An overview of the basic economic principles and concepts that are essential for understanding financial markets and decision-making in the field of finance.
Introduction to Economics for Finance
Key concepts, terminology, and the link between economics and finance
| Aspect | Definition |
|---|---|
| Microeconomics | Study of individual agents (consumers, firms, workers) and how they make choices under scarcity. |
| Macroeconomics | Study of the economy as a whole—aggregate output, inflation, unemployment, fiscal and monetary policy. |
| Positive vs. Normative | Positive: statements that can be tested (e.g., “A 1 % rise in interest rates reduces investment by 0.5 %).* Normative: value‑judgments about what ought to be (e.g., “The government should lower taxes”). |
| Scarcity & Choice | Resources are limited; agents must allocate them to satisfy competing wants. This creates trade‑offs and opportunity costs. |
| Principle | Financial Implication |
|---|---|
| Opportunity Cost | The return you forgo by choosing one investment over another. |
| Time Value of Money (TVM) | A dollar today is worth more than a dollar tomorrow because it can be invested. |
| Risk‑Return Trade‑off | Higher expected returns compensate investors for taking on higher risk. |
| Marginal Analysis | Investment decisions are made by comparing marginal benefits (additional return) with marginal costs (additional risk). |
| Market Efficiency | In an efficient market, prices reflect all available information (EMH). |
| Supply & Demand | Determine asset prices, interest rates, and exchange rates. |
Monetary Policy
Fiscal Policy
Business Cycle
Inflation
Exchange Rates
| Model | Purpose | Key Variables |
|---|---|---|
| IS‑LM | Interaction of goods market (IS) and money market (LM) → equilibrium output & interest rate. | Y (output), i (interest rate), G (government spending), M (money supply). |
| AD‑AS | Aggregate demand & supply → price level, output, inflation. | P (price level), Y, AD, AS. |
| Solow Growth Model | Long‑run economic growth driven by capital, labor, technology. | K, L, A (technology), s (savings rate), δ (depreciation). |
| CAPM (Capital Asset Pricing Model) | Relates expected return of an asset to its systematic risk (β). | E(Ri), Rf, βi, E(Rm). |
| Black‑Scholes | Pricing of European options under assumptions of log‑normal returns. | S, K, r, σ, T. |
| **Heckscher‑Ohlin / |