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SME Consultant · LESSON 1

Economics and economic policyEqual subject marks; equal sampling here · 11 topics

Distinguish demand, supply, elasticity, opportunity cost and marginal decisions. A price change can move quantity along a demand curve; changes in income or substitute prices can shift the curve itself. Separate nominal from real measures and production from prices. Externalities show why a transaction price may miss impacts on other parties.

1.1Economics and economic policy

Concept

Distinguish demand, supply, elasticity, opportunity cost and marginal decisions. A price change can move quantity along a demand curve; changes in income or substitute prices can shift the curve itself. Separate nominal from real measures and production from prices. Externalities show why a transaction price may miss impacts on other parties.

How it works / steps

  1. Divide the percentage change in quantity by that in price: the absolute value is 20/10 = 2.
  2. A substitute becoming more expensive can shift demand toward the other good.
  3. Opportunity cost is the value of the best alternative that is given up.

Workplace example

When considering a price increase, estimate quantity response and compare revenue and profit. Demand expectations alone do not justify an investment.

Common confusions and exam tips

Reference links

1.2Demand, supply and equilibrium

Concept

A demand curve holds nonprice determinants constant. Income or preferences can shift it; a change in the good’s own price moves along it. Solve demand and supply together for equilibrium. A price ceiling creates a shortage when it binds below equilibrium.

How it works / steps

  1. Equate the two: 100=5P, so P=20 and both quantities equal 80.
  2. A normal good has greater demand at a given price when income increases; this is a shift, not a price-driven movement.
  3. Demand is 90 and supply is 65. The shortage is 90−65=25.

Workplace example

With Qd=120−2P and Qs=20+3P, equilibrium is P=20, Q=80. At a ceiling of 15, demand is 90 and supply 65: a shortage of 25.

Common confusions and exam tips

Mini quiz

Q1. Demand is Q=120−2P and supply Q=20+3P. What is the equilibrium price?

  1. 20
  2. 16
  3. 24
  4. 40
Show answer and explanation

Answer: A 20

Equate the two: 100=5P, so P=20 and both quantities equal 80.

Q2. Only income rises for a normal good. What usually happens to its demand curve?

  1. It shifts left
  2. A move upward along it
  3. A move downward along it
  4. It shifts right
Show answer and explanation

Answer: D It shifts right

A normal good has greater demand at a given price when income increases; this is a shift, not a price-driven movement.

Reference links

1.3Elasticity and revenue

Concept

Absolute price elasticity divides the percentage quantity change by the percentage price change. Above one, a small price increase normally lowers revenue. Cross elasticity is positive for substitutes and negative for complements; negative income elasticity identifies an inferior good.

How it works / steps

  1. New revenue is 8,800 versus 10,000, a change of −1,200.
  2. The goods are complements: the other good’s price and ink demand move in opposite directions.
  3. −5% divided by 10% is −0.5, an inferior-good response.

Workplace example

Moving from price 100 and quantity 100 to price 110 and quantity 80 reduces revenue from 10,000 to 8,800.

Common confusions and exam tips

Mini quiz

Q1. Price goes from 100 to 110 and quantity from 100 to 80. What is the revenue change?

  1. +1,000
  2. −800
  3. −1,200
  4. −2,000
Show answer and explanation

Answer: C −1,200

New revenue is 8,800 versus 10,000, a change of −1,200.

Q2. A printer price increase lowers demand for its dedicated ink, other things equal. What is the sign of cross elasticity?

  1. Necessarily one
  2. Negative
  3. Positive
  4. Zero
Show answer and explanation

Answer: B Negative

The goods are complements: the other good’s price and ink demand move in opposite directions.

Reference links

1.4Consumer choice and budget constraints

Concept

The budget line PxX+PyY=I describes affordable bundles; an indifference curve connects bundles of equal utility. At a regular interior optimum, the marginal rate of substitution equals the price ratio. Separate substitution and income effects when analyzing a price change.

How it works / steps

  1. 1,200/300=4. Six is the Y intercept.
  2. The price ratio stays fixed while both intercepts increase.
  3. MUx/MUy=Px/Py: marginal utility per unit of money is equalized.

Workplace example

With income 1,200 and X priced at 300, the X intercept is four units. An income increase alone shifts the budget line outward in parallel.

Common confusions and exam tips

Mini quiz

Q1. Income is 1,200; X costs 300 and Y costs 200. How many units of X can be bought if no Y is bought?

  1. 2
  2. 4
  3. 6
  4. 3
Show answer and explanation

Answer: B 4

1,200/300=4. Six is the Y intercept.

Q2. Both prices stay fixed and income increases. How does the budget line change?

  1. Parallel outward shift
  2. Only its slope steepens
  3. Only its slope flattens
  4. Parallel inward shift
Show answer and explanation

Answer: A Parallel outward shift

The price ratio stays fixed while both intercepts increase.

Reference links

1.5Production costs and profit maximization

Concept

In the short run, distinguish fixed and variable costs. Marginal cost is the extra cost of one more unit. A competitive firm compares price with marginal cost when producing; shutdown depends on average variable cost, while long-run exit requires consideration of total cost recovery.

How it works / steps

  1. Differentiate TC with respect to Q. The fixed cost of 100 drops out.
  2. Set P=MC: 12=4+2Q, giving Q=4; check shutdown conditions separately.
  3. Each unit contributes 8−6=2 toward fixed costs. Operating can reduce the short-run loss.

Workplace example

At price 8, average variable cost 6 and average total cost 10, production can contribute to fixed costs despite an accounting loss.

Common confusions and exam tips

Mini quiz

Q1. Total cost is TC=100+4Q+Q². What is marginal cost?

  1. 100/Q+4+Q
  2. 4+2Q
  3. 100+4Q
  4. 4+Q
Show answer and explanation

Answer: B 4+2Q

Differentiate TC with respect to Q. The fixed cost of 100 drops out.

Q2. A competitive firm faces price 12 and MC=4+2Q. What is its interior profit-maximizing output?

  1. 4
  2. 6
  3. 8
  4. 2
Show answer and explanation

Answer: A 4

Set P=MC: 12=4+2Q, giving Q=4; check shutdown conditions separately.

Reference links

1.6Market structure and game theory

Concept

A competitive firm takes price as given. A monopolist chooses output where MR=MC and then reads price from demand. Oligopoly requires strategic interdependence. A Nash equilibrium is a strategy profile in which no player gains by changing its own strategy alone.

How it works / steps

  1. MR=100−2Q=20 gives Q=40. Substitute into demand to obtain P=60.
  2. Each player is best responding to the others; collective optimality and identical actions are not required.
  3. The firm takes the market price as given; this does not make aggregate market demand horizontal.

Workplace example

If P=100−Q, total revenue is 100Q−Q² and MR=100−2Q. With MC=20, output is 40 and price is 60.

Common confusions and exam tips

Mini quiz

Q1. A monopolist has P=100−Q and MC=20. What is the profit-maximizing price?

  1. 20
  2. 80
  3. 60
  4. 40
Show answer and explanation

Answer: C 60

MR=100−2Q=20 gives Q=40. Substitute into demand to obtain P=60.

Q2. Which condition defines a Nash equilibrium?

  1. A leading firm sets all market prices
  2. No profitable unilateral deviation
  3. Maximum sum of all players’ payoffs
  4. Identical strategies for all players
Show answer and explanation

Answer: B No profitable unilateral deviation

Each player is best responding to the others; collective optimality and identical actions are not required.

Reference links

1.7Surplus, taxation and market failure

Concept

Consumer surplus is willingness to pay less price; producer surplus is price less supply cost. A tax creates a wedge between buyer and seller prices and can cause deadweight loss from forgone trades. Externalities and public goods can separate private incentives from social welfare.

How it works / steps

  1. It is the triangle between demand and price: 40×40/2=800.
  2. Social marginal cost adds marginal external harm to private marginal cost.
  3. One person’s use does not reduce another’s and exclusion is difficult, creating free-rider incentives.

Workplace example

For linear demand with intercept 100, price 60 and quantity 40, consumer surplus is (100−60)×40/2=800.

Common confusions and exam tips

Mini quiz

Q1. Linear demand has price intercept 100, price 60 and quantity 40. What is consumer surplus?

  1. 1,600
  2. 2,400
  3. 4,000
  4. 800
Show answer and explanation

Answer: D 800

It is the triangle between demand and price: 40×40/2=800.

Q2. Production emits harmful smoke. How do private and social marginal cost compare?

  1. They are equal by definition
  2. Social cost is set by demand
  3. Social marginal cost is higher
  4. Private marginal cost is higher
Show answer and explanation

Answer: C Social marginal cost is higher

Social marginal cost adds marginal external harm to private marginal cost.

Reference links

1.8GDP, prices and unemployment

Concept

GDP measures value added produced domestically during a period, excluding double counting of intermediate inputs. Nominal GDP uses current prices; real GDP removes price effects. The unemployment rate uses the labor force, rather than the entire population, as its denominator.

How it works / steps

  1. Nominal divided by real GDP, times 100, is 110.
  2. The labor force is 100; 5/100=5%. Those outside it are excluded from the denominator.
  3. Value added is output minus intermediate consumption: 300−180=120.

Workplace example

Nominal GDP of 550 and real GDP of 500 imply a deflator of 110. Five unemployed and 95 employed imply 5% unemployment.

Common confusions and exam tips

Mini quiz

Q1. Nominal GDP is 550 and real GDP is 500. What is the GDP deflator?

  1. 50
  2. 105
  3. 110
  4. 90.9
Show answer and explanation

Answer: C 110

Nominal divided by real GDP, times 100, is 110.

Q2. There are 95 employed, five unemployed and 25 outside the labor force. What is unemployment?

  1. 5.3%
  2. 5%
  3. 4%
  4. 20%
Show answer and explanation

Answer: B 5%

The labor force is 100; 5/100=5%. Those outside it are excluded from the denominator.

Reference links

1.9Goods market, multipliers and IS–LM

Concept

In a simple closed economy without taxes, Y=C0+cY+I+G and the spending multiplier is 1/(1−c). Taxes, imports and interest-rate responses change the result. IS represents goods-market equilibrium and LM money-market equilibrium; fiscal expansion can crowd out private investment through interest rates.

How it works / steps

  1. 1/(1−0.8)=5; the formula uses marginal propensity to consume.
  2. Y=100+0.75Y, so 0.25Y=100 and Y=400.
  3. Higher income raises money demand; with fixed money supply, interest rates can rise and restrain investment.

Workplace example

At MPC 0.75, the simple multiplier is four, so 20 extra government spending raises equilibrium income by 80.

Common confusions and exam tips

Mini quiz

Q1. With no taxes or imports and MPC 0.8, what is the government-spending multiplier?

  1. 1.25
  2. 0.2
  3. 5
  4. 4
Show answer and explanation

Answer: C 5

1/(1−0.8)=5; the formula uses marginal propensity to consume.

Q2. In a simple model C=50+0.75Y, I=30 and G=20. What is equilibrium income?

  1. 500
  2. 400
  3. 100
  4. 300
Show answer and explanation

Answer: B 400

Y=100+0.75Y, so 0.25Y=100 and Y=400.

Reference links

1.10Money, monetary policy and inflation

Concept

Money demand reflects transactions and portfolio choices; interest is an opportunity cost of holding cash. The simple reserve-ratio multiplier 1/r ignores cash leakage and other constraints. The real interest rate is approximately the nominal rate minus expected inflation.

How it works / steps

  1. The approximate Fisher relation gives 4−1=3%; the exact expression is 1.04/1.01−1.
  2. 1/r=1/0.2=5; it is a model result, not a guaranteed expansion.
  3. Inflation remains positive, so the price level rises, but at a slower rate.

Workplace example

A nominal rate of 3% and expected inflation of 2% imply roughly 1% real interest. Slower positive inflation still means prices are rising.

Common confusions and exam tips

Mini quiz

Q1. Nominal interest is 4% and expected inflation 1%. What is the approximate real rate?

  1. −3%
  2. 3%
  3. 5%
  4. 4%
Show answer and explanation

Answer: B 3%

The approximate Fisher relation gives 4−1=3%; the exact expression is 1.04/1.01−1.

Q2. Ignoring cash leakage and other constraints, required reserves are 20%. What is the simple deposit multiplier?

  1. 5
  2. 20
  3. 0.2
  4. 4
Show answer and explanation

Answer: A 5

1/r=1/0.2=5; it is a model result, not a guaranteed expansion.

Reference links

1.11Comparative advantage, exchange rates and external accounts

Concept

Comparative advantage depends on opportunity cost, not absolute productivity. Check the quotation direction before interpreting exchange rates. Separate current transactions in goods, services and income from financial transactions; a trade balance alone does not determine the current account.

How it works / steps

  1. One cloth costs 0.5 rice in A and one rice in B, so A has lower opportunity cost.
  2. 10,000×(150−120)=JPY300,000, holding the dollar price fixed.
  3. Investment interest is primary income; acquiring the underlying financial asset is a financial transaction.

Workplace example

A move from JPY150/USD to JPY120/USD is yen appreciation; a USD10,000 import falls from JPY1.5 million to JPY1.2 million.

Common confusions and exam tips

Mini quiz

Q1. A can make four cloth or two rice per hour; B can make three cloth or three rice. Who has comparative advantage in cloth?

  1. The more populous country
  2. A
  3. B
  4. Both equally
Show answer and explanation

Answer: B A

One cloth costs 0.5 rice in A and one rice in B, so A has lower opportunity cost.

Q2. A USD10,000 import is paid after JPY/USD moves from 150 to 120. How much less yen is paid?

  1. JPY300,000
  2. JPY200,000
  3. JPY1,200,000
  4. JPY1,500,000
Show answer and explanation

Answer: A JPY300,000

10,000×(150−120)=JPY300,000, holding the dollar price fixed.

Reference links

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Notes (unofficial, original questions, no pass guarantee)