FP511 Module 6 Flashcards
(45 cards)
Microeconomics
Microeconomics is the study of how individuals and companies make decisions to allocate scarce resources, which helps in understanding how individuals and companies prioritize their wants.
Macroeconomics
Macroeconomics is the study of an economy as a whole. For example, macroeconomics examines factors that affect a country’s economic growth.
Supply/Demand Curve with Equilibrium Point (image)
View image.
Test Tip: Whenever you are presented with a problem relating to the supply and demand or price and quantity relationship, you should immediately draw a freehand version of Figure 6.1. A seemingly complex problem can be made relatively simple if this approach is used. Price increases as you go up the price axis (y-axis), and quantity increases as you go to the right on the quantity axis (x-axis).
Price elasticity
Price elasticity is the responsiveness of the quantity of a good demanded to changes in price, all other economic forces remaining constant.
What you are trying to do with elasticity is determine how many units of quantity are changed for every unit of price change.
inelastic good
Demand for necessities, such as food or gasoline, responds relatively little to price changes; therefore, those types of goods are said to be inelastic
Elastic good or price elasticity
the demand for luxuries, such as a new motorboat, responds relatively more to price changes; therefore, those types of goods are said to be elastic or demonstrate a great deal of price elasticity
gross domestic product (GDP)
total monetary value of all goods and services produced within the domestic United States over the course of a given year, including income generated domestically by a foreign firm (e.g., Toyota Motor Corp.)
Measured in constant non-inflation dollars which can be transferred to real GDP after accounting for inflation
GDP equation (4 components)
The four components are Consumption, Investment, Government spending, and Net exports (CIGNE)
GDP = C + I + G + NE
C = consumption (generally spending by individuals on durable and nondurable goods and services)
Typically about 2/3s the full GDP for USA
I = investment (generally business spending on inventory, plants, and equipment, but including new housing purchases by consumers)
G = government spending, including federal, state, and local
NE = net exports (total exports less total imports)
Gross National Product (GNP)
measures activity by ownership and takes into account any production by a company both in-and outside the home country, it is not as widely followed.
Fiscal policy (2 tools)
Congress and the president make policy desicions.
The power to tax - changes in the rate of government taxation will affect the amount of corporate earnings, the amount of consumer disposable income, and the incentives for individual workers to produce. IF they raise taxes, people have less money to spend, That will put pressure on increasing interest rates and dampen the economy
The power to spend - Changes in the rate of government spending will affect corporate earnings as well as consumer demand.
If they spend on services, infrastructure, more people are at work, money supply is up, downward pressure on interest rate and economic activity is spurred
Monetary policy (3 tools)
The Fed manages monetary policy.
(1) reserve requirements how much of their overall cash deposits need to be kept at the bank (10% for recent years)
The money not reserved at the bank is loaned out, invested or utilized in other ways for the bank to make profit
Impact: If they raise the requirement, banks have less money to lend out, upward pressure on interest rates and it is going to mean economic activity will be contracted
(2) discount rate
The rate at which banks can borrow from any of the Federal Reserve Banks
The only rate the FED has direct control over
When the Fed raises the discount rate, it increases the cost of borrowing and discourages member banks from borrowing funds, resulting in a contraction of the money supply/economy.
The Fed will lower the discount rate when it wants to increase the money supply. When banks are able to borrow funds at lower rates and lend more money, they increase the supply of money in circulation and this stimulates demand.
Spurs economic activity
(3) open-market operations
Most important and most frequently practiced (buying and selling government securities
They are exchanging cash for those government securities (thus they are injecting money into the environment)
Depending on the intended economic outcome, the Fed can either sell government securities to banks and market makers or buy back government securities in the open market.
If the Fed wants to expand economic activity, it will buy government securities in exchange for money, thereby increasing the money supply and driving down overall interest rates and bolstering the economy.
If the Fed wants to contract economic activity, it will sell government securities from its existing inventory, thereby decreasing the money supply, driving up overall interest rates, and reducing prices.
federal funds rate
Indirectly controlled by the Fed.
The federal funds rate is the interest rate charged on short-term borrowing (often overnight to fulfill reserve requirements) between banks; the Fed targets, but does not directly control, this rate in all of its interest rate decisions.
prime rate
The prime rate is the rate of interest charged by commercial banks to their best business and personal customers. This rate is set directly by commercial banks; however, it normally is about 3% higher than the federal funds rate.
business cycle
The business cycle reflects movements in economic activity and illustrates the concepts of supply and demand.
The economy is a dynamic, rather than static, system.
Usually, the economy is either in an expansion or contraction phase.
Business cycle peak
by analyzing the characteristics of past economic conditions, economists can pinpoint when the expansion phase has reached its top or maximum, otherwise known as a peak, and when the contraction phase has reached its bottom, otherwise known as a trough.
Business cycle trough
by analyzing the characteristics of past economic conditions, economists can pinpoint when the expansion phase has reached its top or maximum, otherwise known as a peak, and when the contraction phase has reached its bottom, otherwise known as a trough.
Economic expansion / contraction & peak/trough indicators
Think of this chart as the early stages of expansion or contraction
recession
occurs when the GDP has experienced a decrease in real terms for two consecutive quarters or a minimum of six months from a baseline of zero.
Characterized by high unemployment, reduction in manufacturing, increases in inventory of durable goods, a decline in GDP, contractions in corporate profits and lower consumer spending
Depression
the GDP has experienced a decrease in real terms for six consecutive quarters or a minimum of 18 months from a baseline of zero.
Three types of economic indicators
(1) Leading indicators - tend to precede actual economic change
Housing starts
New claims for unemployment
Bond yields
Indexes of stock prices (S&P 500)
Orders for durable goods
Changes in investor sentiment
(2) Coincident indicators - occur simultaneously during the business cycle and confirm the stage that the economy is currently experiencing
Industrial production
Level of personal income
Amount of corporate profits
(3) Lagging or confirming indicators - usually change after the economy has passed through one business cycle and allow confirmation of a previous economic environment
Prime interest rates
Changes in consumer price index CPI (particularly for services)
Amount of business and consumer loans outstanding
Average duration of unemployment
Unemployment rate
Inflation
rise in the average level of prices of goods and services. The two most common measures of inflation are the
Consumer Price Index (CPI)
CPI program produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services
Producer Price Index (PPI).
PPI program measures the average change over time in the selling prices received by domestic producers for their output
Consumer Price Index (CPI)
CPI program produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services
Producer Price Index (PPI)
PPI program measures the average change over time in the selling prices received by domestic producers for their output
Deflation
when prices are falling in absolute terms
In general, a deflationary period is one where preservation of capital should be of primary concern; investments should center on very high-quality debt instruments.
Lower-quality bonds should be avoided because the likelihood of default increases during a deflationary period.
High-quality bonds, especially U.S. Treasury obligations, can be a good investment because interest rates fall significantly in this period.
Bond prices rise and purchasing power increases during deflation
