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CFA Level II · Cheat Sheet

Economics

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CFA Level II Economics: Cheat Sheet

ECONOMIC GROWTH FACTORS

Solow Growth Model (Neoclassical)

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Definitions:

  • TFP Growth (Solow Residual): %ΔA = %ΔY − α×%ΔK − (1−α)×%ΔL
  • α (alpha): Capital's income share (~1/3 in advanced economies)
  • δ (delta): Depreciation rate
  • n: Population/labor growth rate
  • s: Savings rate

Growth Accounting Application

Q: Country data: %ΔY = 5%, %ΔK = 6%, %ΔL = 1.5%, α = 0.35 → %ΔA = 5% − 0.35(6%) − 0.65(1.5%) = 1.925%

Convergence Hypothesis

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Driver: Countries below steady-state capital per worker converge upward; convergence speed depends on institutional quality, property rights, rule of law.

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GROWTH SUSTAINABILITY: Solow vs. Endogenous

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Key Distinction: Endogenous models eliminate diminishing returns via *human & knowledge capital*, allowing sustained growth from investment alone.

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DETERMINANTS OF LONG-RUN GROWTH

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EXAM-FOCUSED DECISION RULES

Is growth sustainable?

  • ✅ Sustainable: TFP-driven; supported by R&D, education, institutions
  • ❌ Unsustainable: Factor accumulation alone; hits diminishing returns

Comparing two countries at similar income:

  • Higher savings rate → Higher steady-state capital per worker (unless Golden Rule exceeded)
  • Better institutions → Higher investment, ↑TFP efficiency → Higher long-run income
  • Higher population growth → Lower capital per worker, lower per capita growth

Policy scenario question:

  • Identify if growth is TFP-driven or input-driven
  • Check institutional constraints (property rights, rule of law)
  • Assess demographic trends (labor force growth trajectory)
  • Evaluate financial market efficiency (capital allocation)
  • Most sustainable policy: Institutional reform + education + R&D support

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    COMMON PITFALLS

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    ComponentFormula/Definition
    Production FunctionY = A × F(K, L) where A = TFP, K = capital, L = labor
    Growth Accounting (Cobb-Douglas)%ΔY = %ΔA + α×%ΔK + (1-α)×%ΔL
    Steady State Conditions×y = (δ + n)×k
    Key InsightDiminishing returns to capital → long-run growth driven only by TFP
    TypeDefinitionEmpirical Support
    AbsolutePoor countries grow faster than rich → equalize income❌ Weak
    ConditionalPoor countries grow faster *IF* similar institutions/savings/TFP✅ Strong
    DimensionSolow ModelEndogenous Growth (Romer/Lucas)
    Capital ReturnsDiminishingConstant/increasing (broad capital)
    TFPExogenous (unexplained)Endogenous (R&D, human capital)
    R&D SubsidiesTemporary effect (transitional)Permanent effect on growth rate
    Long-Run Growth DriverTFP onlyCapital accumulation (incl. knowledge)
    Policy ImplicationAid/investment boosts are temporaryEducation & R&D have lasting impact
    FactorCFA Exam Context
    Savings Rate (s)↑s → ↑steady-state capital & income; fiscal policy affects s
    Depreciation (δ)↑δ → ↓steady-state capital (infrastructure quality matters)
    Population Growth (n)↑n → ↓capital per worker (aging populations → lower n → higher per capita growth)
    InstitutionsProperty rights, rule of law, low corruption → ↑investment, ↑TFP efficiency
    Human CapitalEducation & health investment → ↑productivity, enables TFP
    Trade OpennessTechnology transfer, scale economies → ↑TFP
    Financial DevelopmentEfficient capital allocation → ↑investment productivity
    Financial Market StabilityReduces investment risk, lowers cost of capital
    MistakeCorrect Approach
    TFP growth ≈ GDP growth − labor growthTFP = GDP − weighted contributions: %ΔA = %ΔY − α(%ΔK) − (1-α)(%ΔL)
    Higher savings always → higher consumptionFalse; Golden Rule savings rate balances steady-state consumption; above it, extra savings ↓consumption
    Absolute convergence holds empiricallyNo; only conditional convergence; institutions & policies critical
    Solow & endogenous models equivalentNo; differ on capital returns & TFP persistence; diverge on R&D impact
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    KEY FORMULAS CHECKLIST

    • [ ] Growth accounting: %ΔY = %ΔA + α%ΔK + (1−α)%ΔL
    • [ ] TFP residual: %ΔA = %ΔY − α%ΔK − (1−α)%ΔL
    • [ ] Steady state: s·y = (δ + n)·k

    Aligned to the CFA Institute Level II curriculum.

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    Sections in this topic

    Economic Growth FactorsInternational TradeCurrency Exchange Rates