Microeconomics

Section: Microeconomics Estimated study time: 45 minutes Content: Microeconomics analyzes decision-making at the level of individual consumers, firms, and markets. For CFA candidates, the most important microeconomic concepts are supply and demand dynamics, price elasticity, market structures, and the theory of the firm — all of which feed directly into industry analysis, equity valuation, and understanding competitive dynamics. Demand curves slope downward (as price rises, quantity demanded falls) while supply curves slope upward (as price rises, quantity supplied increases). Market equilibrium occurs where supply equals demand. Shifts in the demand or supply curve — caused by changes in income, substitute prices, input costs, technology, or expectations — change the equilibrium price and quantity. For investment analysis, anticipating these shifts allows analysts to forecast industry revenue and margin trends. Price elasticity of demand (PED) measures the responsiveness of quantity demanded to a change in price: PED = % change in quantity demanded / % change in price. Elastic demand (|PED| > 1) means consumers are price-sensitive; a small price increase leads to a proportionally larger drop in quantity demanded, reducing total revenue. Inelastic demand (|PED| < 1) means consumers are price-insensitive; a price increase raises total revenue. Unit elastic demand (|PED| = 1) means a price change causes an equal proportional change in quantity, leaving total revenue unchanged. Factors affecting elasticity include availability of substitutes, necessity versus luxury, and the time horizon. Cross-price elasticity measures how the demand for one good responds to a price change in another: positive cross-price elasticity indicates substitutes; negative indicates complements. Market structures describe the competitive environment in which firms operate. In perfect competition, many small firms sell homogeneous products with no pricing power; price…