other Comprehensive Income  
491
Statement of Changes in Equity and Cash Flow Statement  
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Cash Flow Statement  
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Financial Notes, Supplementary Schedules, and Management Commentary  495

Management Commentary or Management’s Discussion and
Analysis  
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Auditor's Reports  
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Other Sources of Information  
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Financial Statement Analysis Framework  
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Articulate the Purpose and Context of Analysis  
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Collect Data  
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Process Data  
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Analyze/Interpret the Processed Data  
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Develop and Communicate Conclusions/Recommendations  
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Follow-­
Up  
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Summary  
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Practice Problems  
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Solutions  
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Reading 16


Financial Reporting Standards  
Introduction  
The Objective of Financial Reporting  
Accounting Standards Boards  
Accounting Standards Boards  
Regulatory Authorities  
International Organization of Securities Commissions  
The Securities and Exchange Commission (US)  
Capital Markets Regulation in Europe  
The International Financial Reporting Standards Framework  
Qualitative Characteristics of Financial Reports  
Constraints on Financial Reports  
The Elements of Financial Statements  
Underlying Assumptions in Financial Statements  
Recognition of Financial Statement Elements  
Measurement of Financial Statement Elements  
General Requirements for Financial Statements  
Required Financial Statements  
General Features of Financial Statements  
Structure and Content Requirements  
Comparison of IFRS with Alternative Reporting Systems  
Monitoring Developments in Financial Reporting Standards  
New Products or Types of Transactions  
Evolving Standards and the Role of CFA Institute  
Summary  
Practice Problems  
Solutions  

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GlossaryG-1
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© CFA Institute. For candidate use only. Not for distribution.


© CFA Institute. For candidate use only. Not for distribution.

How to Use the CFA
Program Curriculum
Congratulations on your decision to enter the Chartered Financial Analyst (CFA®)

Program. This exciting and rewarding program of study reflects your desire to become
a serious investment professional. You are embarking on a program noted for its high
ethical standards and the breadth of knowledge, skills, and abilities (competencies) it
develops. Your commitment should be educationally and professionally rewarding.
The credential you seek is respected around the world as a mark of accomplishment and dedication. Each level of the program represents a distinct achievement in
professional development. Successful completion of the program is rewarded with
membership in a prestigious global community of investment professionals. CFA
charterholders are dedicated to life-­long learning and maintaining currency with
the ever-­changing dynamics of a challenging profession. CFA Program enrollment
represents the first step toward a career-­long commitment to professional education.
The CFA exam measures your mastery of the core knowledge, skills, and abilities
required to succeed as an investment professional. These core competencies are the
basis for the Candidate Body of Knowledge (CBOK™). The CBOK consists of four
components:
■■

A broad outline that lists the major CFA Program topic areas (www.cfainstitute.
org/programs/cfa/curriculum/cbok);

■■


Topic area weights that indicate the relative exam weightings of the top-­level
topic areas (www.cfainstitute.org/programs/cfa/curriculum);

■■

Learning outcome statements (LOS) that advise candidates about the specific
knowledge, skills, and abilities they should acquire from readings covering a
topic area (LOS are provided in candidate study sessions and at the beginning
of each reading); and

■■

CFA Program curriculum that candidates receive upon exam registration.

Therefore, the key to your success on the CFA exams is studying and understanding
the CBOK. The following sections provide background on the CBOK, the organization of the curriculum, features of the curriculum, and tips for designing an effective
personal study program.

BACKGROUND ON THE CBOK
CFA Program is grounded in the practice of the investment profession. CFA Institute
performs a continuous practice analysis with investment professionals around the
world to determine the competencies that are relevant to the profession, beginning
with the Global Body of Investment Knowledge (GBIK®). Regional expert panels and
targeted surveys are conducted annually to verify and reinforce the continuous feedback about the GBIK. The practice analysis process ultimately defines the CBOK. The
CBOK reflects the competencies that are generally accepted and applied by investment
professionals. These competencies are used in practice in a generalist context and are
expected to be demonstrated by a recently qualified CFA charterholder.

© 2021 CFA Institute. All rights reserved.


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© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

The CFA Institute staff—in conjunction with the Education Advisory Committee
and Curriculum Level Advisors, who consist of practicing CFA charterholders—designs
the CFA Program curriculum in order to deliver the CBOK to candidates. The exams,
also written by CFA charterholders, are designed to allow you to demonstrate your
mastery of the CBOK as set forth in the CFA Program curriculum. As you structure
your personal study program, you should emphasize mastery of the CBOK and the
practical application of that knowledge. For more information on the practice analysis, CBOK, and development of the CFA Program curriculum, please visit www.
cfainstitute.org.

ORGANIZATION OF THE CURRICULUM
The Level I CFA Program curriculum is organized into 10 topic areas. Each topic area
begins with a brief statement of the material and the depth of knowledge expected.
It is then divided into one or more study sessions. These study sessions should form
the basic structure of your reading and preparation. Each study session includes a
statement of its structure and objective and is further divided into assigned readings.
An outline illustrating the organization of these study sessions can be found at the
front of each volume of the curriculum.
The readings are commissioned by CFA Institute and written by content experts,
including investment professionals and university professors. Each reading includes
LOS and the core material to be studied, often a combination of text, exhibits, and in-­
text examples and questions. End of Reading Questions (EORQs) followed by solutions
help you understand and master the material. The LOS indicate what you should be

able to accomplish after studying the material. The LOS, the core material, and the
EORQs are dependent on each other, with the core material and EORQs providing
context for understanding the scope of the LOS and enabling you to apply a principle
or concept in a variety of scenarios.
The entire readings, including the EORQs, are the basis for all exam questions
and are selected or developed specifically to teach the knowledge, skills, and abilities
reflected in the CBOK.
You should use the LOS to guide and focus your study because each exam question
is based on one or more LOS and the core material and practice problems associated
with the LOS. As a candidate, you are responsible for the entirety of the required
material in a study session.
We encourage you to review the information about the LOS on our website (www.
cfainstitute.org/programs/cfa/curriculum/study-­sessions), including the descriptions
of LOS “command words” on the candidate resources page at www.cfainstitute.org.

FEATURES OF THE CURRICULUM
End of Reading Questions/Solutions  All End of Reading Questions (EORQs) as well
as their solutions are part of the curriculum and are required material for the exam.
In addition to the in-­text examples and questions, these EORQs help demonstrate
practical applications and reinforce your understanding of the concepts presented.
Some of these EORQs are adapted from past CFA exams and/or may serve as a basis
for exam questions.


© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

Glossary   For your convenience, each volume includes a comprehensive Glossary.
Throughout the curriculum, a bolded word in a reading denotes a term defined in
the Glossary.

Note that the digital curriculum that is included in your exam registration fee is
searchable for key words, including Glossary terms.
LOS Self-­Check  We have inserted checkboxes next to each LOS that you can use to
track your progress in mastering the concepts in each reading.
Source Material  The CFA Institute curriculum cites textbooks, journal articles, and
other publications that provide additional context or information about topics covered
in the readings. As a candidate, you are not responsible for familiarity with the original
source materials cited in the curriculum.
Note that some readings may contain a web address or URL. The referenced sites
were live at the time the reading was written or updated but may have been deactivated since then.
 
Some readings in the curriculum cite articles published in the Financial Analysts Journal®,
which is the flagship publication of CFA Institute. Since its launch in 1945, the Financial
Analysts Journal has established itself as the leading practitioner-­oriented journal in the
investment management community. Over the years, it has advanced the knowledge and
understanding of the practice of investment management through the publication of
peer-­reviewed practitioner-­relevant research from leading academics and practitioners.
It has also featured thought-­provoking opinion pieces that advance the common level of
discourse within the investment management profession. Some of the most influential
research in the area of investment management has appeared in the pages of the Financial
Analysts Journal, and several Nobel laureates have contributed articles.
Candidates are not responsible for familiarity with Financial Analysts Journal articles
that are cited in the curriculum. But, as your time and studies allow, we strongly encourage you to begin supplementing your understanding of key investment management
issues by reading this, and other, CFA Institute practice-­oriented publications through
the Research & Analysis webpage (www.cfainstitute.org/en/research).

Errata  The curriculum development process is rigorous and includes multiple rounds
of reviews by content experts. Despite our efforts to produce a curriculum that is free
of errors, there are times when we must make corrections. Curriculum errata are periodically updated and posted by exam level and test date online (www.cfainstitute.org/
en/programs/submit-­errata). If you believe you have found an error in the curriculum,

you can submit your concerns through our curriculum errata reporting process found
at the bottom of the Curriculum Errata webpage.

DESIGNING YOUR PERSONAL STUDY PROGRAM
Create a Schedule  An orderly, systematic approach to exam preparation is critical.
You should dedicate a consistent block of time every week to reading and studying.
Complete all assigned readings and the associated problems and solutions in each study
session. Review the LOS both before and after you study each reading to ensure that

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© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

you have mastered the applicable content and can demonstrate the knowledge, skills,
and abilities described by the LOS and the assigned reading. Use the LOS self-­check
to track your progress and highlight areas of weakness for later review.
Successful candidates report an average of more than 300 hours preparing for each
exam. Your preparation time will vary based on your prior education and experience,
and you will probably spend more time on some study sessions than on others.
You should allow ample time for both in-­depth study of all topic areas and additional concentration on those topic areas for which you feel the least prepared.

CFA INSTITUTE LEARNING ECOSYSTEM (LES)
As you prepare for your exam, we will email you important exam updates, testing
policies, and study tips. Be sure to read these carefully.
Your exam registration fee includes access to the CFA Program Learning Ecosystem
(LES). This digital learning platform provides access, even offline, to all of the readings

and End of Reading Questions found in the print curriculum organized as a series of
shorter online lessons with associated EORQs. This tool is your one-­stop location for
all study materials, including practice questions and mock exams.
The LES provides the following supplemental study tools:
Structured and Adaptive Study Plans  The LES offers two ways to plan your study
through the curriculum. The first is a structured plan that allows you to move through
the material in the way that you feel best suits your learning. The second is an adaptive
study plan based on the results of an assessment test that uses actual practice questions.
Regardless of your chosen study path, the LES tracks your level of proficiency in
each topic area and presents you with a dashboard of where you stand in terms of
proficiency so that you can allocate your study time efficiently.
Flashcards and Game Center  The LES offers all the Glossary terms as Flashcards and
tracks correct and incorrect answers. Flashcards can be filtered both by curriculum
topic area and by action taken—for example, answered correctly, unanswered, and so
on. These Flashcards provide a flexible way to study Glossary item definitions.
The Game Center provides several engaging ways to interact with the Flashcards in
a game context. Each game tests your knowledge of the Glossary terms a in different
way. Your results are scored and presented, along with a summary of candidates with
high scores on the game, on your Dashboard.
Discussion Board  The Discussion Board within the LES provides a way for you to
interact with other candidates as you pursue your study plan. Discussions can happen
at the level of individual lessons to raise questions about material in those lessons that
you or other candidates can clarify or comment on. Discussions can also be posted at
the level of topics or in the initial Welcome section to connect with other candidates
in your area.
Practice Question Bank  The LES offers access to a question bank of hundreds of
practice questions that are in addition to the End of Reading Questions. These practice
questions, only available on the LES, are intended to help you assess your mastery of
individual topic areas as you progress through your studies. After each practice question, you will receive immediate feedback noting the correct response and indicating
the relevant assigned reading so you can identify areas of weakness for further study.



© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

Mock Exams  The LES also includes access to three-­hour Mock Exams that simulate
the morning and afternoon sessions of the actual CFA exam. These Mock Exams are
intended to be taken after you complete your study of the full curriculum and take
practice questions so you can test your understanding of the curriculum and your
readiness for the exam. If you take these Mock Exams within the LES, you will receive
feedback afterward that notes the correct responses and indicates the relevant assigned
readings so you can assess areas of weakness for further study. We recommend that
you take Mock Exams during the final stages of your preparation for the actual CFA
exam. For more information on the Mock Exams, please visit www.cfainstitute.org.

PREP PROVIDERS
You may choose to seek study support outside CFA Institute in the form of exam prep
providers. After your CFA Program enrollment, you may receive numerous solicitations for exam prep courses and review materials. When considering a prep course,
make sure the provider is committed to following the CFA Institute guidelines and
high standards in its offerings.
Remember, however, that there are no shortcuts to success on the CFA exams;
reading and studying the CFA Program curriculum is the key to success on the exam.
The CFA Program exams reference only the CFA Institute assigned curriculum; no
prep course or review course materials are consulted or referenced.
SUMMARY
Every question on the CFA exam is based on the content contained in the required
readings and on one or more LOS. Frequently, an exam question is based on a specific
example highlighted within a reading or on a specific practice problem and its solution.
To make effective use of the CFA Program curriculum, please remember these key points:


1 All pages of the curriculum are required reading for the exam.
2 All questions, problems, and their solutions are part of the curriculum and are
required study material for the exam. These questions are found at the end of the
readings in the print versions of the curriculum. In the LES, these questions appear
directly after the lesson with which they are associated. The LES provides immediate feedback on your answers and tracks your performance on these questions
throughout your study.

3 We strongly encourage you to use the CFA Program Learning Ecosystem. In
addition to providing access to all the curriculum material, including EORQs, in
the form of shorter, focused lessons, the LES offers structured and adaptive study
planning, a Discussion Board to communicate with other candidates, Flashcards,
a Game Center for study activities, a test bank of practice questions, and online
Mock Exams. Other supplemental study tools, such as eBook and PDF versions
of the print curriculum, and additional candidate resources are available at www.
cfainstitute.org.

4 Using the study planner, create a schedule and commit sufficient study time to
cover the study sessions. You should also plan to review the materials, answer
practice questions, and take Mock Exams.

5 Some of the concepts in the study sessions may be superseded by updated
rulings and/or pronouncements issued after a reading was published. Candidates
are expected to be familiar with the overall analytical framework contained in the
assigned readings. Candidates are not responsible for changes that occur after the
material was written.

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xiv


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How to Use the CFA Program Curriculum

FEEDBACK
At CFA Institute, we are committed to delivering a comprehensive and rigorous curriculum for the development of competent, ethically grounded investment professionals.
We rely on candidate and investment professional comments and feedback as we
work to improve the curriculum, supplemental study tools, and candidate resources.
Please send any comments or feedback to You can be assured
that we will review your suggestions carefully. Ongoing improvements in the curriculum will help you prepare for success on the upcoming exams and for a lifetime of
learning as a serious investment professional.


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Economics

STUDY SESSIONS
Study Session 3
Study Session 4

Economics (1)
Economics (2)

TOPIC LEVEL LEARNING OUTCOME
The candidate should be able to demonstrate knowledge of microeconomic and
macroeconomic principles.
The next study sessions introduce fundamental microeconomic and macroeconomic
concepts relevant to financial analysis and investment management. Microeconomic
factors such as a firm’s competitive (or non-­competitive) environment and its pricing

strategy may be critical inputs for cash flow forecasting and bottom up security selection approaches. Economic output, global trade flows, monetary and fiscal policies,
and the business cycle are key considerations for conducting top own investment
analysis and economic forecasting.
Candidates should be familiar with the material covered in the following
prerequisite economics readings available in Candidate Resources on the CFA
Institute website:
■■
■■
■■

Demand and Supply Analysis: Introduction

Demand and Supply Analysis: Consumer Demand
Demand and Supply Analysis: The Firm

© 2021 CFA Institute. All rights reserved.


© CFA Institute. For candidate use only. Not for distribution.


© CFA Institute. For candidate use only. Not for distribution.

E conomics

3

STUDY SESSION

Economics (1)


This study session begins by introducing fundamental concepts of demand and

supply analysis for individual consumers and firms. Also covered are the various
market structures (perfect competition, oligopoly, monopoly) in which firms operate.
Key macroeconomic concepts and principles then follow, including aggregate output
and income measurement, aggregate demand and supply analysis, and analysis of
economic growth factors. The study session concludes with coverage of the business
cycle and its effect on economic activity.

READING ASSIGNMENTS
Reading 8

Topics in Demand and Supply Analysis
by Richard V. Eastin, PhD, and Gary L. Arbogast, PhD, CFA

Reading 9

The Firm and Market Structures
by Richard Fritz, PhD, and Michele Gambera, PhD, CFA

Reading 10

Aggregate Output, Prices, and Economic Growth
by Paul R. Kutasovic, PhD, CFA, and Richard Fritz, PhD

Reading 11

Understanding Business Cycles
by Michele Gambera, PhD, CFA, Milton Ezrati, and Bolong Cao,

PhD, CFA

© 2021 CFA Institute . All rights reserved.


© CFA Institute. For candidate use only. Not for distribution.


© CFA Institute. For candidate use only. Not for distribution.

READING

8

Topics in Demand and Supply Analysis
by Richard V. Eastin, PhD, and Gary L. Arbogast, PhD, CFA
Richard V. Eastin, PhD, is at the University of Southern California (USA). Gary L.
Arbogast, PhD, CFA (USA).

LEARNING OUTCOMES
Mastery

The candidate should be able to:
a. calculate and interpret price, income, and cross-­price elasticities
of demand and describe factors that affect each measure;
b. compare substitution and income effects;

c. contrast normal goods with inferior goods;
d. describe the phenomenon of diminishing marginal returns;
e. determine and interpret breakeven and shutdown points of

production;

f. describe how economies of scale and diseconomies of scale affect
costs.

INTRODUCTION
In a general sense, economics is the study of production, distribution, and consumption
and can be divided into two broad areas of study: macroeconomics and microeconomics. Macroeconomics deals with aggregate economic quantities, such as national
output and national income, and is rooted in microeconomics, which deals with
markets and decision making of individual economic units, including consumers and
businesses. Microeconomics is a logical starting point for the study of economics.
Microeconomics classifies private economic units into two groups: consumers
(or households) and firms. These two groups give rise, respectively, to the theory of
the consumer and the theory of the firm as two branches of study. The theory of the
consumer deals with consumption (the demand for goods and services) by utility-­
maximizing individuals (i.e., individuals who make decisions that maximize the satisfaction received from present and future consumption). The theory of the firm deals
with the supply of goods and services by profit-­maximizing firms.

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1


© CFA Institute. For candidate use only. Not for distribution.
Reading 8 ■ Topics in Demand and Supply Analysis

6

It is expected that candidates will be familiar with the basic concepts of demand and
supply. This material is covered in detail in the recommended prerequisite readings. In

this reading, we will explore how buyers and sellers interact to determine transaction
prices and quantities. The reading is organized as follows: Sections 2–6 discuss the
consumer or demand side of the market model, and Sections 7–12 discuss the supply
side of the consumer goods market, paying particular attention to the firm’s costs.
Section 13 provides a summary of key points in the reading.

2

DEMAND CONCEPTS
a calculate and interpret price, income, and cross-­price elasticities of demand and
describe factors that affect each measure;
The fundamental model of the private-­enterprise economy is the demand and supply
model of the market. In this section, we examine three important topics concerning
the demand side of the model: (1) elasticities, (2) substitution and income effects,
and (3) normal and inferior goods. The candidate is assumed to have a basic understanding of the demand and supply model and to understand how a market discovers
the equilibrium price at which the quantity willingly demanded by consumers at that
price is just equal to the quantity willingly supplied by firms. Here, we explore more
deeply some of the concepts underlying the demand side of the model.

2.1  Demand Concepts
The quantity of a good that consumers are willing to buy depends on a number of
different variables. Perhaps the most important of those variables is the item’s own
price. In general, economists believe that as the price of a good rises, buyers will
choose to buy less of it, and as its price falls, they buy more. This opinion is so nearly
universal that it has come to be called the law of demand.
Although a good’s own price is important in determining consumers’ willingness
to purchase it, other variables also influence that decision. Consumers’ incomes, their
tastes and preferences, and the prices of other goods that serve as substitutes or complements are just a few of the other variables that influence consumers’ demand for a
product or service. Economists attempt to capture all these influences in a relationship
called the demand function. (A function is a relationship that assigns a unique value

to a dependent variable for any given set of values of a group of independent variables.)
Equation  1 is an example of a demand function. In Equation  1, we are saying,
“The quantity demanded of good X depends on (is a function of ) the price of good
X, consumers’ income, and the price of good Y”:
Qxd



f Px , I , Py




(1)

where


Qxd = the quantity demanded of some good X (such as per household demand
for gasoline in liters per month)

Px = the price per unit of good X (such as € per liter)
I = consumers’ income (as in €1,000s per household annually)
P y = the price of another good, Y. (There can be many other goods, not just
one, and they can be complements or substitutes.)


Demand Concepts

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Often, economists use simple linear equations to approximate real-­world demand
and supply functions in relevant ranges. Equation 2 illustrates a hypothetical example
of our function for gasoline demand:
Qxd = 84.5 – 6.39Px + 0.25I – 2P y

(2)




where the quantity of gasoline demanded Qxd is a function of the price of a liter of
gasoline (Px), consumers’ income in €1,000s (I), and the average price of an automobile
in €1,000s (P y).
The signs of the coefficients on gasoline price (negative) and consumers’ income
(positive) reflect the relationship between those variables and the quantity of gasoline
consumed. The negative sign on average automobile price indicates that if automobiles go up in price, fewer will likely be purchased and driven; hence, less gasoline
will be consumed. (As discussed later, such a relationship would indicate that gasoline and automobiles have a negative cross-­price elasticity of demand and are thus
complements.)
To continue our example, suppose that the price of gasoline (Px) is €1.48 per liter,
per household income (I) is €50,000, and the price of the average automobile (P y) is
€20,000. In this case, this function would predict that the per-­household monthly
demand for gasoline would be 47.54 liters, calculated as follows:
Qxd = 84.5 – 6.39(1.48) + 0.25(50) – 2(20) = 47.54
recalling that income and automobile prices are measured in thousands. Note that the
sign on the “own-­price” variable (Px) is negative; thus, as the price of gasoline rises, per
household consumption would decrease by 6.39 liters per month for every €1 increase
in gas price. Own price is used by economists to underscore that the reference is to
the price of a good itself and not the price of some other good.
In our example, there are three independent variables in the demand function

and one dependent variable. If any one of the independent variables changes, so
does the quantity demanded. It is often desirable to concentrate on the relationship
between the dependent variable and just one of the independent variables at a time.
To accomplish this goal, we can hold the other independent variables constant and
rewrite the equation.
For example, to concentrate on the relationship between the quantity demanded of
the good and its own price, Px, we hold constant the values of income and the price of
good Y. In our example, those values are 50 and 20, respectively. The equation would
then be rewritten as
Qxd = 84.5 – 6.39Px + 0.25(50) – 2(20) = 57 – 6.39Px

(3)

The quantity of gasoline demanded is a function of the price of gasoline (6.39
per liter), per household income (€50,000), and the average price of an automobile
(€20,000). Notice that income and the price of automobiles are not ignored; they are
simply held constant, and they are “collected” in the new constant term, 57 [84.5 +
(0.25)(50) – (2)(20)]. Notice also that we can solve for Px in terms of Qxd by rearranging
Equation 3, which gives us Equation 4:
Px

8.92  0.156Qxd   

(4)

7