Economics covers both microeconomic and macroeconomic principles relevant to investment analysis. Topics include supply and demand, market structures, GDP, business cycles, monetary and fiscal policy, and international trade and currency exchange rates.
The law of demand states that quantity demanded falls as price rises (ceteris paribus). The law of supply states that quantity supplied rises as price rises. Market equilibrium occurs where supply equals demand. Consumer surplus is the difference between willingness to pay and actual price; producer surplus is the difference between actual price and minimum acceptable price. Elasticity measures the responsiveness of quantity to price changes.
Gross Domestic Product (GDP) measures the total market value of all final goods and services produced within a country. GDP can be calculated using the expenditure approach (C + I + G + NX), income approach, or production approach. Real GDP adjusts for inflation using a base-year price level. The GDP deflator = (Nominal GDP / Real GDP) × 100. Economic growth is driven by increases in labor, capital, and total factor productivity.
Business cycles consist of four phases: expansion (rising GDP, falling unemployment), peak (maximum output), contraction/recession (falling GDP, rising unemployment), and trough (minimum output). Leading indicators (stock prices, building permits) predict turning points; coincident indicators (industrial production, employment) confirm current conditions; lagging indicators (unemployment rate, CPI) confirm past trends.
Monetary policy is conducted by central banks through tools like open market operations, the policy rate, and reserve requirements. Expansionary monetary policy lowers interest rates to stimulate the economy; contractionary policy raises rates to slow inflation. Fiscal policy involves government spending and taxation. Expansionary fiscal policy increases spending or cuts taxes; contractionary policy does the opposite. The effectiveness of each depends on the economic environment and policy lags.
Comparative advantage explains why countries trade — each specializes in producing goods where its opportunity cost is lowest. Exchange rates are determined by supply and demand for currencies. Key concepts include spot rates, forward rates, and the interest rate parity condition. Purchasing power parity (PPP) suggests exchange rates should adjust so identical goods cost the same across countries. The balance of payments records all economic transactions between residents and non-residents.
Consumption + Investment + Government Spending + Net Exports.
Measures the price level of all domestically produced goods and services.
Relates nominal interest rates to real rates and inflation expectations.
The forward exchange rate premium/discount reflects the interest rate differential between two countries.
Measures the responsiveness of quantity demanded to a change in price.
The AD-AS model explains short-run and long-run macroeconomic equilibrium.