L1 - JN - Economics 2024 V1

2024
Economics
FinTree © 2024 FinTree Education Private Ltd
FinTree
Economics
LM No. Name of Reading Page No.
1 The Firm & Market Structures
2 Understanding Business Cycles
3 Fiscal Policy
4 Monetary Policy
5 Introduction to Geopolitics
6 International Trade
7 Capital Flows and the FX Market
8 Exchange Rate Calculations
Economics
Firms and Market Structures

FinTree Fruit 1 : Pre-requisite Concepts 1
Perfect Competition:
Many Small Firms:
• Numerous small firms operate in the market.
• No single firm has the ability to influence the market price.
Homogeneous Products:
• Products offered by firms are identical or nearly identical.
• Consumers perceive no significant differences between products.
Free Entry and Exit:
• Firms can enter or exit the market without significant barriers.
• New firms can easily compete with existing ones.
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Imperfect Markets (e.g., Monopoly or Monopolistic
Competition):
Limited Competition:
• Few large firms or a single dominant firm may control the market.
• Market power allows firms to influence prices.
Product Differentiation:
• Products may be similar but not identical, leading to product differentiation.
• Firms have some control over pricing based on perceived differences.
Barriers to Entry:
• Barriers such as patents, high startup costs, or exclusive access to resources can limit new
firms from entering the market.
• Existing firms may have a sustained advantage.
FinTree Fruit 2 : Average Revenue (AR), Marginal Revenue (MR), and Total Revenue (TR):
Average Revenue (AR)

• AR is equal to the market price since all units are sold at the same price.
• Example: Selling 8 units at $4 each results in AR of $4.
Imperfect Competition:
• AR is the same as the price at which each unit is sold, as firms are price makers.
• Example: If a monopolistic firm sells 6 units at $7 each, AR (and P) is $7.
Marginal Revenue (MR)

• MR is equal to AR and the market price due to constant pricing.
• Example: If the market price (and AR) is $3, selling one more unit at $3 results in MR of $3.
• MR is less than AR and P, reflecting the impact on revenue of lowering prices to sell
additional units.
• Example: If a monopolistic firm lowers the price to $6 to sell one more unit, MR is $6.
Total Revenue (TR)
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• TR increases at a constant rate with quantity sold due to constant AR.
• Example: Selling 5 units at $2 each yields TR of $10 (5 * $2).
• TR may increase at a decreasing rate as MR is below AR, leading to a more complex TR
curve.
• Example: Selling 3 units at $8 each yields TR of $24, but selling the 4th unit at $7 may
only add $7 to TR.
Graph for Both

• In both cases, AR and demand curve are present.
• For perfect competition, MR lies on the demand curve and equals AR.
• For imperfect competition, MR lies below AR and P, with a steeper slope
FinTree Fruit 3 : Cost Related Concepts
Total Fixed Cost (TFC):
• TFC is the total cost of fixed inputs.

• Example: If TFC is $25, it remains constant regardless of the quantity produced.
Total Variable Cost (TVC):
• TVC is the total cost of variable inputs.

• Example: If producing 7 units incurs a TVC of $35, TVC is $35.
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Total Fixed Cost (TFC):
• TFC is the total cost of fixed inputs.

• Example: If TFC is $25, it remains constant regardless of the quantity produced.
Total Cost (TC):
• TC is the sum of total fixed cost and total variable cost.

• Example: If TFC is $20 and TVC is $40 for producing 6 units, TC is $60 ($20 + $40).
Average Fixed Cost (AFC):
• AFC is the cost per unit of fixed inputs.

• Calculated by dividing total fixed cost by the quantity of output.
• Example: If the total fixed cost for producing 10 units is $30, AFC is $3 ($30 / 10).
Average Variable Cost (AVC):
• AVC is the cost per unit of variable inputs (e.g., labor, raw materials).
• It is calculated by dividing total variable cost by the quantity of output.
• Example: If the total variable cost for producing 5 units is $50, AVC is $10 ($50 / 5).
Average Total Cost (ATC):
• ATC is the cost per unit of total inputs, including both fixed and variable costs.
• Calculated by dividing total cost by the quantity of output.
• Example: If the total cost for producing 8 units is $80, ATC is $10 ($80 / 8).
• AVC and ATC are U-shaped due to economies and diseconomies of scale.
• Initially, both decline as fixed costs are spread over more units (economies of scale).
• They reach a minimum point and then rise as diminishing returns and diseconomies of scale
set in.
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Marginal Cost (MC) Curve:
• MC is the additional cost incurred by producing one more unit.

• Calculated by the change in total cost divided by the change in quantity.
• Example: If producing 5 units costs $50 and producing 6 units costs $55, MC for the 6th unit
is $5.
Relationship with Cost Minimization:
• Cost minimization occurs where MC equals the average cost.

• When MC is below the average cost, producing more units lowers the average cost.
• Conversely, when MC is above the average cost, producing fewer units reduces the average
cost.
Shape of the Curves:
• AVC and ATC initially decline, reach a minimum, and then rise due to economies and
diseconomies of scale.
• AFC continually declines as fixed costs are spread over more units.
• The distance between AVC and ATC represents AFC.
FinTree Fruit 4 : Profit Maximization
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FinTree Fruit 5 : Break-even, and Shutdown Points of Production

FinTree Fruit 6 : Economies and Dis-economies of Scale
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FinTree Fruit 7 : Market Structures
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FinTree Fruit 8 : Supply Analysis under Perfect Competition
▪ In the short run, supply curve is that part of MC curve which is above AVC
▪ In the Long run, supply curve is that part of MC curve which is above ATC
▪ There is no well defined supply function for imperfectly competitive markets
FinTree Fruit 9 : Long Run Equilibrium under Perfect Competition
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Firms Enter and Exit
• In the long run, firms can freely enter or exit the market.
• If there is profit, new firms enter; if there is a loss, some firms exit.
Zero Economic Profit
• Firms earn only normal profit (covering all costs, including opportunity costs).
• Economic profit is zero in the long run.
Marginal Cost (MC) Equals Average Revenue (AR) Equals

Marginal Revenue
• Firms produce where MC equals AR (market price).

• Optimal output level is where cost is minimized.
Price Equals Minimum Average Total Cost (ATC)
• Price equals the minimum point on the ATC curve.
Efficient allocation of resources
• Resources are allocated efficiently due to the absence of economic profit.

• Consumer and producer surplus are maximized.
FinTree Fruit 10: Long Run Equilibrium under Imperfect Competition
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Firms Can Enter but Face Barriers
• New firms can enter, but barriers such as brand loyalty or patents may exist.
Normal Profit or Slight Economic Profit
• Firms aim for normal profit or slight economic profit.

• Brand differentiation allows for some pricing power.
Marginal Cost (MC) Equals Marginal Revenue (MR)
• Firms produce where MC equals MR.

• Pricing influenced by the level of product differentiation.
Price May Exceed Average Total Cost (ATC)
• Price may exceed ATC due to product differentiation.

• Some economic profit may persist in the long run.
Product Differentiation and Advertising
• Firms engage in product differentiation and advertising to maintain a competitive edge.

• Consumers may be willing to pay a premium for unique features.
FinTree Fruit 11 : Oligopoly and Pricing Strategies
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• In the Cournot assumption, each firm determines its profit-maximizing production level by assuming
that the other firms’ output will not change
• This assumption simplifies pricing strategy because there is no need to guess what the other firm will
do to retaliate.
• Consider, a two-firm duopoly market, in equilibrium, neither firm has an incentive to change output,
given the other firm’s production level.
• Each firm attempts to maximize its own profits under the assumption that the other firm will continue
producing the same level of output in the future.
• The Cournot strategy assumes that this pattern continues until each firm reaches its long-run
equilibrium position.
• In long-run equilibrium, output and price are stable: No change in price or output will increase
profits for either firm
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FinTree Fruit 12 : Determining market structure

Understanding Business Cycles

FinTree Fruit 1 : Overview of the business cycle
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• Business cycles are ups and downs in a country's overall economy.
• Economic activities mostly happen in businesses. Business cycles are typical of economies
that rely mainly on business enterprises, therefore, not agrarian societies or centrally
planned economies.
• Cycles include times of growth and decline in various sectors.
• These ups and downs happen across different industries at the same time. These Phases
occur at about the same time throughout the economy
• The cycle includes recessions, contractions, and recoveries.
• It's a repeating pattern but not always at fixed intervals. Cycles are recurrent; they happen
again and again over time but not in a periodic way; they do not all have the exact same
intensity and duration
• Business cycles can last from a bit over a year to around 10 or 12 years.
FinTree Fruit 2 : Phases of the Business Cycle

FinTree Fruit 3 : Types of Cycle
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Types of Cycles
Classical Cycle Growth Cycle Growth Rate

• Refers to fluctuations in the • Refers to fluctuations in Cycle
level of economic activity (e.g., economic activity around the • Refers to fluctuations in the
measured by GDP in volume trend growth level growth rate of economic activity
terms) • Focusses on whether actual (e.g., GDP growth rate)
• contraction phases is short, economic activity is below or • Peaks and troughs are mostly
expansion phases are much above trend growth recognized earlier than when
longer • This definition is closest to how using the other two definition
• it does not easily allow the mainstream economists think • One advantage of this approach
breakdown of movements in • It breaks down economic is that it is not necessary to first
GDP between short-term activity into long-run trends estimate a long-run growth
fluctuations and long-run and short-run fluctuations. path.
trends • Compared with the classical
• an absolute decline in activity view of business cycles, peaks
between peaks and troughs does generally are reached earlier
not occur frequently and troughs later in time
• The time periods below and
above trend growth are of
similar length.
FinTree Fruit 4 : Four Phases of the Cycle
Phase
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Recovery
Economy going
through a trough.
Expansion
Economy enjoying
an upswing.
Slowdown
Economy going
through a peak.
Contraction
Economy weakens
and may go into a
Negative output Positive output gap Positive output gap recession. Negative
Description gap starts to opens starts to narrow output gap opens.
narrow.
Activity levels are Activity measures Activity measures

Activity below potential but show are above average
Levels: start to increase. above-average but decelerating.
Consumers growth rates Moving to
and below-average
Businesses rates of growth.
Business continue
hiring but at a
Layoffs slow.
slower pace.
Businesses rely on
Unemployment
Employment overtime before
rate continues to
moving to hiring.
fall but at
Unemployment
decreasing rates
remains higher
than average.
Inflation remains Inflation picks up Inflation further Inflation

moderate. modestly. accelerates. decelerates but
Inflation with a lag.
FinTree Fruit 5 : Investor Behavior
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Recovery Phase
• Asset markets anticipate the end of a recession and the start of expansion.
• Risky assets get higher prices.
• Markets incorporate higher profit expectations into corporate bonds and stocks.
• Equity markets hit a low about three to six months before the economy bottoms out.
• Equity market serves as a leading indicator of the economy.
Expansion Phase
• Well-established expansion leads to a "boom" phase.
• The boom tests the limits of the economy with strong confidence, profit, and credit growth.
• Companies may struggle to find qualified workers and raise wages to compete.
• Government or central bank may intervene if there are concerns about the economy
overheating.
Slowdown Phase
• During the boom, riskier assets see significant price increases.
• Safe assets, like government bonds, may have lower prices and higher yields.
• Investors may fear higher inflation, contributing to higher nominal yields.
Contraction Phase
• During contraction, investors value safer assets like government securities.
• Shares of companies with steady positive cash flows gain preference.
• Preferences reflect increased utility of a safe income stream during insecure or declining
employment periods.
FinTree Fruit 6 : Credit Cycles
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• Business cycles measure economic activity with GDP, while separate studies focus on
financial variables like credit cycles.
• Credit cycles track changes in credit availability and pricing, especially in private sector
credit for investments and real estate.
• They mirror real economic activity in business cycles, reflecting GDP fluctuations.
• Strong economies see more accessible and affordable credit; weak economies experience
tightened credit, impacting asset values and defaults.
• Credit cycles are part of broader financial cycles.
FinTree Fruit 7 : Applications of Credit Cycles
Credit Crisis Impact

• Previously, financial factors were overlooked by macroeconomists.
• Loose private sector credit contributed to various crises (e.g., Latin America in the
1980s, Asian crisis in 1997, Global Financial Crisis in 2008).
Credit Conditions and Crises

• Expansive credit leads to asset and real estate bubbles.
• Bubbles burst during capital outflows due to weaker fundamentals.
• Financial frictions amplify business cycles, causing deeper recessions and more
extensive expansions.
Link between Business and Credit Cycles

• Recession severity and duration tied to business and credit cycle interplay.
• Recessions with financial disruptions (e.g., house and equity price busts) are longer
and deeper.
• Recoveries with rapid credit growth, risk-taking, and rising house prices tend to be
stronger.
Financial Variables and Expansion

• Financial variables closely relate to economic size changes.
• Not always synchronized with traditional business cycles.
• Credit cycles are longer, deeper, and sharper.
Cycle Duration
• Credit cycles are generally longer than business cycles.
FinTree Fruit 8 : Economic indicators over the business cycle
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Phase Recovery Expansion Slowdown Contraction
Layoffs slow. Businesses Businesses move from Businesses continue Businesses first cut hours,
rely on overtime before using overtime and hiring but at a slower eliminate overtime, and
moving to hiring. temporary employees to pace. Unemployment rate freeze hiring, followed by
Employment Unemployment remains hiring. Unemployment continues to fall but at outright layoffs.
Levels of employment higher than average. rate stabilizes and starts slowly decreasing rates Unemployment rate starts
lag the cycle falling. to rise.
Capex emphasizes Increased capacity New capacity-boosting

efficiency over capacity. utilization. orders may hint at the
Capital Upturn noticeable in Companies pivoting later expansion phase.
Spending orders for rapidly towards expanding Companies consistently

evolving equipment, capacity. place orders while
especially software and new equipment spending operating at or close to
technology. may be necessary. full capacity
Sales decelerate faster

Sales decline slows. than production, resulting
Subsequent recovery in in increased inventories.
sales leads to a production Economic slowdown
Sales and upturn, lagging behind triggers production
Production sales growth. cutbacks and order
cancellations.
Begins to fall as sales Ratio stable. Ratio increases. Signals Ratio begins to fall back
recovery outpaces weakening economy. to normal
Inventory production
to
Sales
Ratio
FinTree Fruit 9 : Types of Economic Indicators
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Economic Indicators
• Variables offering insights into the overall economic state
• Used by policy makers and analysts to assess the economy's
current condition, predict or confirm turning points for better
financial and market predictions.
Leading Coincident Lagging

• Turning points that usually • Have turning points that are
precede those of the overall usually close to those of the • Have turning points that take
economy. overall economy. place later than those of the
• They are believed to have value • They are believed to have value overall economy.
for predicting the economy’s for identifying the economy’s • They are believed to have value
future state, usually near term. present state. in identifying the economy’s
• Stock market • Industrial production index past condition
• House prices • Real personal incomes • Avg. duration of unemployment
• Retail sales • Manufacturing and trade sales • Inventory to sales ratio
• Interest spread (between LT • Change in unit labor costs
and ST rates) • Inflation
• Building permits • Average prime lending rate
• Consumer expectations • Ratio of consumer instalment
• Average weekly hours debt to income
(manufacturing) • Commercial and industrial
• Manufacturers’ new orders outstanding loans
FinTree Fruit 10 : Diffusion Index
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Diffusion Index Basics
• The Conference Board in the U.S. compiles a monthly diffusion index to understand
economic changes.
• It shows how many indicators are moving in line with the overall index, offering a broad
view of economic shifts.
Interpreting the Index
• A higher index value indicates more indicators are moving in a consistent direction,
providing a broader view of economic changes.
• This helps analysts gain confidence that the overall index value truly reflects widespread
movements in the economy.
Overall Significance
• The diffusion index captures common changes across all indicators, giving a more
comprehensive view without being influenced by outliers.
• It reflects the consensus change in economic indicators.
Fiscal Policy
FinTree Fruit 1 : Introduction to Monetary and Fiscal Policy
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FinTree Fruit 2 : Roles and Objectives of Fiscal Policy
FinTree Fruit 3 : Fiscal Policy Tools
The Marginal Propensity to Consume (MPC) is the portion of extra income that a person
spends rather than saves. For instance, if someone receives $100 more and spends $80 of it, the
MPC is 0.8 (or 80%).
FinTree Fruit 4 : Arguments about being concerned about size of fiscal deficit
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FinTree Fruit 5 : The Balanced Budget Multiplier
• Balanced Budget Multiplier Principle: When government spending (G) increases by the
same amount as taxes (T), the economy experiences an increase in output through the
multiplier effect.
Example: Suppose a government injects $100 million into infrastructure (G) while increasing
taxes by $100 million (T) to maintain a balanced budget.
• Multiplier Effect: Due to consumer spending habits (MPC), the tax hike doesn't reduce
spending by the full $100 million. If the MPC is 0.8, the reduced spending would be $80
million (80% of the tax increase).
• Initial Impact: The initial effect on demand is the difference between increased government
spending and reduced consumer spending, which in this case is $20 million ($100 million -
$80 million).
• Multiplier Value: The balanced budget multiplier always equals 1, indicating that despite
the initial balance in government spending and tax increase, the subsequent rise in output
generates more tax revenue, preserving the budget balance.
FinTree Fruit 6 : Implementation of fiscal policy and difficulties
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Monetary Policy
FinTree Fruit 1 : Roles and objectives of Central Banks
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FinTree Fruit 2 : Monetary policy tools and the monetary transmission mechanism
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FinTree Fruit 3 : Monetary Policy Objective
Exchange rate targeting may result in volatily

of money supply as domestic monetary policy
will have to adapt to the necessity of maintaining
stable exchange rate.
Net effect of exchange rate targeting is that the

targeting country will have the same
inflation rate as the targeting currency.
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FinTree Fruit 4 : Interaction

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of MONETARY and FISCAL POLICY
Introduction to Geopolitics
FinTree Fruit 1 : Introduction
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Geopolitics
• Geopolitics studies how geography influences politics and international relations.

• Analysts in geopolitics focus on understanding how individuals, organizations, companies,
and governments interact in political, economic, and financial activities.
State Actors
• State actors are typically national governments, political organizations, or country leaders
that exert authority over a country’s national security and resources.
Non-State Actors
• Non-state actors are those that participate in global political, economic, or financial affairs
but do not directly control national security or country resources.
• Examples of non-state actors are non-governmental organizations (NGOs), multinational
companies, charities, and even influential individuals, such as business leaders or cultural
icons.
• These actors are influenced not only by their relationship with one another but also by
factors affecting their other allies and adversaries
FinTree Fruit 2 : Political Cooperation
International Relations Overview
• Relations between countries can be cooperative or competitive.

• Cooperation involves countries working together for shared goals, spanning strategic,
military, economic, or cultural aspects.
• Country interactions are complex, creating potential geopolitical risks due to diverse goals.
Political Cooperation Focus

• Political cooperation measures how countries agree on rules and standardization for their
activities and interactions.
• A cooperative country engages in rules standardization, harmonizes tariffs, and supports
international agreements on trade, immigration, and regulation.
• In contrast, a non-cooperative country has inconsistent rules, restricted movement across
borders, retaliation, and limited technology exchange.
FinTree Fruit 3 : Country Cooperation Motivations
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National Security or Military Interest
• Involves protecting a country, its citizens, economy, and institutions from external threats.
• Threats range from military attacks and terrorism to crime, cybersecurity, and natural
disasters.
• Geographic factors influence a country's approach to national security; landlocked
countries depend on neighbors, while trade-connected nations leverage their location.
Economic Interest
• National security now includes economic factors, ensuring access to resources like energy,
food, and water.
• Growing national wealth and limiting income inequality contribute to social stability.
• Global operational capacity for national firms becomes crucial.
• Cooperation focuses on securing essential resources through trade or leveling the global
playing field for companies through standardization.
FinTree Fruit 4 : Geophysical Resource Endowment
Geophysical Resource Endowment

• Includes livable geography, climate, and access to food and water for sustainable growth
Resource Inequality Among Countries

• Some countries (e.g., U.S., Russia, Australia, China) are relatively self-sufficient.
• Others (e.g., Western Europe, Japan, Turkey) heavily rely on external resources,
particularly fossil fuels.
• Some nations (e.g., Saudi Arabia) possess abundant fossil fuels but depend on others for
basic needs.
Power Dynamics
• Countries rich in resources may wield more political leverage in dealings with those in
desperate need of those resources.
• However, a resource-rich country can become vulnerable if resource use benefits specific
groups more than others, contributing to internal political instability.
FinTree Fruit 5 : Standardization
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• Economic and financial activities may cross borders with or without explicit government
support
• As they do, governments have more incentive to cooperate with others in standardizing the
rules of engagement
• Standardization is the process of creating protocols for the production, sale, transport, or
use of a product or service
• Standardization occurs when relevant parties agree to follow these protocols together.
• It helps support expanded economic and financial activities across borders, such as trade
and capital flows, which support higher economic growth and standards of living
• Rules standardization can take many forms—from regulatory cooperation, to process
standardization, to operational synchronization.
• Rules standardization may also be driven by non-state entities, such as industry groups or
organizations
FinTree Fruit 6 : Cultural Considerations and Soft Power
Cultural Reasons for Cooperation

• Countries may cooperate due to cultural factors, including historical ties, immigration
patterns, shared experiences, or cultural similarities.
Soft Power Influence

• Soft power involves influencing another country's decisions without force, often built over
time.
• Achieved through cultural programs, advertisements, travel grants, and university
exchanges
FinTree Fruit 7 : Role of Institutions:
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Role of Institutions
• An institution is an established organization or practice in society, formal or informal.
• It can be backed by law, like a university, or informal, like customs important to a society.
• Institutions may or may not be formed by national governments.
Impact of Strong Institutions

• Strong institutions contribute to stable internal and external political forces.
• This stability creates opportunities for a country to develop cooperative relationships.
Advantages of Strong Institutions

• They include organizations and structures promoting government accountability, rule of
law, and property rights.
• Strong institutions allow countries to act with more authority and independence in the
international space.
Durability of Cooperative Relationships

• Strong institutions make cooperative relationships more durable by integrating them into
multiple layers of society.
• This reduces the likelihood of a country deviating from its cooperative roles.
FinTree Fruit 7 : Hierarchy of Interests
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Hierarchy of Interests
• National interest varies among countries, encompassing goals and ambitions.
• Some emphasize geospatial terms, while others consider a range of interrelated factors
Factors Influencing National Interest

• Priorities include self-determination, survival, national borders, and economic and social
considerations.
• Conflicts may arise among these diverse needs.
Hierarchy in National Interest

• Countries prioritize interests, with survival factors at the top and less essential elements lower.
• Governments use this hierarchy to guide behavior, favoring more critical needs in conflicting
cooperation situations.
Considerations for Investors

• Investors need to understand how a country's resources, goals, and leadership styles interact or
conflict over time.
• Misalignment or changes in countries' goals may lead to geopolitical risk.
FinTree Fruit 8 : Hierarchy Dynamics
Hierarchy Dynamics
• Clear-cut Elements: Some aspects, like securing access to food and water, are straightforward
in the hierarchy.
• Subjectivity with Progress: As basic societal needs are met, the hierarchy becomes more
subjective, varying among governments.
Government Prioritization
• Differing Approaches: Governments treat prioritization of interests differently, such as military
buildup or healthcare.
• Impact on Cooperation: How governments weigh these issues shapes the depth and nature of
political cooperation
Political Cycle Impact

• Short-Term Focus: Countries with short political cycles may prioritize short-term goals over
long-term risks like climate change or income inequality.
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Decision Makers' Influence
• Motivations Matter: Governmental decision makers, whether political parties or individuals,
have unique motivations.
• Cooperative Choices: Decision makers' motivations can influence a country’s cooperative and
non-cooperative choices
Psychology and Non-Predictability

• Introduction of Psychology: Decision makers' motivations introduce a psychological factor,
impacting choices along the hierarchy.
• Shaping Geopolitical Relationships: Non-predictability in decision-making shapes geopolitical
relationships..
FinTree Fruit 9 : Political Non-Cooperation
Political Cooperation Spectrum

• Political cooperation and non-cooperation exist on a spectrum.
• Most countries cooperate on standardized rules internationally.
Extreme Non-Cooperation Instances

• In rare instances of extreme non-cooperation, a country prioritizes political self-determination
over cooperative benefits.
• Coercive attempts may be made by other state actors to involve non-cooperative countries.
FinTree Fruit 10 : Globalization
Capacity Constraints
• Global trade cannot constitute 100 percent of global economic activity.
• Expansion may slow due to capacity constraints, even without specific disruptions
Political vs. Economic Cooperation

• Political cooperation/non-cooperation primarily involves national or state actors.
• Globalization results from economic and financial cooperation, mostly by non-state actors.
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Anti-globalization/Nationalism
• Antiglobalization/nationalism focuses on a country’s economic interests, excluding or harming
others.
• Limited economic and financial cooperation, emphasizing national production and sales.
• Involves restricted cross-border investment, capital flows, and currency exchange.
Psychology and Non-Predictability

• Introduction of Psychology: Decision makers' motivations introduce a psychological factor,
impacting choices along the hierarchy.
• Shaping Geopolitical Relationships: Non-predictability in decision-making shapes geopolitical
relationships..
FinTree Fruit 11 : Motivations for Globalization
Consideration of Three Potential Gains:

1. Increasing Profits:
- Profit Generation Methods:
- Increasing sales or reducing costs.
Increasing Sales
- Motivates companies to globalize.
- Requires extensive investment, including property, plant, and equipment.
- Involves hiring workers in new markets.
- Directly benefits the countries involved.
Reducing Costs:
- Allows access to lower tax-operating environments.
- Reduces labor costs.
- Achieves supply chain efficiency gains.
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Consideration of Three Potential Gains:
.
2. Access to Resources and Markets
Resource Access
- Seeking sustainable access to resources like talent or raw materials.
- Globalizing to improve access if not readily available or affordable domestically.
Market Access and Investment Opportunities
- Seeking market access or investment opportunities abroad.
- Increased propensity for cross-border risk in search of higher returns.
- Two important types of flows: Portfolio investment and foreign direct investments (FDI).
- Establishment of processes for facilitating globalizing needs.
3. Intrinsic Gain
Definition
- Side effect or consequence generating benefits beyond profit.
Difficult to Measure
- Contributes to globalization’s momentum.
Stabilizing Force
- Increases empathy between actors.
- Reduces the likelihood of geopolitical threats.
Examples
- Personal growth or education.
- Accelerated productivity from learning new methods.
FinTree Fruit 12 : Cost of Globalization
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Unequal Economic Gains
• Economic theory supports profit maximization and efficiency in global activities.
• However, benefits are not evenly distributed; moving operations abroad can create jobs in one
country but reduce them in another.
Lower Standards Impact

• Companies operating in lower-cost countries may adopt local standards, potentially
compromising environmental, social, and governance practices.
• While corporate profits may rise, the overall impact on resources and standards can be
negative
Political Consequences
• Globalization may lead to political and economic inequality, causing fears and job losses in
certain countries.
• This can result in a push for reduced international cooperation and even a rollback in political
collaboration.
Interdependence Risks
• Increased economic cooperation can make countries dependent on others for key resources.
• Disruptions, such as in commodity production (e.g., rare earth metals from China), can have
cascading effects on global industries
FinTree Fruit 13 : Threats of Rollback of Globalization
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Deglobalization Unlikelihood
- Complete reversal of globalization unlikely despite discussions.
- Companies are expected to adopt strategic tactics to strengthen their supply chains.
Tactics for Supply Chain Fortification

1. Reshoring Essentials
- Critical items like prescription medication and protective equipment may be reshored for
emergency preparedness.
- Companies may relocate manufacturing to home countries to mitigate risks.
2. Reglobalizing Production
- Concerns about disruptions, rising costs, or political risks might lead to the duplication
or fortification of supply chains.
3. Doubling Down on Key Markets
- Focus on essential markets like China, Canada, and Mexico.
- Some manufacturing may stay in key markets due to market size, infrastructure, and the
challenges of relocating.
"In Country, For the Country" Approach
- Developing production locally in combination with external supply chains may become a
necessity.
- Balancing global and local strategies to ensure resilience in the supply chain.
FinTree Fruit 14 : International Organizations
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FinTree Fruit 13 : Archetypes (typical example) of Country Behavior
Globalization
• Note that each of the axes
explored in this
framework—cooperation
Hegemony Multilateralism versus non-cooperation
and globalization versus
nationalism—represent a
Non-Cooperation Cooperation spectrum.
• Rarely do countries
represent full extremes of
Autarky Bilateralism either of these factors
Nationalism/ Anti-Globalization
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Regionalism
• Typically, countries exist on a spectrum between bilateralism and multilateralism.
• In between the two extremes is regionalism, in which a group of countries cooperate with
one another.
FinTree Fruit 15 : Archetypes (typical example) of Country Behavior
The Tools of Geopolitics

• Among each of these tools, there are choices that reflect or
improve cooperation and those that reflect or escalate conflict
(non-cooperation).
National Security Economic Tools Financial Tools

• National security tools may be • Economic tools are the actions
active, meaning they are being used to reinforce cooperative or • Financial tools are the actions
used at the time of analysis, or non-cooperative stances used to reinforce cooperative or
threatened, meaning they are through economic means non-cooperative stances
not currently used but their use • Nationalization, the process of through financial mechanisms
is likely enough to warrant transferring an activity or • Cooperative financial tools may
concern. industry from private to state reduce geopolitical risk if they
• Example: Armed Conflict control, is a non-cooperative encourage cooperation in
• Not all national security tools approach to asserting economic security, economic, or financial
are used in a non-cooperative control. arenas.
way. State actors can combine • Nationalization is most • However, the same tools may
forces to reduce the likelihood common in sectors perceived as also create vulnerabilities in the
that national security tools are vital to economic security international system. The
used (NATO) dominance of the US dollar is
one such example
FinTree
Cabotage
• Systems of political, economic, and financial cooperation can be, and often are, intertwined.
• One interesting example is cabotage, or the right to transport passengers or goods within a
country by a foreign firm.
• Many countries, including those with multilateral trade agreements, impose restrictions on
cabotage across transportation subsectors, meaning that shippers, airlines, and truck drivers are
not allowed to transport goods and services within another country’s borders.
• Allowing cabotage requires coordination on areas like physical security and economic
coordination, a highly multilateral process.
• Generally, as actors incorporate more tools of collaboration, they are less likely to initiate conflict
or use a non-cooperative tool against associated actors.
FinTree Fruit 16 : Geopolitical Risk and Comparative Advantage
• Geopolitical risk and the tools of geopolitics can tilt comparative advantage in one
direction or another.
• Countries or regions with limited geopolitical risk exposure may attract more labor and
capital.
• In contrast, those with higher geopolitical risk exposure may suffer a loss of labor and
capital.
• A consistent threat of conflict may drive more regular volatility in asset prices, prompting
FinTree Fruit 17 : Geopolitical Risk and Comparative Advantage
Types of Geopolitical Risk

(note that the predictability of an event does not necessarily change its likelihood, its speed of impact, or the size of impact on investors;
however, it does give investors more time to prepare a response)
Event Risk Exogenous risk Thematic Risk

• Event risk evolves around set dates, such as • Exogenous risk is a sudden or unanticipated risk • Thematic risks are known risks that evolve and
elections, new legislation, known in advance. that affects either a country’s cooperative stance expand over a period of time. (Cyber Attacks)
• Political events often result in changes to investor • Examples: sudden uprisings, invasions, or the • Climate change, pattern migration, the rise of
expectations related to a country’s cooperative aftermath of natural disasters. populist forces, and the ongoing threat of
stance terrorism fall into this category.
• As a result, risk analysts often use political
calendars as a starting place for assessing event
risk.
FinTree Fruit 17 : Geopolitical Risk Assessment
FinTree
Geopolitical Risk Assessment
(Investor considers geopolitical risk in terms of the following three areas)
Likelihood it will occur Velocity (speed) of its impact Size and nature of that impact.
• The likelihood of a risk is the • The velocity of geopolitical risk • A high-impact risk may merit
probability that it will occur is the pace at which it affects an extensive study of its drivers and
• this exercise can be more art investor portfolio motivations, whereas a
than science • A black swan risk is an event low-impact risk may not
• Highly collaborative and that is rare and difficult to • risk tends to have a greater
globalized countries are less predict but has an important impact on markets experiencing
likely to experience geopolitical impact. a general contraction or
risk • Risks with a medium-term economic downturn.
• That same interconnectedness, impact may begin to impair • Impact may also be discrete or
however, may make multilateral companies’ processes, costs etc, broad in nature.
countries more vulnerable to resulting in lower valuations. • Discrete impacts are those that
certain risks • These risks tend to be affect only one company or
distributed toward specific sector at a time, whereas broad
sectors, meaning they will affect impacts are felt more holistically
some companies much more than by a sector, a country, or the
others global economy
• Long-term risks may have
important environmental, social,
governance, and other impacts.
This can affect an investor’s
asset allocation.
• Geopolitical risks seldom develop in linear fashion, making it difficult to monitor
FinTree
• As a result, many investors deploy an approach that includes scenario analysis and signposting rather
than a single point forecast.
• Scenarios can take the form of qualitative analysis, quantitative measurement, or both
• One form of a simple quantitative scenario is a stylized scenario in which portfolio sensitivity is
measured against one key factor relevant to the portfolio, such as interest rates, asset prices, or exchange
rates
• Teams that read similar research or speak with similar client groups may be affected by groupthink, the
practice of thinking or making decisions as a group in a way that discourages creativity or individual
responsibility
• One important process is identifying signposts for priority risk.
• A signpost is an indicator, market level, data piece, or event that signals a risk is becoming more or less
likely.
• An analyst can think of signposts like a traffic light
• Good signposts are anchored in the key assumptions made up-front around a scenario and mark
whether a scenario is materializing.
• Identifying the right signposts can require some trial and error.
• A basic rule of thumb for distinguishing signal from noise is the distinction between politics and policy.
FinTree Fruit 17 : Manifestations of Geopolitical Risk
• High-velocity risks are most likely to manifest in market volatility through prompt changes in asset
prices.
• Low-velocity geopolitical risks can have a more prolonged impact on investor inputs.
• For countries, regions, or sectors perceived to be at more consistent risk of geopolitical disruption,
investors may require higher compensation, effectively increasing the discount rate investors use when
valuing those securities (higher risk premium)
• This dynamic is a key reason why asset prices in emerging and frontier markets are typically maintained
at a discount to those in developed countries that are perceived to have a lower threat of risk.
FinTree Fruit 17 : Manifestations of Geopolitical Risk
• Taking a top-down approach, asset allocators may consider geopolitical risk in their asset allocation
strategy
• The asset allocator would thus allocate more capital to the countries with lower expected risk profiles.
• At the portfolio management level, investors can consider geopolitical risk as a factor in multifactor
models
• When making a buy or sell recommendation, the analyst may consider relative geopolitical risk exposure
as a factor in their analysis.
International Trade
FinTree Fruit 1 : Benefits and Costs of Trade
FinTree
FinTree Fruit 2 : Trade Restrictions and Agreements—Tariffs, Quotas, and Export Subsidies
FinTree Fruit 3 : Trading Blocs and Regional Integration
Trade Creation Trade Diversion
Trade creation occurs when region-

Trade diversion occurs when lower
al integration results in the replace-
- cost imports from nonmember
ment of higher - cost domestic
countries are replaced with higher -
production by lower - cost imports
cost imports from members.
from other members.
FinTree
Capital Flows and the FX Market

FinTree Fruit 1 : The Foreign Exchange Market and Exchange Rates
FinTree
FX Market Participants
•
Buy Side
Corporate Accounts
FinTree Public Sector Sell Side
• Real Money Accounts (Institutional

Investors)
• Governments • Large Money Center Dealing Banks (e.g.,
• Leveraged Accounts (Hedge Funds,
• Central Banks Deutsche Bank, Citigroup, UBS, HSBC)
Proprietary Trading, CTAs, Algorithmic
• Sovereign Wealth Funds (SWFs) • Second and Third-Tier Banks
Traders)
• Retail Accounts (Individuals, Small Hedge
Funds, Active Traders)
FinTree Fruit 2: Exchange Rate Regimes

FinTree Fruit 3: Capital restrictions
FinTree
FinTree Fruit 3: Balance of Trade

Exchange Rate Calculations

FinTree Fruit 1 : Cross-Rate Calculations
FinTree
FinTree Fruit 2: Point in Percentage (PIP)
FinTree Fruit 2: Arbitrage relationship between spot and forward exchange rates and interest rates
FX Market Participants
FinTree
FinTree Fruit 3: Forward Discounts and Premiums

CFA® Level I JuiceNotes 2024
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2024

Firms and Market Structures

Average Revenue (AR)

Marginal Revenue (MR)

Total Revenue (TR)

Graph for Both

FinTree Fruit 3 : Cost Related Concepts

Total Fixed Cost (TFC):

• TFC is the total cost of fixed inputs.

Total Variable Cost (TVC):

• TVC is the total cost of variable inputs.

• TFC is the total cost of fixed inputs.

Total Cost (TC):

• TC is the sum of total fixed cost and total variable cost.

Average Fixed Cost (AFC):

• AFC is the cost per unit of fixed inputs.

Average Variable Cost (AVC):

Average Total Cost (ATC):

• MC is the additional cost incurred by producing one more unit.

Relationship with Cost Minimization:

• Cost minimization occurs where MC equals the average cost.

Shape of the Curves:

FinTree Fruit 4 : Profit Maximization

FinTree Fruit 5 : Break-even, and Shutdown Points of Production

FinTree Fruit 6 : Economies and Dis-economies of Scale

FinTree Fruit 7 : Market Structures

FinTree Fruit 8 : Supply Analysis under Perfect Competition

FinTree Fruit 9 : Long Run Equilibrium under Perfect Competition

Zero Economic Profit

Marginal Cost (MC) Equals Average Revenue (AR) Equals

• Firms produce where MC equals AR (market price).

Price Equals Minimum Average Total Cost (ATC)

• Price equals the minimum point on the ATC curve.

Efficient allocation of resources

• Resources are allocated efficiently due to the absence of economic profit.

FinTree Fruit 10: Long Run Equilibrium under Imperfect Competition

Normal Profit or Slight Economic Profit

• Firms aim for normal profit or slight economic profit.

Marginal Cost (MC) Equals Marginal Revenue (MR)

• Firms produce where MC equals MR.

Price May Exceed Average Total Cost (ATC)

• Price may exceed ATC due to product differentiation.

Product Differentiation and Advertising

• Firms engage in product differentiation and advertising to maintain a competitive edge.

FinTree Fruit 11 : Oligopoly and Pricing Strategies

FinTree Fruit 12 : Determining market structure

Understanding Business Cycles

FinTree Fruit 2 : Phases of the Business Cycle

FinTree Fruit 3 : Types of Cycle

Classical Cycle Growth Cycle Growth Rate

FinTree Fruit 4 : Four Phases of the Cycle

Activity levels are Activity measures Activity measures

Inflation remains Inflation picks up Inflation further Inflation

FinTree Fruit 5 : Investor Behavior

FinTree Fruit 6 : Credit Cycles

FinTree Fruit 7 : Applications of Credit Cycles

Credit Crisis Impact

Credit Conditions and Crises

Link between Business and Credit Cycles

Financial Variables and Expansion

FinTree Fruit 8 : Economic indicators over the business cycle

Capex emphasizes Increased capacity New capacity-boosting

Capital Upturn noticeable in Companies pivoting later expansion phase.

Spending orders for rapidly towards expanding Companies consistently