Basic Economic Concepts Flashcards Preview

Certified Financial Planner > Basic Economic Concepts > Flashcards

Flashcards in Basic Economic Concepts Deck (55)
Loading flashcards...
1
Q

Quantity Supplied

A

Quantity supplied is the amount of a particular product that a firm would be willing and able to offer for sale at a particular price during a given time period. There is a direct relationship between the quantity of a good supplied and its price.

2
Q

Law of Supply

A

An increase in market price will lead to an increase in quantity supplied, and a decrease in market price will lead to a decrease in quantity supplied. Changes in the quantity of a good or service supplied by the producers result in a move along the supply curve.

3
Q

Factors that can lead to a supply curve shift

A

New Technology

Market Expectations or Conditions

Changes to the Number of Producers

Changes in Input Prices

Changes in Prices of Related Goods or Services

4
Q

Quantity Demanded

A

Quantity demanded is the amount (number of units) of a product that a household would buy in a given period if it could buy all it wanted at the current market price. The relationship between quantity demanded and price is either negative, or inverse.

5
Q

Law of Demand

A

When price rises, quantity demanded falls, and when price falls, quantity demanded rises. This negative relationship between price and quantity demanded is referred to as the law of demand.

6
Q

Factors that can shift the demand curve

A

Changes in income levels

Changes in consumer preferences

Change in expectations

Changes to number of consumers in the market

Changes in prices of related goods and services

7
Q

Equilibrium Price

A

Equilibrium price is the point where the supply curve intersects the demand curve of a good or service. It is the price where there is no tendency for change.

8
Q

Excess Demand

A

The quantity demanded exceeds the quantity supplied at the current price. This would result in an increase in price (for example, the price people are willing to pay for a ticket to a sold out sporting event or our previous discussion on the hot holiday toy).

9
Q

Excess Supply

A

The quantity supplied exceeds the quantity demanded at the current price. This will result in a decrease in price (for example, a liquidation sale of the excess inventory of current-year car models in anticipation of the arrival of next year’s model).

10
Q

Equilibrium

A

The quantity supplied equals the quantity demanded at the current price.

11
Q

Price Elasticity of Demand (PED)

A

A measure of a buyer’s responsiveness or sensitivity to changes in price.

12
Q

Three things that determine price elasticity of demand

A

Availability of substitutes

Relevance to budget

Time

13
Q

Availability of Substitutes

A

Availability of substitutes: If more substitutes are available, then an increase in price will cause a drop in quantity demanded. Consumers simply buy a competitor’s lower priced product instead.

14
Q

Relevance to Budget

A

Relevance to budget: If the product is a small part of consumer budgets, a small increase in price will not cause a change in quantity demanded.

15
Q

Time

A

Time: In the short run, a change in price for a product without substitute can be effective because it is price inelastic. Consumers who want or need the product would still buy it, regardless of the price, so they are insensitive to the price change. An example would be the price of food, fuel, water and other consumer staples. In the long run, consumers may be able to find or develop substitute products to bring down prices.

16
Q

Gross Domestic Product

A

In order to understand the government’s influence on the economy, it is helpful to understand how the economy is measured. In macroeconomics, one measure of the economy is to look at the aggregate output or income (Y). Aggregate output is the sum total of consumption, corporate capital investments, net exports, and government spending. Another term for aggregate output is real Gross Domestic Product (GDP).

17
Q

Fiscal Policy

A

Fiscal policy refers to the government’s tax and spending policies and how these interventions influence the economy. Only the federal government, not state government, has the power and flexibility to run budget deficits or surpluses large enough to influence total consumer demand.

18
Q

How does the government use spending policy to increase the equilibrium level of national output?

A

The government uses spending policy to increase the equilibrium level of national output. To increase spending without raising taxes (which provides the government with revenue to spend), the government must borrow. When government spending (G) exceeds taxes collected (T), the government runs a deficit. The difference between G and T must be borrowed.

19
Q

What are then effects of increased government spending?

A

Increased government spending will throw the economy out of equilibrium. As output rises, the economy generates more income. An increase in government spending has the same impact on the equilibrium level of output and income as an increase in planned investment (I). A dollar of extra spending from either G or I is identical with respect to its impact on equilibrium output. There is an immediate and direct impact on the economy’s total spending when the government increases spending.

20
Q

Monetizing the Debt

A

If government expenditures exceed the revenue collected, then the government runs a budget deficit. The US Treasury borrows by issuing bonds that are bought by banks and investors. Banks pay for bonds by crediting the checking account of the Treasury, which increases the money supply. This process is known as monetizing the debt.

21
Q

Monetary Policy

A

Monetary policy controls the supply of money and influences bank lending and interest rates. It can be used to slow down inflation or stimulate the economy.

22
Q

M1 Money Supply

A

Currency

Demand Deposits

Travelers Cheques

23
Q

M2 Money Supply

A

M1

Savings

Money Market

24
Q

Tree ways the Fed influences economic activity

A

Setting short-term interest rates (discount rates and fed funds targets for inter-bank loans).

Buying and or selling treasury securities to increase/decrease money supply.

Setting member bank reserve requirements to increase/decrease funds available for loans.

25
Q

Three ways the Fed regulates the money supply

A

Manipulating the Reserve Requirements.

Manipulating the Discount Rate.

Engaging in open market operations.

26
Q

Reserve Requirement

A

The reserve requirement is the amount of total deposits that the Fed requires its members to keep with the Federal Reserve at the end of the business day.

27
Q

Discount Rate

A

Banks sometimes borrow money from the Federal Reserve. The discount rate is the interest rate banks pay the Fed. The Fed periodically sets the discount rate which regulates the flow of money into the economy. The interest rate that banks charge firms and individuals for borrowing will adjust as the discount rate changes. When banks borrow from the Fed, there is an increase in the money supply. The discount rate is the only rate controlled directly by the Fed.

28
Q

Impact of a higher discount rate

A

The higher the discount rate, the higher the cost of borrowing, therefore, the less borrowing banks will do. When the Fed increases the discount rate, the cost of borrowing (for example, mortgage rates, coupon rates and others) will ultimately increase for consumers, which discourages borrowing in general.

29
Q

Impact of a lower discount rate

A

If the Fed decreases the discount rate, the cost of borrowing will be cheaper. Firms and individuals will take advantage of lower rates by purchasing new homes or by financing the construction of new plants. If the Fed sets the discount rate too low, then banks may be tempted to borrow more.

30
Q

Fed Funds Rate

A

Rates will be lower if the banks, in turn, lower the interest rate they charge other banks on overnight loans. This is known as the federal funds rate. The Fed sets a targeted range for the federal funds rate which is currently 0 - 0.25% (June 2020), due to uncertainty associated with the US economic recovery from the coronavirus pandemic. If banks are unwilling to lend to one another given various uncertainties, or are charging their clients and other banks much higher interest rates, then a credit crunch will ensue. The federal funds rate is only targeted, or, indirectly influenced by the Fed.

31
Q

Prime Rate

A

The prime rate is another lending rate which banks extend to their most favored customers. This rate is also based upon the discount rate. Therefore, the Fed indirectly influnces the prime rate.

32
Q

Open Market Operations

A

Open market operations describe the Fed’s buying and selling of government securities in the open market. It is a tool used to expand or contract the amount of reserves in the system and, thus, the money supply.

33
Q

The Primary job of the Federal Reserve

A

The primary job of the Federal Reserve is to control inflation while avoiding a recession.

34
Q

Gross Domestic Product

A

Gross Domestic Product (GDP) is a statistic used to measure the economy on a quarterly basis. GDP measures the total market value of a country’s income and output of goods and services produced by all the people and companies in the U.S. Since nominal GDP includes inflation, it is higher than real GDP.

35
Q

Components of Real GDP

A

Market value of all final goods and services produced within a country. For example, if a U.S. company makes shoelaces that are used to make shoes in the U.S. then only the value of the shoe is counted.

Income of foreigners working in the United States.

Profits that foreign companies earn in the United States.

36
Q

GDP Excludes

A

Imports, to avoid the impact of exchange rates and trade policies.

The effects of inflation.

Intermediate goods (goods that could be counted, both when they are purchased as inputs and when they are sold as final products).

All transactions in which money or goods change hands but in which no new goods and services are produced.

The income of U.S. citizens working abroad.

Profits earned by U.S. companies in foreign countries.

37
Q

Unemployment Rate

A

The unemployment rate measures the number of people unemployed as a percentage of the labor force. To be counted as unemployed, a person must be out of a job and actively looking for work. When someone stops looking for work, they are considered out of the labor force and no longer counted as unemployed.

38
Q

Inflation

A

Inflation is the general rise in prices of goods and services. Too much inflation can erode the purchasing power of your savings. In order for you to increase your wealth, your investments must earn a higher return than your tax rate and the inflation rate.

39
Q

Deflation

A

Deflation is a decrease in the overall price level. It occurs when many prices decrease simultaneously. The last time the U.S. experienced deflation was in the era of the Great Depression. The consensus for economists is that modest inflation, with rates between 1% and 3%, is a more likely long-term scenario.

40
Q

Disinflation

A

Disinflation occurs when the rate of inflation decreases and prices are still rising, but at a slower rate.

41
Q

Hyperinflation

A

Hyperinflation is a period of rapid increase in the overall price level. Most Americans are unaware of what life is like under hyperinflation. In some countries, people were accustomed to prices rising by the day, hour, or even minute. During 1984 and 1985, the people of Bolivia experienced hyperinflation. By 1985, three bottles of aspirin sold for the same price a luxury car had sold for in 1982. When inflation approaches rates of 2,000% per year, the economy and structure of a country begin to break down. Workers may go on strike to demand wage increases and firms may find it hard to secure credit.

42
Q

Stagnation

A

Stagnation results in declining prices, slow economic growth, and high unemployment. In business cycles, the economy generally alternates between stagnation and inflation.

43
Q

Stagflation

A

Stagflation is a term coined in 1965 which signifies a period of high inflation combined with slow or stagnant economic growth (i.e. high unemployment.) When stagflation occurs, the economy is contracting, yet prices continue to rise. Stagflation occurred in the early 1970s when oil prices and unemployment rates sky-rocketed, triggering inflation during an economic recession.

44
Q

Types of Inflation

A

Sustained inflation

Demand-pull inflation

Cost-push or supply-side inflation

Expected inflation

45
Q

Sustained Inflation

A

Sustained inflation occurs when the overall price level continues to rise over a fairly long period of time. Most economists believe that sustained inflation can occur only if the Fed continuously increases the money supply.

46
Q

Demand Pull Inflation

A

Demand-pull inflation is initiated by an increase in aggregate demand. As demand shifts higher while supply remains the same, the equilibrium price will increase.

47
Q

Cost Push or supply side inflation

A

Cost-push or supply-side inflation is initiated by an increase in costs. An increase in costs may also lead to stagflation - when the economy is experiencing inflation during a time of contraction.

48
Q

Expected Inflation

A

Expected inflation is “built into the system” as a result of expectations. If prices have been rising and people form their expectations from this past behavior, firms may continue raising prices even if demand is slowing.

49
Q

Consumer Price index

A

This represents a measure of the average change in prices of goods and services over a period of time.

50
Q

Yield Curve

A

A yield curve gives an indication of the market’s expectation of the future direction of interest rates. It is a graph that shows the yields-to-maturity (on the vertical axis) for Treasury securities of various maturities (on the horizontal axis) as of a particular date. This provides an estimate of the current term structure of interest rates and changes daily as yields-to-maturity fluctuate. The slope of the curve indicates the relationship between short-term and long-term interest rates.

51
Q

Three types of yield curves

A

Upward-sloping

Flat

Downward-sloping

52
Q

Three yield curve theories

A

Horizon premium theory

Market segmentation theory

Expectations theory

53
Q

Horizon Premium Theory

A

The horizon premium theory, or liquidity premium theory, asserts that on average, investors pay a price premium for bonds with short-term maturities. This is to avoid the greater interest rate and price risks of bonds with longer maturities. Due to this premium, long-term bond yields are typically higher than short-term bond yields. Thus, an upward sloping yield curve is considered normal.

54
Q

Market Segmentation Theory

A

The market segmentation theory, or segmented market hypothesis, asserts that the yield curve is composed of a series of independent maturity segments.

55
Q

Expectations Theory

A

The expectations theory asserts that long-term yields are the average of the short-term yields expected to prevail during the period before a bond matures.