Module 42: Economics, Strategy, and Globalization Flashcards
(345 cards)
1
Q
Absolute advantage
A
An advantage a country has over other countries in the production of a good or service
2
Q
Business cycle
A
A fluctuation in aggregate economic output that lasts for several years
3
Q
Comparative advantage
A
An advantage a country has in producing a good or service because it has no alternative users of its resources that would involve a higher return
4
Q
Consumption function
A
Depicts the relationship between changes in personal disposable income and consumption
5
Q
Cost leadership
A
A strategy that involves focusing on reducing the costs and time to produce, sell, and distribute a product or service
6
Q
Demand
A
The quantity of a good or service that a consumer is willing and able to purchase at a given price
7
Q
Deflation
A
The rate of decline in the price level of goods and services
8
Q
Depression
A
A deep and long-lasing recession
9
Q
Dumping
A
A form of predatory pricing in which a manufacturer in one country exports a product at a price that is lower than the priced charged in its home country
10
Q
Economic profit
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The amount of profit in excess of normal profit
11
Q
Export subsidies
A
Payments made by a government to encourage the production and export of specific products
12
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Government budget surplus (deficit)
A
The excess (deficit) of government taxes in relation to government transfer payments and purchases
13
Q
Inflation
A
The rate of increase in the price level of goods and services
14
Q
Marginal product
A
The additional output obtained from employing one additional unit of resource (e.g. one additional worker)
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Q
Marginal revenue
A
The additional revenue received from the sale of one additional unit of product
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Marginal revenue product
A
The change in total revenue from employing one additional unit of resource
17
Q
Market equilibrium
A
The price at which all the goods offered for sale will be sold
18
Q
Monopolistic competition
A
A market characterized by many firms selling a differentiated product or service
19
Q
Nominal gross domestic product
A
The price of all goods and services produced by a domestic economy for a year at current market prices
20
Q
Nominal interest rate
A
The interest rate in terms of the nation’s currency
21
Q
Normal profit
A
The amount of profit necessary to compensate the owners for their capital and/or managerial skills
22
Q
Oligopoly
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A market characterized by significant barriers to entry. As a result there are few sellers of the product.
23
Q
Personal disposable income
A
The amount of income that individuals receive and have available to purchase goods and services
24
Q
Potential gross domestic product
A
The maximum amount of production that could take place in an economy without putting pressure on the general level of prices
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Price ceiling
A specified maximum price that may be charged for a good, usually established by a government. A price ceiling will cause good shortages.
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Price floor
A specified minimum price that may be charged for a good, usually established by a government. A price floor will cause overproduction of the good.
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Product differentiation
A strategy that involves modification of a product to make it more attractive to the target market or to differentiate it from competitors' products
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Pure competition
An industry in which there are a large number of sellers of virtually identical products or services. No individual seller is able to affect the market price.
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Pure monopoly
A market in which there is a single seller of a product or service for which there are no close substitutes
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Real gross domestic product
The price of all goods and services produced by a domestic economy at price level adjusted (constant) prices
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Real interest rate
The interest rate adjusted for inflation
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Recession
A period of negative gross domestic product growth
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Substitution effect
The fact that as the price of a good or service falls, consumers will use it to replace similar goods or services
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Supply
The quantity of a good or service that will be supplied by producers at a given price
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Unemployment rate
The percentage of the total labor force that is unemployed at a given time
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Microeconomics
Focuses on the behavior and purchasing decisions of individuals and firms
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How is the market price determined?
Based on supply and demand
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What a demand curve show graphically?
Inverse relationship between the price and quantity demanded - less products are demanded at higher prices
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What shifts a demand curve?
Shifts when demand variables other than price change
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What are variables that may cause a demand curve shift?
- changes in the price of other goods and services
- changes in consumer tastes
- changes in spendable income
- changes in wealth
- changes in the size of the market
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What is the effect on demand if the price of other goods and services (substitutes) change?
Direct relationship. As goods that may be purchased instead go up in price the demand for the product goes up. As an example, if the price of pork increases the demand for beef may increase.
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What is the effect on demand if the price of other goods and services (complements) change?
Inverse relationship. As the prices of complement goods go up, the demand for the product goes own. As an example, if the price of hamburger increases the demand for hamburger buns decreases.
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What is the effect on demand if expectations of price increase?
Direct relationship. If the price of the good is expected to increase in the future, there will be an increase in demand.
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What is the effect on demand if consumer income and wealth change?
Generally a direct relationship. As consumer income (wealth) goes up, the demand for many products (normal goods) goes up. However, there are certain goods that are inferior (e.g. bread, potatoes) and the demand for such goods actually goes up as consumer income(wealth) goes down.
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What is the effect on demand if consumer tastes change?
Indeterminate relationship. The effect depends on whether the shift is towards or away from the product.
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What is the effect on demand if the size of the market changes?
Direct relationship. As the size of the market increases, the demand for the product will increase.
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What is the effect on demand if there is a group boycott?
Inverse relationship. If a group of consumers boycott a product, demand will be decreased.
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Price elasticity of demand?
Measures the sensitivity of demand to a change in price?
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Price elasticity demand equation
E = % change in QD/% change in price
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What is the arc method in regards to price elasticity demand?
This makes results the same regardless of whether there is an increase or decrease in price
E = Change in QD/Avg Q / Change in price/Avg price
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Interpretation of the demand elasticity coefficient?
ED > 1 = demand is elastic (sensitive to price changes)
ED = 1 = demand is unitary (not sensitive or insensitive to price changes)
ED
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What is the relationship between price elasticity and total revenue?
Total revenue from the sale of a good is equal to the price times the quantity
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What happens when there is a price increase and the demand is elastic E > 1?
Total revenue decreases
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What happens when there is a price increase and the demand is inelastic E
Total revenue increases
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What happens when there is a price increase and the demand is unitary E = 1?
Total revenue does not change
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What happens when there is a price decrease and the demand is elastic E > 1?
Total revenue increases
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What happens when there is a price decrease and the demand is inelastic E
Total revenue decreases
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What happens when there is a price decrease and the demand is unitary E = 1?
Total revenue does not change
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Why is price elasticity an important concept?
Reveals whether the firm is likely to be able to [pass on cost increases to its customers. E.g. when demand is inelastic the firm can increase its price with less of a negative impact.
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Income elasticity of demand
Measures the change in the quantity demanded of a product given a change in income
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Equation of income elasticity of demand?
E = % change in QD / % change in income
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What does income elasticity of demand describe?
Nature of the product (normal v. inferior goods)
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Normal goods
Demand for normal products increases as consumer income increases (EI is positive)
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Inferior goods
Demand for inferior products decreases as consumer income decreases (EI is negative)
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Cross-elasticity of demand
Measures the change in demand for a good when the price of a related or competing product is changed
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Coefficient (equation) for cross-elasticity of demand
Exy = % change in the QD of product x / % change in the price of product y
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What does a positive cross-elasticity coefficient mean?
The products are substitutes
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What does a negative cross-elasticity coefficient mean?
The products are complements
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What does a zero cross-elasticity coefficient mean?
The products are unrelated
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Substitution effect
As the price of a good falls, consumers will use it to replace similar goods
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Income effect
As the price of a good falls, consumers can purchase more with a given level of income
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Law of diminishing marginal utility
The more goods an individual consumes the more total utility the individual receives. However, the marginal (additional) utility from consuming each additional unit decreases.
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When does a consumer maximize utility?
When marginal utility of the last dollar spent on each commodity is the same
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Utility maximization mathematically
Marginal Utility of A / Price of A = Marginal Utility of B / Price of B = Marginal Utility of C / Price of C
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Indifference curves
Illustrate utilities
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What is the optimal level of consumption?
Individual's budget constraint line intersects the highest possible utility curve
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What is one of the factors that consumption depends on?
Personal disposable income - amount of income consumers have after receiving transfer payments from the government (welfare) and paying their taxes
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Consumption function
Relationship between changes in personal disposable income and consumption
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What is the equation for consumption function?
C = c0 + c1Yd
- C = Consumption for a period
- Yd = Disposable income for the period
- c0 = constant
- c1 = slope of the consumption function
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Why is the slope, c1, important in the consumption factor?
Measures the consumer's marginal propensity to consume (MPC) . Describes how much of each additional dollar in personal disposable income that the consumer will spend
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Marginal propensity to save (MPS)
Percentage of additional income that is saved
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MPS & MPC equation
MPS + MPC = 1
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What are other nonincome factors that may affect consumption?
- Expectations about future prices of goods
- Quantity of consumer liquid assets
- Amount of consumer debt
- Stock of consumer durable goods
- Attitudes about saving money
- Interest rates
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What does a supply curve show?
The amount of a product that would be supplied at various prices. Shows a direct relationship between price and quantity sold. The higher the price the more products that would be supplied.
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How does a change in price affect the supply curve?
Causes a shift along the existing supply curve (does not shift the curve out)
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What causes a supply curve shift?
When supply variables other than price change
- Changes in number or size of producers
- Changes in various production costs (wages, rents, raw materials)
- Technological advances
- Government actions
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How does the number of producers affect the supply of the product?
Direct relationship. Generally an increase in the number of producers will cause an increase in the amount of goods supplied at a given price.
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How does a change in production costs or technological advances affect the supply of the product?
Inverse relationship. As production costs go up, fewer products will be supplied at a given price. If costs go down, more products will be produced
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How does government subsidies affect the supply of the product?
Direct relationship. Subsidies in effect reduce the production cost of goods and therefore increase the goods supplied at a given price
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How do government price controls affect the supply of the product?
Price controls would tend to limit the amount of goods supplied by holding the price artificially low.
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How do prices of other goods affect the supply of the product?
Inverse relationship. If the products can be produced with greater returns, producers will produce those goods.
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How do price expectations affect the supply of the product?
Direct relationship. If it is expected that prices will be higher for the good in the future, production of the good will increase.
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What is the elasticity of supply?
Measures the percentage change in the quantity supplied of a product resulting from a change in the product price.
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Elasticity of supply equation
Es = $ change in quantity supplied / percentage change in price
- Es > 1 = elastic (% increase in price will create a larger % increase in supply)
- Es
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Market equilibrium
Determined by demand and supply. It is the price at which all the goods offered for sale will be sold (QD = QS)
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Examples of government interventions
Taxes, subsidies, and rationing
E.g. subsidy paid to farmers will reduce the cost of producing a particular product and cause equilibrium price to be lower than it would be without the subsidy
E.g. import taxes would increase the cost of an imported product causing equilibrium price to be higher
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Price ceiling
Specified max price that may be charged for a good; if max price is set below equilibrium price, this causes a shortage
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Price floor
Specified price that may be charged for a good; if price floor is set for a good above equilibrium price, it will cause overproduction and surpluses will develop
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What does government intervention result int?
Inefficient allocation of resources
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Externalities
Describe damage to common areas that is caused by the production of certain goods
E.g. pollution
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What happens when there is an increase in demand with no change in supply?
Equilibrium price will increase and quantity purchased will increase
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What happens when there is a decrease in demand with no change in supply?
Equilibrium price will decrease and quantity purchased will decrease
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What happens when there is an increase in supply with no change in demand?
Equilibrium price will decrease and quantity purchased will increase
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What happens when there is a decrease in supply with no change in demand
Equilibrium price will increase and quantity purchased will decrease
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What happens when both demand and supply increase?
Quantity purchased will increase and new equilibrium price will be indeterminate
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What happens when both demand and supply decrease?
Quantity purchased will decrease and new equilibrium price will be indeterminate
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What happens when demand increases and supply decreases?
Equilibrium price will increase and quantity purchased is indeterminate
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What happens when demand decreases and supply increases?
Equilibrium price will decrease and quantity purchased is indeterminate
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In the short-run, what do firms have?
Variable and fixed costs
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Total fixed costs
Costs that are committed and will not change with different levels of production
E.g. Rent paid on a long-term lease for a factory
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Variable costs
Costs of variable inputs, such as raw materials, variable labor costs, and variable overhead.
These costs are directly related to the level of production for the period
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Average fixed cost (AFC)
Fixed cost per unit of production. It goes down consistently as more units are produced.
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Average variable cost (AVC)
Total variable costs divided by number of units produced; initially stays constant until the inefficiencies of producing in a fixed-size facility cause variable costs to begin to rise
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Marginal cost (MC)
The added cost of producing one extra unit. It initially decreases but then begins to increase due to inefficiencies
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Average total cost (ATC)
Total costs divided by the number of units produced. Its behavior depends on the makeup of fixed and variable costs
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Long-run total costs
All inputs are variable because additional plant capacity can be built
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If in the long run a firm increases all production factors by a given proportion; three possible outcomes
- Constant returns to scale: output increases in same proportion
- Increasing returns to scale: output increases by a greater proportion
- Decreasing returns to scale: output decreases by a smaller proportion
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Normal profit
Amount of profit necessary to compensate the owners for their capital and/or managerial skills; just enough profit to keep the firm in business in the long-run
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Economic profit
The amount of profit in excess of normal profit; cannot be experienced in a perfectly competitive market in the long-run
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How does management make production decisions?
Based on relationship between marginal revenue and marginal cost.
A good should be produced and sold as long as the marginal cost of producing the good is less than or equal to the marginal revenue from the sale of the good
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Marginal product
Additional output obtained from employing one additional unit of a resource
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Marginal revenue product
Change in total revenue from employing one additional unit of a resource
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Marginal revenue per-unit
Marginal revenue product / increase in products produced by employing one additional unit of resource (marginal product)
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How is the cost of production in the long-run minimized?
When the marginal product (MP) per dollar of every input is the same
MP of input A/Price input A = MP input B /Price input B
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Macroeconomics
- Looks at the economy as a whole
| - Focuses on measures of economic output, employment, inflation, and trade surpluses or deficits
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What are the three major segments of the economy?
Consumers, business, and government
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Nominal gross domestic product (GDP)
The price of all goods and services produced by a domestic economy
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Real GDP
The price of all goods and services produced by the economy at price level adjusted (constant) prices. Price level adjustment eliminates the effect of inflation on the measure
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Potential GDP
The maximum amount of production that could take place in an economy without putting pressure on the general level of prices.
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What is the difference between potential GDP and real GDP?
This is the GDP gap.
- Positive GDP gap indicates there are unemployed resources in the economy and we would expect unemployment
- Negative GDP gap indicates that the economy is running above normal capacity and prices should begin to rise
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Net domestic product (NDP)
GDP minus depreciation
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Gross National Product (GNP)
The price of all goods and services produced by labor and property supplied by the nation's residents
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Income approach
One way to calculate GDP
Adds up all incomes earned in the production of final goods and services, such as wages, interest, rents, dividends
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Expediture approach
One way to calculate GDP
Adds up all expenditures to purchase final goods and services by households, businesses, and the government. Specifically, it includes personal consumption expeditures, gross private investment in capital goods. Also includes the country's net exports.
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Income side of GDP
```
Compensation to employees
Corporate profits
Net interest
Proprietor's Income
Rental income of persons
=National income
Plus: indirect taxes
Minus: other, including statutory discrepancy
=Net national product
Plus: consumption of fixed capital
=Gross national product
Plus: payments of factor income to other countries
Minus: receipts of labor income from other countries
=Gross domestic product
```
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Product side of GDP
```
Personal consumption expeditures
Gross private domestic fixed investment
Government purchases
Net exports (negative)
Changes in business inventories
=Gross domestic product
```
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Aggregate demand curve
Depicts the demand of consumers, businesses, and government as well as foreign purchasers for the goods and services of the economy at different price levels
-Inversely related to price level
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Interest rate effect
As price levels increase (inflation increases) nominal interest rates increase causing a decrease in interest sensitive spending.
Interest sensitive spending includes spending for items such as houses, automobiles, and appliances
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Wealth effect
When price levels increase, the market value of certain financial assets decreases (e.g. fixed rate bonds) causing individuals to have less wealth and therefore they reduce their consumption
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International purchasing power effect
When domestic price levels increase relative to foreign currencies, foreign products become less expensive causing an increase in imported goods and a decrease in exported goods. This decreases the aggregate demand for domestic products.
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Why do aggregate demand curves shift?
Consumers, businesses or governments are willing to spend more or less or when there is an increase or decrease in the demand for domestic products abroad (i.e. an increase or decrease in net exports)
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What happens when economy reaches near capacity?
Prices remain relatively constant until they reach near capacity then prices begin to increase at a significant rate.
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What may cause shifts in aggregate supply curve?
Technology improvements, changes in resource availability, or changes in resource costs
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What is the multiplier?
Refers to the fact that an increase in spending by consumers, businesses, or the government has a multiplied effect on equilibrium GDP.
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How can the multiplier be estimated?
Examining an economy's MPC and MPC
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What is the formula for the multiplier?
(1 / MPS) x Change in Spending
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What is a business cycle?
A fluctuation in aggregate economic output that lasts for several years. Depicted as a series of peaks and troughs.
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Peak in a business cycle
Marks the end of a period of economic expansion and the beginning of a recession (contraction)
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Trough in a business cycle
Marks the end of a recession and the beginning of an economic recovery (expansion)
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Economic contractions
Characterized by a decrease in real gross domestic product (GDP) due to reduced spending
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Economic expansions
Real GDP is increasing; at the peak, real GDP generally surpasses potential GDP causing a scarcity of labor and materials; shortages usually cause inflation
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Okum's Law
Clear relationship between the change in unemployment and GDP growth. High growth associated with a decrease in the unemployment rate
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Recession
Period of negative GDP growth; at least two consecutive quarters of negative GDP growth
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Depression
deep and long-last recession
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Explanation for occurrence of business cycles?
Relate to level of investment spending by businesses, or the level of consumer spending for durable goods (e.g. automobiles and appliances)
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Cyclical businesses
Businesses perform better in periods of expansion and worse in periods of recession
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Defensive businesses
Affected little by business cycles; some may actually perform better in periods of recession
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Examples of some leading indicators of business cycles
- Average weekly hours
- Average weekly initial claims for unemployment insurance
- Manufacturer's new orders, consumer goods and materials
- Vendor performance, slower deliveries diffusion index
- Stock prices
- Interest rate spread
- Money supply, M2
- Index of consumer expectations
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Examples of some coincidental indicators of business cycles
- Employees on nonagricultural payrolls
- Personal income less transfer payments
- Industrial production
- Manufacturing and trade sales
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Examples of some lagging indicators of business cycles
- Average duration of unemployment
- Inventories to sales ratio, manufacturing and trade
- Labor cost per unit of output, manufacturing
- Average prime rate
- Commercial and industrial loans
- Consumer installment credit to personal income ratio
- Consumer price index for services
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Investment
Includes expenditures for residential construction, inventories, and plant and equipment
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What affects investment spending?
- Rate of technology growth
- Real interest rate (nominal rate minus the inflation premium)
- Stock of capital goods
- Actions by the government (e.g. fiscal policy)
- Acquisition and operating cost of capital goods
Investment spending is the most volatile portion of GDP
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Autonomous investment
Includes expenditures made by businesses based on expected profitability that are independent of the level of national income. Constant regardless of whether the economy is expanding or contracting
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Induced investment
Incremental spending based on an increased level of economic activity
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Accelerator theory
As economic activity increases, capital investment must be made to meet the level of increased demand. This increased capital investment in turn creates additional economic demand which further feeds the economic expansion.
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Unemployment rate
Percent of the total labor force that is unemployed at a given time
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Frictional unemployment rate
Individuals are forced or voluntarily change jobs. New entrants also fall into this category
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Structural unemployment
Changf=es in demand for products or services, or technological advances causing not as many individuals with a particular skill to be needed. This is reduced by retraining programs.
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Cyclical unemployment
Caused by the condition in which real GDP is less than potential GDP. Unemployment increases during recessions and decreases during expansions
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Inflation
Rate of increase in the price level of goods and services, usually measured on an annual basis
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Deflation
Decrease in price levels. Very damaging because businesses do not want to borrow money and pay it back with money that has more purchasing power and they do not want to invest in plant and equipment given that the cost of P & E is declining.
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Why are high rates of inflation not good for the economy?
Generally causes economic activity to contract and redistributes income and wealth.
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Price index
Measures the prices of a basket of goods and/or services at a point in time in relation to the prices in a base period
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Consumer price index (CPI)
Measures the price that urban consumers paid for a fixed basket of goods and services in relation to the price of the same goods and services purchased in some base period
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Producer price index (PPI)
Measures the prices of finished goods and materials at the wholesale level
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GDP deflator
Measures the prices for net exports, investment, government expeditures, and consumer spending. Most comprehensive measure of price level
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What are the main causes for inflation?
- Demand-pull
| - Cost-push
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Demand-pull inflation
Occurs when aggregate spending exceeds the economy's normal full-employment output capacity. Generally occurs at the peak of a business cycle and is characterized by real GDP exceeding potential GDP.
Labor is short so companies bid up the price and inflation occurs
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Cost-push inflation
Occurs from an increase in the cost of producing goods and services. Characterized by decreases in aggregate output and unemployment because consumers are not willing to pay the inflated prices
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What type of relationship does inflation and unemployment have?
Inverse relationship. When unemployment rate is low, inflation tends to increase. Inflation tends to decrease when the unemployment rate is high.
Relationship depicted by the Phillips curve
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Personal disposable income
Amount of income that individuals receive and have available to purchase goods and services .
Has a significant effect on the economy because it is a large determinant of consumer demand.
Personal disposable income is equal to personal income minus personal taxes.
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Interest rates
Interest is the price paid for the use of money.
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What determines the interest rate?
The intersection of the demand and supply curves for money determines the equilibrium price or interest rate.
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Real interest rate
Interest rate in terms of goods. These rates are adjusted for inflation.
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Nominal interest rate
Interest rate in terms of the nation's currency. These are the rates quoted by financial institutions and in the financial pages of newspapers.
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Inflation premium
Difference between the real rate and the nominal interest rate. This represents the expected inflation rate.
The higher the expected inflation rate the larger the inflation premium.
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Credit risk
Risk that the firm will not pay the interest or principal of the loan
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Government budget surplus (deficit)
The excess (deficit) of government taxes in relation to government transfer payments and purchases. To finance a deficit the government issues debt (Treasury bonds)
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Money
Medium of exchange; common denominator to measure prices, revenue, expenses, and income and a store of value allowing individuals and firms to save
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M1 money
Includes only currency and demand deposits
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M2 money
Equal to M1 plus savings accounts and small-time deposits (less than $100,000)
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M3 money
M2 plus other (larger) time deposits. Federal reserve focuses on M2
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What are depository institutions?
Banks, savings and loans, and credit unions
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Who controls depository institutions?
The Federal Reserve (US central bank)
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Monetary policy: Reserve requirements
Federal Reserve controls a bank's ability to issue check-writing deposits by imposing a reserve requirement on checking deposits. The institution must hold in reserve a certain percentage of their total checking deposits.
Fed Reserve can influence interest rates by changing the reserve requirements and therefore increasing or decreasing the supply of money.
This method is rarely done.
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Monetary policy: Open-market operations
More common policy by Federal Open-Market Committee)
This involves the purchase or sale of government securities using the Federal Reserve Bank deposits.
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Monetary policy: Expansionary open-market operation
Central bank is purchasing government securities and expanding the money supply
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Monetary policy: Contractionary open-market operation
Central bank is selling government securities - reduces the money supply
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Monetary policy: discount rate
When a bank has a reserve deficiency, it may borrow funds from a Federal Reserve Bank. Can influence interest rates in the economy
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Principle of monetary policy
Decrease in interest rates will stimulate the economy, and an increase in interest rates will slow the economy
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Rational expectations
Assume that investors, firms, and consumers develop expectations about inflation, interest rates, and output based on a consideration of all available information
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Fiscal policy
Government actions such as taxes, subsidies, and government spending, designed to achieve achieve economic goals
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Fiscal policy: Taxes
Taxes are levied on two general principles:
1. Ability to pay (e.g. progressive taxes)
2. Derived benefit (e.g. gasoline taxes used to pay for roads)
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Income tax
Levied on taxable income; rate structure in US is generally progressive
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Property tax
Levied based on wealth; progressive based on value of property
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Sales tax
Levied based on the amount of income spent. Viewed as regressive because low-income individuals pay the same percentage as high-income individuals
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Wage taxes
Most significant wage tax in the US is social security tax; tax is borne both directly (employee) and indirectly (employer)
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Value-added tax
Tax commonly used in other industrial nations (VAT). Levied on the increase in value of each product as it proceeds through production and distribution processes. Ultimately, tax is paid by the final consumer.
Encourage savings because it taxes consumption instead of earnings
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What does lower budget deficits mean?
Means more savings and investment and therefore more output
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What does lower budget deficits mean in the short-run?
Leads to reductions in spending and therefore less output
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Classical economic theory
Market equilibrium will eventually result in full employment over the long run without government intervention. Does not support use of fiscal policy to stimulate the economy
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Keynesian theory
Economy does not necessarily move towards full employment on its own. Focuses on the use of fiscal policy (e.g. reductions in taxes and government spending) to stimulate the economy
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Monetarist theory
This theory holds that fiscal policy is too crude a tool for control of the economy. Focuses on the use of monetary policy
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Supply-side theory
This theory holds that bolstering an economy's ability to supply more goods is the most effective way to stimulate growth. A decrease in taxes is an effective way to stimulate the economy.
215
Laffer Curve
Attempts to explain how consumers react to changes in rates of income tax
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Neo-Keynesian theory
Combines Keynesian and monetarist theories. Focuses on combination of fiscal and monetary policy to stimulate the economy and control inflation
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Absolute advantage
Low cost labor, technology
Incentive for that country to produce more than its citizens need to export the good to countries with higher production costs
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Comparative advantage
Country has no alternate uses of its resources that would involve a higher return (i.e. opportunity costs are less). In the long-term, production of specific goods and services will mitigate to countries that have a comparative advantage.
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Diamond of national advantage
Developed by Michael Porter to explain how a country can create new advanced factor endowments that contribute to the country's comparative advantage.
- Factor conditions: country can create its own important factors such as skilled resources and tech infrastructure. Country can overcome shortages of factors through innovation.
- Demand Conditions: a country has a comparative advantage for a particular product when it has a strong domestic market because the firms in the country devote more attention to the product than in other countries
- Related and Supporting Industries: Comparative advantage if supporting industries are strong because of the cost effective and innovative inputs that result
- Firm Strategy, Structure, and Rivalry: intense rivalry of an industry in a country tends to lead to a competitive advantage for that country's industry globally
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Protectionism
Restriction of free trade to protect industries within one's country
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Import tariff
Tax on an imported product
Designed to discourage consumption of goods from foreign companies or to raise revenue, or both
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Trigger price mechanism
Automatically imposes a tariff barrier against cheap imports by imposing a duty on all imports below a trigger price
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Import quota
Restriction on the amount of a good that may be imported during a period
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Embargo
Total ban on the importation of specific goods
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Voluntary export restraint
Limit quality of goods that can be exported to appease importing countries and keep them from imposing stiffer import restrictions
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Foreign-exchange control
Imposed by a government on the purchase or sale of foreign currencies by residents, or on the purchase or sale of local currency by nonresidents
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Examples of foreign-exchange control
- Banning the use of foreign currency in the country
- Banning possession of foreign currency by citizens
- Restricting currency exchange to government-approved exchangers
- Fixed exchange rates
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Dumping
Form of predatory pricing in which a manufacturer in one country exports a product at a price that is lower than the price charged in its home market or below the company's cost of production.
Condemned by WTO because it causes material injury to a domestic industry in the importing country
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Export subsidies
Payments made by a government to encourage the production and export of specific products
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Countervailing duties
Duties imposed by an importing country to neutralize the negative effects of export subsidies
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WTO (World Trade Organization)
Organization of countries designed to supervise and liberalize trade among participating countries. Facilitates trade agreements among participants and provides a resolution process to enforce the agreements.
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Favored nation status
Member country will not establish trade barriers that discriminate against other members
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NAFTA (North American Free Trade Agreement)
Free trade agreement between the countries of Canada, Mexico and US. Adopted by US Congress in 1993.
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What are the advantages for US businesses from NAFTA?
- Ability to take advantage of the lower labor costs in Mexico for such functions as manufacturing and assembly
- Opening of new markets for goods and lower labor costs in Mexico for such functions as manufacturing and assembly
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Disadvantages to US business from NAFTA?
- Concerns that firms will be hurt by the availability of less expensive products from Mexico
- Certain jobs will be lost because of lower-cost labor in Mexico combined with more lax environmental laws and regulations
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Balance of payments
Account summary of a nation's transactions with other nations.
1. Current account
2. Capital account
3. Official reserve account
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What is the current account in the balance of payments?
Shows the flow of goods and services and government grants for a period of time
- balance of trade for a period is the difference between the total goods exported and total goods imported
- balance on goods and services is the difference between the total value of goods and services exported and the total value of goods and services imported
- when a nation exports more than it imports, a trade surplus occurs
- when a nation imports more than it exports, a trade deficit occurs
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What is the capital account in the balance of payments?
Shows the flow of investments in fixed and financial assets for a period of time
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What is the official reserve account in the balance of payments?
Shows the changes in the nation's reserves (e.g. gold and foreign currency)
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What is the G-20?
Group of finance ministers and central bank governors from 20 economies (EU and 19 countries)
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European Union (EU)
Economic and political union of 27 countries primarily in Europe.
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Eurozone
Economic and monetary union composed of 17 member countries that use the euro currency
European Central Bank establishes monetary policy for the members of the eurozone
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What is the objective of the World Bank?
Objective of promoting world-wide economic development
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International Monetary Fund
Objective of maintaining order in the international monetary system by preventing currency, banking, and financial debt crises
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GATT - General Agreement on Tariffs and Trade
Works on reduction of trade barriers
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What are the factors influencing exchange rates?
Exchange rates are determined by managed float.
1. Inflation
2. Interest rates
3. Balance of payments
4. Government intervention
5. Other factors
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How does inflation influence exchange rates?
Inflation tends to deflate the value of a currency because holding the currency results in reduced purchasing power.
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How does interest rates influence exchange rates?
If interest returns in a particular country are higher relative to other countries, individuals and companies will be enticed to invest in that country.
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How does balance of payments influence exchange rates?
If country X is a net exporter of goods and therefore has a surplus balance of trade, countries purchasing the goods must use country X's currency. This increases the demand for the currency and therefore its relative value.
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How does government intervention influence exchange rates?
Central bank of a country may support or depress the value of its currency
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What other factors can influence exchange rates?
Political and economic stability, extended stock market rallies, significant declines in the demand for major exports
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Exchange rate regime
Way a country manages its currency in respect to currencies of other countries
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Floating exchange rate
One in which the exchange rate is dictated by market factors
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Pegged exchange rate
One in which the country's central bank keeps the rate from deviating too far from a target band or value
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Fixed exchange rate
One in which the rate is tied to the value of another currency, such as the US dollar or the euro
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Managed exchange rate
One in which the country's central bank attempts to control the movement in currency value
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Spot rate
Exchange rate of the currency for immediate delivery
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Forward rate
Exchange rate of a currency for future delivery
E.g. forward contract might obligate a company to purchase or sell euros at a specific exchange rate three months hence
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What is the difference between the spot rate and forward rate called?
Discount or premium
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What happens if the forward rate is less than the spot rate?
Market believes that the value of the currency is going to decline
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What happens if the forward rate is greater than the spot rate?
Market believes the value of the currency is going to increase
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Forward premium or discount formula
Forward rate - spot rate / spot rate
TIMES
Month (or days) in year / Months (or days) in forward period
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What are the two types of foreign exchange risk for a multinational company?
- Translation (accounting) risk
| - Transaction risk
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Translation risk
Exposure that a multinational company has because its financial statements must be converted to its functional currency
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Transaction risk
Possibility of gains and losses resulting from income transactions occurring the year
Cause volatility in reported earnings that motivates management to use strategies to minimize the company's exposure
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What are the various forms of contracts to hedge foreign currency risk?
- Options
- Forwards
- Futures
- Currency swaps
- Money market hedge
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Hedging foreign currency risk: Options
Allow, but do not require, the holder to buy (call) or sell (put) a specific or standard commodity or financial instrument, at a specified price during a specified period of time (American option) or at a specified date (European option)
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Hedging foreign currency risk: Forwards
Negotiated contracts to purchase and sell a specific quantity of a financial instrument, foreign currency, or commodity at a price specified at origination of the contract, with delivery and payment at a specified future date
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Hedging foreign currency risk: Futures
Forward-based standardized contracts to take delivery of a specified financial instrument, foreign currency, or commodity at a specified future date or during a specified period generally at the then-market price
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Hedging foreign currency risk: Currency swaps
Forward-based contracts in which two parties agree to exchange an obligation to pay cash flows in one currency for an obligation to pay in another currency
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Heading foreign currency risk: Money market hedge
This eliminates transaction risk. Borrow money in one currency (e.g. yen) when the agreement is executed. The yen is then immediately converted to another currency (e.g. US dollars). When the yen are collected from the sale, the loan can be repaid, resulting in no foreign exchange loss or gain over the six-month period
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What is repatriation?
Transfer (of foreign subsidiary's profits)
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What is expropriate?
Take
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What are strategies used to reduce political risk?
- Joint ventures
- Financing with local-country capital
- Purchase of insurance
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Transfer pricing
Price at which services or products are bought and sold across international borders between related parties
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Why is it important to establish transfer pricing?
Transfer price affects the parent and subsidiary's net income and also affects the taxes that the firm pays in the respective countries.
Avoid foreign withholding of taxes on cash payments, avoid import duties and circumventing profit repatriation restrictions
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How to minimize tax burden using transfer pricing?
Minimize net income in jurisdictions with higher income tax rates, and maximizing net income in jurisdictions with lower income tax rates
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What are the methods used to determine transfer prices?
- Cost method
- Market price method
- Negotiated price method
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Transfer Price Determination - Cost Method
The price is determined based on the cost of producing the item. Commonly used when a market price for the product is not available
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Transfer Price Determination - Market Price Method
The price is determined based on the external market for the item
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Transfer Price Determination - Negotiated Price Method
The price is determined based on a negotiated agreement
282
Business risks
Conditions that threaten management's ability to execute strategies and achieve the firm's objectives
283
Industry environment
Set of factors that influence the firm's competitive actions
284
What are the five forces of the industry environment?
1. Competitors
2. Potential entrants into the market
3. Equivalent products
4. Bargaining power of customers
5. Bargaining power of input suppliers
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What are some entry barriers?
- Economies of scale
- Proprietary product of differences
- Brand identity
- Switching costs
- Capital requirements
- Access to distribution
- Absolute cost advantages
- Government policy
- Expected retaliation
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What are the determinants of supplier power?
- Differentiation of inputs
- Switching cost of suppliers and firms in the industry
- Presence of substitute inputs
- Supplier concentration
- Importance of volume to supplier
- Cost relative to total purchases in the industry
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What are the determinants of substitution threat?
- Relative price performance of substitutes
- Switching costs
- Buyer propensity to substitute
288
What are the determinants of rivalry?
- Industry growth
- Fixed (or storage) costs/value added
- Intermittent overcapacity
- Product differences
- Brand identity
- Exit barriers
- Corporate stakes
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What are the determinants of buyer power?
In regards to price sensitivity:
- Price/total purchases
- Product differences
- Brand identity
- Buyer profits
In regards to bargaining leverage:
-Buyer informaaoducts
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What does management have control over in regards to general environment factors and industry factors?
Management has little or no control over general environment factors, but can have significant influence over industry factors
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What techniques can management use to forecast the future (general environment) and analyze?
- Scanning
- Monitoring
- Forecasting
- Assessing
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Scanning
Study of all segments in the general environment
293
What is the objective of scanning?
Predict the effects of the general environment on firm's industry.
Important to do in volatile industries
294
What are examples of sources for scanning?
Trade publications, news papers, business publications, public polls, government publications
295
Monitoring
A study of environmental changes identified by scanning to spot important trends.
Effective monitoring involves identifying the firm's major stakeholders.
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Forecasting
Developing probably projections of what might happen and its timing
297
Assessing
Determining changes in the firm's strategy that are necessary as a result of the information obtained from scanning, monitoring and forecasting.
298
What is an industry?
A group of firms that produce products that are substitutes or close substitutes
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Perfect (pure) competition
- Composed of large number of sellers, each of which are too small to affect the price
- Virtually sell identical product
- Firms can enter/leave market easily (no barriers to entry)
Very few perfectly competitive markets (corn, soy, wheat)
Produce until MC > MR
No economic profits in LR
No product differentiation
300
What is the firms demand curve like in a perfectly competitive market?
Perfectly elastic (horizontal). Firm can sell as many goods as it can produce at the equilibrium price but no goods at a higher price. Firm is price taker
301
What is the market demand curve like in a perfectly competitive market?
Downwards sloping. Demand will increase if all suppliers lower prices and will decrease if all suppliers raise their prices.
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Pure monopoly
There is a single seller of a product or service for which there are no close substitutes
Monopolist sets price unless regulated
Demand curve is negatively sloping - reduce price to sell more output
Firm will continue to produce and sell as long as MR > AVC
303
Reasons for existence of a pure monopoly?
- Increasing returns to scale
- Control over the supply of raw materials
- Patents (e.g. drug manufacturer)
- Government franchise (e.g. public utility)
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Natural monopoly
Exist when economic or technical conditions permit only one efficient supplier
305
What did the Sherman Act of 1980, Clayton Act of 1914, Robinson-Patman Act of 1936 and Celler-Kefauver Anti-Merger Act of 1950 intend to do?
Discourage the development of monopolies - lower output and higher cost.
306
Monopolistic competition
Many firms selling a differentiated product or service - real or only created by advertising
E.g. markets for groceries, detergents, and breakfast cereals
307
What is the demand curve like in a monopolistic competitive market?
Negatively sloped and firms produce until MR
308
Oligopoly
Form of market characterized by significant barriers to entry
Few (large) sellers of product
E.g. automobile industry
309
What type of competition do oligopolists engage in?
Nonprice competition (e.g. product differentiation or providing high levels of service)
310
What does a demand curve look like in an oligopoly?
Kinked-demand curve to explain price rigidity.
Kinked down at the market price because other oligopolists will not match price increases but will match price decreases
311
What happens if oligopolists are left unregulated?
Tend to establish cartels that engage in price fixing; regulations prohibit collusion by firms to set prices
312
Threat of substitute products
Goods/services from outside a given industry that perform similar functions
313
Monopsony
Market where only one buyer exists for all sellers
Has monopoly power in the purchase of a resource
Marginal cost curve for a monopsonist is different from other firms' in that each time it purchases an additional unit of product or labor t increases the cost of all of the resource
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Industry analysis: Competitor analysis
Management considers the strategies of the firm's competitors
315
What are the two major activities in competitor analysis?
1. Gathering information about competitors' capabilities, objectives, strategies, and assumptions (competitor intelligence)
2. Using the information to understand the competitor's behavior
316
What are some sources that are used in competitor analysis?
- Annual reports and SEC filings
- Interviews with analysts
- Press releases
317
Response profile
Information from the analysis of the competitor's objectives, assumptions, strategy and capabilities
318
Price elasticity of demand
Measures the effect of a change in price on the demand for the product
319
Price elasticity of demand equation
Ed = Change in Qd/Avg quantity
DIVIDED BY
Change in price / Avg price
320
Simple regression equation
y=a + bx
```
y = dependent variable
a = y-axis intercept
b = slope of the line
x = independent variable
```
321
What is a mission statement?
Sets forth the purpose of the organization, including its distinguishing characteristics
322
What is a vision?
Sets forth where the organization would like to be in the future
323
Environmental scan
Situational analysis performed which involves colection and evaluation of past and present economical, political, social, and technology data to:
1. identify internal and external forces that may affect the organization's performance and choice of strategies
2. to assess the organization's strengths, weaknesses, opportunities, and threats (SWOT analysis)
324
What are some generic business strategies?
Classified as being product differentiation or cost leadership
325
Product differentiation
Involves development of a unique
326
How can products be differentiated?
1. Physical characteristics
2. Perceived differences
3. Support service differences
327
Cost leadership
Involves focusing on reducing the costs and time to produce, sell, and distribute a product or service
328
What are some techniques used to attempt to reduce costs and time?
- Process reengineering
- Lean manufacturing (production)
- Supply chain management
- Strategic alliances
- Outsourcing
329
Process reengineering
Critical evaluation and major redesign of existing processes to achieve breakthrough improvements in performance
Involves radical redesign and drastic improvement in processes
330
Total quality management (TQM)
Involves gradual improvement of processes
331
Lean manufacturing
Management technique that involves the identification and elimination of all types of waste in the production function
Focus on improving design, increasing flexibility, and reducing time, defects, and inventory, costs can be minimized
332
Supply chain management
Describes the flow of goods, services, and information from basic raw materials through the manufacturing and distribution process to delivery of the product to the consumer, regardless of whether those activities occur in one or many firms
333
Firm's operations within supply chain management include what?
Assembly and distribution processes
334
What does supply chain management help improve?
- Operations and manage the relationships with their suppliers
- Processes to reduce time, defects, and costs all along the supply chain
335
What are the issues that arise from supply chain management?
- Incompatible information systems
- Refusal of some companies to share information
- Failure of suppliers or customers to meet their obligations
336
Target market
Market in which the firm actually sells or plans to sell its product or services
To understand exactly who the firm's customers are
Usually involves market segmentation
337
Market segmentation
Involves breaking the market into groups that have different levels of demand for the firm's product or service
338
Strategic alliances
Collaborative agreements between two or more firms
339
What are some reasons for entering into a strategic alliance?
- Refocus the firm's efforts on its core competencies and value creation activities
- Speed innovation
- Compensate for limited resources
- Reduce risk
340
How do companies in developed countries compete with developing countries?
- Use of sophisticated technology to reduce costs
- Effective process management
- Innovation in products or services
- Product quality
- Customer service
- Adopting a global strategy
341
How do companies benefit from global strategy?
- Pooling international production to one or a few locations can achieve increased economies of scale
- Manufacturing costs can be cut by moving production to low-cost countries
- A firm that can switch production among different countries has increases bargaining power over labor, suppliers, and host governments
- Worldwide access to resources, labor, suppliers and customers
342
Outsourcing
Contracting for the performance of processes by other firms
| -Opportunity to decrease costs
343
Advantages of outsourcing
1. cost savings
2. higher quality
3. reduced time to delivery
4. scalability
344
Risks of outsourcing
- Time to draft agreements appropriately structured to allow the firm to control performance, quality, and ethical employment practices of the other firm
- Reputation for low quality or outsourcing
- Legal risk and foreign currency risk
345
What does successful management involve?
Being able to anticipate changes in economic conditions and competitor actions and devising strategies and plans to react to those changes
