Tài liệu CFA Level I - Study Session 5 pptx

CFA Level I - Study Session 5

1. A. “Demand and Consumer Choice”, including addendum “Consumer

Choice and Indifference Curves”

The candidate should be able to:

a. explain consumer choice in an economic framework;

Principles behind Consumer Choice

i) Limited income versus unlimited desires necessitates choices.

ii) Consumers make rational choices to achieve their goals.

iii) Consumers can substitute between “like” goods.

iv) Consumers make decisions based on less than perfect information.

v) Law of Diminishing Marginal Utility: As consumption of a good increases,

the additional utility derived eventually declines.

Consumer Behavior in making Choices

• Consumer will adjust consumption of a good until the marginal utility of consuming

the good just equals the price of the good.

Consumer Demand Curve:

• Diminishing Marginal Utility implies that as the price of a good rises, the amount

demanded by the consumer should fall.

• Income & a substitution effect associated with change in price.

b. calculate and interpret price and income elasticity of demand;

c. discuss the determinants of price and income elasticity of demand;

Price Elasticity of Demand = %∆Q

d

÷ %∆P where %∆Q

d

= (Qd

1 – Qd

0)/[(Qd

1 + Qd

0)/2], etc.

• Is always NEGATIVE:

o Increase in price %∆P > will always reduce quantity demanded %∆Q

d

< 0.

• Shows degree of consumer responsive to variations in good’s price.

• Elasticity affected by:

i) Availability of Substitutes,

ii) Share of Total Budget spent on Good, and

iii) Length of Time period.

Income Elasticity of Demand = %∆Q

d

÷ %∆Income

• Shows degree of consumer responsive to variations in income.

i) Normal Goods: positive income elasticity, demand rises with income.

ii) Luxuries: high positive elasticity, demand rises strongly with income.

iii) Inferior Goods: negative income elasticity, demand falls with income.

SASF CFA®

Review 2005 Level I – SS 5 – Macroeconomics Page 1 of 23

d. describe the relationships among total revenue, total expenditures, and price elasticity of

demand;

%∆expenditures ≅ %∆price + %∆quantity

Inelastic Demand: when elasticity of demand is less than one in absolute value, a 10% fall in

price increases quantity demanded by less than 10%. Thus total expenditure by

consumers, and total revenue received by firms, falls.

Elastic Demand: when elasticity of demand is greater than one in absolute value, a 10% fall in

price increases quantity demanded by more than 10%. Thus total expenditure by

consumers, and total revenue received by firms, rises.

e. explain why price elasticity of demand tends to increase in the long run.

Second Law of Demand: buyers’ response will be greater after they have had time to adjust

more fully to a price change. Why?

• Better able to rearrange consumption patterns to take advantage of substitutes

f. discuss the characteristics of consumer indifference curves.

i) More goods are preferable to fewer goods, thus points to upper right preferred to

points in lower left of utility curve diagram.

ii) Goods are substitutable, hence utility curves slope downward to the right.

iii) Diminishing marginal rate of substitution between goods implies utility curves

always convex to origin.

iv) Indifference curves are everywhere dense, i.e. one through every point.

v) Indifference curves cannot cross because if they did then individual would not be

following a rational ordering.

g. discuss the role of the consumption opportunity constraint and the budget constraint in

indifference analysis.

Consumption opportunity constraint: separates consumption bundles that are attainable from

those that are unattainable.

• In money-income economy, usually same as budget constraint.

Budget constraint: separates consumption bundles that consumer can purchase from those

that cannot be purchased, given the consumer’s limited income and the market prices of the

products involved.

• Consumer’s choice determined by the point at which their highest indifference curve

touches the budget (or consumption opportunity) constraint.

• This point yields highest level of utility for given level of income and market prices.

SASF CFA®

Review 2005 Level I – SS 5 – Macroeconomics Page 2 of 23