Economics and Banking

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chap

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Better Business

3rd EditionSolomon (Contributing Editor) ·

Poatsy · Martin

Economics BasicsEconomics – the study of how individuals and businesses make decisions to best satisfy wants, needs, and desires with limited resources

Microeconomics - the study of how individual businesses, households, and consumers make decisions to allocate their limited resources in the exchange of goods and services

Macroeconomics - the study of behavior of the overall economy

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Economic SystemsEconomic system – the financial and social system through which a country allocated its resources (factors of production) – aka the structure for how resources are used to meet the needs of society

Types of economic systems:– Planned economies (Socialism and Communism)– Market economies (Capitalism)– Mixed economies (Blend of Market and Planned…Hybrid)

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Economic systems differ depending on the answers to four basic economic questions

1. What and how much will be produced?2. How will it be produced?3. For whom will it be produced?4. Who owns/controls factors of production?

Capitalism

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• Capitalism– An economic system in which individuals own and operate the majority of

businesses that provide goods and services– Commonly referred to as a FREE ENTERPISE (MARKET) SYSTEM or

PURE CAPITALISM or LAISSEZ-FAIRE CAPITALISM• System in which individuals are free to decide what to produce, how to

produce it, and at what price to sell it– Derived from Adam Smith’s laissez-faire capitalism (“Wealth of Nations,”

1776) in which a society’s best interests are served by individuals pursuing their own self-interest (called “Invisible Hand”)

• Creation of wealth is the concern of private individuals, not government

• Resources used to create wealth must be privately owned• Economic freedom ensures the existence of a Free Market System• Limited role of government (protection only)

– Pure or Laissez-faire capitalism doesn’t exist anywhere; it’s just a theory– What do we have in America?

The Fundamental Rights of Capitalism

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1. The right to own a business and keep after-tax profits

2. The right to private property

3. The right to free choice

4. The right to fair competition

Types of Economic Systems

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US=Mixed Economy

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“ “In what ways does our government “interfere” with private interests and individual freedoms?

• …an economy that exhibits elements of both capitalism and socialism.

Planned Economies: Socialism and Communism

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Communism Public Ownership of Enterprise Strong Central Government Father of Communism = Karl Marx Examples: North Korea, Cuba, Old China and USSR

Socialism Government Control Key Enterprises Higher Taxes Main Goal = Social Equality

Determining Price:Supply and Demand – The Fundamental

Principles of a Free Market System

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The Foundation of the Free Market How much can we

make/sell? How much will

consumers buy? At what price?

Interaction of buyers & sellers Impact prices Competition

Supply

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• Supply: the relationship between the price of a good and the quantity sellers are willing/able to offer

Sellers tend to supply a greater quantity as the price rises.

• Supply curve: a graph of the supply relationship

The supply curve slopes upward to the right showing that

quantity supplied increases as price rises.

Demand

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• Demand: the relationship between the price of a good and the quantity buyers are willing and can afford to buy

When price falls, consumers tend to buy more.

• Demand curve: a graph of the demand relationship

The demand curve slopes downward showing that

quantity demanded increases as price falls.

Supply and Demand: Determining the Market Price

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• Forces of supply and demand drive equilibrium price

• The point where supply and demand intersect

• Market price adjusts to the equilibrium price

Degrees of Competition

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Pure competition A) a market situation in which there are A LOT of buyers along with a relatively large number of sellers; B) Sellers have NO control over price (market determines price, Supply and Demand); C) Identical products with NO differentiation (cotton, wheat?)

OligopolyA) a market (or industry) situation in which there are FEW sellers; B) Strong barriers to entry (for seller, it’s hard to enter into market); C) Similar products (cereal, cars, airlines); D) relatively higher prices for consumers

Monopolistic competition A) a market situation in which there are many buyers along with a relatively large number of sellers; B) Sellers look for a COMPETITIVE ADVANTAGE by promoting PRODUCT DIFFERENTIAION (real or perceived differences by consumers with sellers’ products); C) Seller retains some control over price

MonopolyA) a market (or industry) with only one seller, and there are barriers to keep other firms from entering the industry; B) Seller has complete control over price; C) Illegal; D) Some legal exceptions – NATURAL MONOPOLY and LIMITED MONOPOLY

Degrees of Competition

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Economic Indicators: Measuring Economic Performance

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Economic Indicators• Gross domestic product (GDP)

– The total dollar value of all goods & services produced within a country’s borders during a one-year period

– Real GDP (RGD) – GDP that adjusts for inflation

– Nominal GDP (NGDP) – GDP measured in current year’s prices

• Inflation – A general rise in the level of prices

• Productivity– The average level of output per worker per

hour• Unemployment rate

– The percentage of a nation’s labor force unemployed at any time

RGDP vs. NGDP

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Year Product Price Q

2012 Chips $1 5

2013 Chips $2 10

2012 Beer $3 4

2013 Beer $4 6

•NGDP2012? NGDP2013?

• RGDP2012? RGDP2013?

Business Cycle

The state of the economy changes over time- Peak

- Recession

- Trough

- Expansion/ Recovery

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Managing The Economy Through Fiscal and Monetary Policy

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Fiscal Policy – Government efforts to influence the economy: Taxation

Taxes, Economy Government Spending

Gov’t Spending, Economy Controlled by Congress/Budget Process

Monetary Policy – Federal Reserve actions to shape the economy: Supply of Money

Money Supply, Economy Influencing Interest Rates

Interest Rates, Economy Controlled by Fed

Fiscal PolicyFiscal policy relates to government management of revenues (taxes) and spending

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The federal government budget outlines Revenue and Expenses (i.e. Gov’t

Spending)

• When Tax Revenue is higher than Gov’t Spending, there is a budget surplus

• When Gov’t Spending is higher than Tax Revenue, the government incurs a budget deficit (FEDERAL DEFICIT)

• The sum of all the money borrowed is the federal debt (NATIONAL DEBT)

• What is our current National Debt?

Monetary Policy and the Federal Reserve System

“Fed” - central banking system in the U.S.- Independent government agency- 12 regional Federal Reserve Banks- Board of Governors

Federal Open Market Committee (FOMC) - sets policies of the Fed, including monetary policies

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Monetary PolicyMonetary policy relates to managing the supply of money

The money supply is the combined amount of money available within an economy, but there are different components to the money supply

– M-1: Currency, traveler’s checks, and checking accounts – M-2: M-1 along with the available money for banks to lend out,

such as savings deposits, money market accounts, and certificates of deposit (CDs) less than $100,000

– M-3: M-2 plus less liquid funds

Why is measurement of the money supply important?

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Managing the Money Supply: Reserve Requirement

Reserve requirement • the minimum amount of money banks must hold

in reserve to cover deposits • set by the Fed

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Decrease in reserve

requirement

More money for lending

Stimulates the economy

Managing the Money Supply: Discount Rate

Discount Rate - Interest rate charged to banks that borrow emergency funds from the Federal Reserve Bank

Fed Funds Rate - Interest rate that banks charge other banks when they borrow funds overnight from one another

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Decrease in discount rate

More money for lending at lower rates

Stimulates the economy

Managing the Money Supply: Open Market Operations

Open market operations

- Primary, and most influential, tool the Fed uses to alter the money supply

- Consists of buying and selling U.S. Treasury and federal agency bonds in the “open market”

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Fed buys securities

through OMOMore money for

lendingStimulates the

economy

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