FOUNDATION 10 / Markets & risk
Economics & market context
Understand prices, incentives and macro indicators without turning a headline into a forecast.
By the end of this lesson
- Distinguish movements along curves from shifts.
- Separate nominal and real growth.
- Describe policy transmission with uncertainty.
IBBC Capital Finance Foundations · Original content drafted with AI assistance. IBBC Capital is responsible for editorial review and content. General education, not an official CFA Institute curriculum or credential.
Scarcity and opportunity cost
Choosing one use of a scarce resource means giving up another. Opportunity cost is the value of the best forgone alternative, not the sum of all alternatives. Sunk costs already incurred should not determine a forward-looking choice by themselves.
In a simple competitive model, a change in the good’s own price moves quantity demanded along a demand curve. Changes in income, preferences or substitutes can shift the curve. Hold other factors fixed when describing a direction.
Supply, demand and constraints
A demand increase with an unchanged upward-sloping supply curve tends to raise equilibrium price and quantity. A supply restriction can raise price while reducing quantity. The observed price alone does not identify which shock occurred.
Elasticity describes responsiveness. Price elasticity of demand compares percentage quantity change with percentage price change, using a stated convention. Market structure, substitutes and time horizon influence the response.
Nominal output, real output and inflation
Nominal GDP measures output at current prices; real GDP uses a price adjustment. If the GDP deflator rises by π and nominal GDP grows by gN, exact real growth is (1+gN)/(1+π)−1. The deflator is not necessarily the same as a consumer-price index.
Inflation is a rate of change in a price index, not the price level itself. Lower positive inflation means prices rise more slowly, not that prices necessarily fall. Compare the same period and check revisions.
Policy and currencies: channels, not certainties
Higher policy rates can influence financing costs, demand and asset discount rates, with lags and other forces at work. The same announcement may have different market effects depending on what was already expected.
An exchange-rate statement needs a quotation convention. If domestic currency per unit of foreign currency rises, the domestic currency has depreciated under that quote. Effects on companies depend on revenues, costs, debt and hedging, not a slogan that depreciation is always good or bad.
Separate output and prices
- Nominal output rises 10%; the GDP deflator rises 4%.
- Real growth = 1.10/1.04−1 = 5.7692%.
- The simple 10%−4%=6% approximation is close but not exact. The example is hypothetical, not a country forecast.
Try before looking at the explanation
Change one input in the practice tool below. Predict the direction first, calculate second, then explain why it changed.
Work the numbers
Common mistakes to catch
- Confusing slower inflation with falling prices.
- Inferring cause from price alone.
- Comparing indicators from different periods or unrevised releases.
Knowledge check · 6 original questions
Answer all six. At least five correct marks the lesson complete for self-study. You can retry; this is not a credential.
Keep these ideas
- State the mechanism, assumptions and countervailing forces.
- A macro number needs a date, definition and source before use.