CFA Level 1 Complete
Private value auctions - ANS Value is subjective and different to each bidder
Ascending price (English) auction - ANS Bidders can bid amounts greater than the previous
bid, and the bidder that first offers the highest bid wins the item and pays the amount
Sealed bid auction - ANS Each bidder submits one bid, which is unknown to the other bidders
and the bidder with the highest bid wins the item and pays the price;
The reservation price is the highest price that a bidder is willing to pay;
The optimal bid for the bidder with the highest reservation price is just slightly above the bidder
with the second highest reservation price;
Bids are not necessarily equal to reservation price
Second sealed bid auction (Vickrey auction) - ANS The bidder with the highest bid wins the
item but pays the price bid by the second highest bidder;
No reason for a bidder not to bid his reserve price;
Similar to a an ascending price auction, the winning bidder tends to pay one increment of price
more than the bidder who values the time the second most
Descending price (Dutch) auction - ANS Begins with a price greater than what any bidder will
pay and the price is reduced until a bidder agrees to pay it;
If there are multiple units available, each bidder and specify how many they want to buy;
Can be modified so that winning bidders all pay the same price
Price elasticity - ANS How responsive the quantity demanded is to a change in price
Elasticity of demand - ANS A measure of how consumers respond to price changes;
Perfectly elastic is when the demand curve is horizontal;
Perfectly inelastic is when the demand curve is perfectly vertical
Unstable equilibrium - ANS When a supply curve intersects a demand curve more than once,
the unstable equilibrium is an equilibrium where supply can increase towards another
equilibrium that results in a lower price;
Caused by a nonlinear supply function
Statutory incidence - ANS Who is legally responsible for paying a tax
Incidence of tax - ANS Who ends up bearing the cost of a tax
,Substitution effect - ANS Always acts to increase the consumption of a good that has fallen in
price
Income effect - ANS Either increase or decrease a good that has fallen in price;
Typical of normal good to have a positive income effect;
Typical of inferior good to have negative substitution effect
Positive substitution, positive income - ANS Consumption increases
Positive substitution, negative income smaller than positive substitution - ANS Consumption
increases
Positive substitution, negative income greater than positive substitution - ANS Consumption
decreases
Causes of demand changes - ANS Income
Increases as prices of substitute goods increase
Decreases as the prices of complement goods increases
Causes of supply changes - ANS Rises if technology increases;
Rises if input prices decrease
Giffen good - ANS An inferior good for which the income effect outweighs the substitution effect
so that the demand curve is positively sloped (higher the price, higher the demand)
Relationship cost curves - ANS AFC slopes downward
Vertical distance between ATC and AVC equals AFC
MC initially declines, then rises
MC intersects AVC and ATC at their minimums
ATC and AVC are u-shaped
The MC above the AVC is the firm's short-rum supply curve
Average Revenue > AVC - ANS Firm continue production
Average Revenue < AVC - ANS Firm should shut down
Average Revenue > ATC - ANS Firm should stay in business for long-run
Profit maximized - ANS Producing up to but not over MR=MC;
Producing quantity where TR-TC is at a maximum
Perfect competition - ANS Many firms compete with identical products, low barriers to entry,
and the only way to compete is on price;
Perfectly elastic demand curves for each firm;
,A firm will continue to expand production until marginal revenue equals marginal cost, which
maximizes profit or where MR = MC;
Economic loss occurs when marginal revenue is less than marginal cost;
Firm can't make economic profit in long-run;
Long-run equilibrium output is where marginal revenue equals marginal cost equals average
total cost ;
An increase/decrease in market demand will increase/decrease both equilibrium price and
quantity;
Short-run supply curve is the marginal cost curve above the average variable cost
Monopolistic competition - ANS Many firms that compete with differentiated products;
Demand curve is downward sloping and is highly elastic;
Quality, Price and Marketing are key differentiators ;
Low barriers to entry;
Firms must advertise and innovate;
In short run maximize economic profits by producing where marginal revenue equals marginal
cost ;
In long run, price equals average total cost and economic profits are 0
Oligopoly - ANS Only a few firms compete and each must consider the actions of others when
setting price and strategy;
High barriers to entry;
Demand is less elastic than monopolistic competition
Monopoly - ANS Only one seller in the market and there are no good substitutes;
High barriers to entry;
Maximize profit, not price;
Profit maximized when marginal revenue equals marginal cost when demand curve is above
ATC
Natural monopoly - ANS When the average cost of production is falling over the relevant range
of demand and having two or more producers would lead to hire production costs and hurt the
consumer
Marginal cost pricing - ANS Forces the monopoly to reduce price to the point where the firms
marginal cost curve intersects the market demand curve
Oligopoly models - ANS -Kinked demand curve
-Cournot duopoly
-Nash equilibrium
-Dominant firm model
Kinked demand curve - ANS Based on the assumption that an increase in a firm's product price
will not be followed by its competitors, but a price decrease will;
, Firms assume that demand is more elastic above a certain price than below it;
Firms produce the quantity at the kink, assuming if they increase production, their revenues will
be eroded by decreased prices and if they decrease production the price won't go up much;
Model doesn't account for cause of kinks
Cournot duopoly - ANS One firm will look at the other's price and production and adjust
accordingly until both firms meet at an equilibrium of the same price and quantity
Nash equilibrium - ANS When the choice of all firms are such that there is no other choice that
makes any firm better off;
Each decision maker will unilaterally choose what's best for himself
Dominant firm model - ANS When a firm with the vast majority prices smaller firms out of the
market over time by lowering prices to the point where it falls below the average total cost of
smaller competitors
Concentration measures - ANS Nth firm indicator
Herfindahl-Hirschman Index
Nth firm indicator - ANS How much market share is held by the top N firms in the market;
Isn't affected by two large companies merging
Herfindahl-Hirschman Index - ANS Adds up the sum of the squares of the largest firms in the
market
Oligopolists and Collusion Agreements - ANS There is an incentive to cheat and raise your
share of the joint profit
Tax Burden - ANS Falls on the party with less elastic curve
Discrete Random Variable - ANS Variable where the number of outcomes can be counted and
each outcome has a measurable and positive probability
Continuous Random Variable - ANS Variable where the number of possible outcomes is infinite,
even if upper and lower bounds exist
Discrete Uniform Random Variable - ANS Variable where all possible outcomes for a discrete
random variable are equal
Binomial Random Variable - ANS Variable may be defined as the number of successes in a
given number of trials where the outcome can be either a success or failure;
Expected value = (probability of success) * (number of trials);
Variance = (expected value) * (1 - probability of success)
Private value auctions - ANS Value is subjective and different to each bidder
Ascending price (English) auction - ANS Bidders can bid amounts greater than the previous
bid, and the bidder that first offers the highest bid wins the item and pays the amount
Sealed bid auction - ANS Each bidder submits one bid, which is unknown to the other bidders
and the bidder with the highest bid wins the item and pays the price;
The reservation price is the highest price that a bidder is willing to pay;
The optimal bid for the bidder with the highest reservation price is just slightly above the bidder
with the second highest reservation price;
Bids are not necessarily equal to reservation price
Second sealed bid auction (Vickrey auction) - ANS The bidder with the highest bid wins the
item but pays the price bid by the second highest bidder;
No reason for a bidder not to bid his reserve price;
Similar to a an ascending price auction, the winning bidder tends to pay one increment of price
more than the bidder who values the time the second most
Descending price (Dutch) auction - ANS Begins with a price greater than what any bidder will
pay and the price is reduced until a bidder agrees to pay it;
If there are multiple units available, each bidder and specify how many they want to buy;
Can be modified so that winning bidders all pay the same price
Price elasticity - ANS How responsive the quantity demanded is to a change in price
Elasticity of demand - ANS A measure of how consumers respond to price changes;
Perfectly elastic is when the demand curve is horizontal;
Perfectly inelastic is when the demand curve is perfectly vertical
Unstable equilibrium - ANS When a supply curve intersects a demand curve more than once,
the unstable equilibrium is an equilibrium where supply can increase towards another
equilibrium that results in a lower price;
Caused by a nonlinear supply function
Statutory incidence - ANS Who is legally responsible for paying a tax
Incidence of tax - ANS Who ends up bearing the cost of a tax
,Substitution effect - ANS Always acts to increase the consumption of a good that has fallen in
price
Income effect - ANS Either increase or decrease a good that has fallen in price;
Typical of normal good to have a positive income effect;
Typical of inferior good to have negative substitution effect
Positive substitution, positive income - ANS Consumption increases
Positive substitution, negative income smaller than positive substitution - ANS Consumption
increases
Positive substitution, negative income greater than positive substitution - ANS Consumption
decreases
Causes of demand changes - ANS Income
Increases as prices of substitute goods increase
Decreases as the prices of complement goods increases
Causes of supply changes - ANS Rises if technology increases;
Rises if input prices decrease
Giffen good - ANS An inferior good for which the income effect outweighs the substitution effect
so that the demand curve is positively sloped (higher the price, higher the demand)
Relationship cost curves - ANS AFC slopes downward
Vertical distance between ATC and AVC equals AFC
MC initially declines, then rises
MC intersects AVC and ATC at their minimums
ATC and AVC are u-shaped
The MC above the AVC is the firm's short-rum supply curve
Average Revenue > AVC - ANS Firm continue production
Average Revenue < AVC - ANS Firm should shut down
Average Revenue > ATC - ANS Firm should stay in business for long-run
Profit maximized - ANS Producing up to but not over MR=MC;
Producing quantity where TR-TC is at a maximum
Perfect competition - ANS Many firms compete with identical products, low barriers to entry,
and the only way to compete is on price;
Perfectly elastic demand curves for each firm;
,A firm will continue to expand production until marginal revenue equals marginal cost, which
maximizes profit or where MR = MC;
Economic loss occurs when marginal revenue is less than marginal cost;
Firm can't make economic profit in long-run;
Long-run equilibrium output is where marginal revenue equals marginal cost equals average
total cost ;
An increase/decrease in market demand will increase/decrease both equilibrium price and
quantity;
Short-run supply curve is the marginal cost curve above the average variable cost
Monopolistic competition - ANS Many firms that compete with differentiated products;
Demand curve is downward sloping and is highly elastic;
Quality, Price and Marketing are key differentiators ;
Low barriers to entry;
Firms must advertise and innovate;
In short run maximize economic profits by producing where marginal revenue equals marginal
cost ;
In long run, price equals average total cost and economic profits are 0
Oligopoly - ANS Only a few firms compete and each must consider the actions of others when
setting price and strategy;
High barriers to entry;
Demand is less elastic than monopolistic competition
Monopoly - ANS Only one seller in the market and there are no good substitutes;
High barriers to entry;
Maximize profit, not price;
Profit maximized when marginal revenue equals marginal cost when demand curve is above
ATC
Natural monopoly - ANS When the average cost of production is falling over the relevant range
of demand and having two or more producers would lead to hire production costs and hurt the
consumer
Marginal cost pricing - ANS Forces the monopoly to reduce price to the point where the firms
marginal cost curve intersects the market demand curve
Oligopoly models - ANS -Kinked demand curve
-Cournot duopoly
-Nash equilibrium
-Dominant firm model
Kinked demand curve - ANS Based on the assumption that an increase in a firm's product price
will not be followed by its competitors, but a price decrease will;
, Firms assume that demand is more elastic above a certain price than below it;
Firms produce the quantity at the kink, assuming if they increase production, their revenues will
be eroded by decreased prices and if they decrease production the price won't go up much;
Model doesn't account for cause of kinks
Cournot duopoly - ANS One firm will look at the other's price and production and adjust
accordingly until both firms meet at an equilibrium of the same price and quantity
Nash equilibrium - ANS When the choice of all firms are such that there is no other choice that
makes any firm better off;
Each decision maker will unilaterally choose what's best for himself
Dominant firm model - ANS When a firm with the vast majority prices smaller firms out of the
market over time by lowering prices to the point where it falls below the average total cost of
smaller competitors
Concentration measures - ANS Nth firm indicator
Herfindahl-Hirschman Index
Nth firm indicator - ANS How much market share is held by the top N firms in the market;
Isn't affected by two large companies merging
Herfindahl-Hirschman Index - ANS Adds up the sum of the squares of the largest firms in the
market
Oligopolists and Collusion Agreements - ANS There is an incentive to cheat and raise your
share of the joint profit
Tax Burden - ANS Falls on the party with less elastic curve
Discrete Random Variable - ANS Variable where the number of outcomes can be counted and
each outcome has a measurable and positive probability
Continuous Random Variable - ANS Variable where the number of possible outcomes is infinite,
even if upper and lower bounds exist
Discrete Uniform Random Variable - ANS Variable where all possible outcomes for a discrete
random variable are equal
Binomial Random Variable - ANS Variable may be defined as the number of successes in a
given number of trials where the outcome can be either a success or failure;
Expected value = (probability of success) * (number of trials);
Variance = (expected value) * (1 - probability of success)
