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2

Economics: The Framework for Business

Define economics and discuss the evolving global economic crisis

Analyze the impact of fiscal and monetary policy on the economy

Explain and evaluate the free market system and supply and demand

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2-2

2-3

©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

2

Economics: The Framework for Business

Explain and evaluate planned market systems

Describe the trend toward mixed market systems

Discuss key terms and tools to evaluate economic performance

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2-5

2-6

©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Economics

Study of the choices that people, companies, and governments make in allocating society’s resources

Guide decision-making

Help understand broad forces that affect business and personal life

Economy: Financial and social system of how resources flow through society

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Macro and Micro Economics

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Macroeconomics: Study of a country’s overall economic dynamics

Employment rate, gross domestic product, and taxation policies

Microeconomics: Study of smaller economic units

Individual consumers, families, and individual businesses

©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Global Economic Crisis

Started with slump in dot-com business followed by the 9/11 terrorist attacks Stock market dropped

Unemployment rose

Economic experts feared that the U.S. was on the edge of a full-blown recession

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Global Economic Crisis

Subprime mortgage loans – Loans to borrowers with:

Low credit scores

High debt-to-income ratios

Other signs of a reduced ability to repay the money they borrow

Financial institutions suffered when mortgage-backed funds lost value

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Steps Taken by the Federal Government and the Federal Reserve

Troubled Assets Relief Program (TARP) – $700 billion economic bailout plan

American Recovery and Reinvestment Act

Designed to turn the economy around over the next two years

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Managing the Economy: Fiscal & Monetary Policy

Help achieve the goal of controlled sustained economic growth

Fiscal policy: Government efforts to influence the economy through taxation and spending

Monetary policy: Federal reserve decisions that shape the economy by influencing interest rates and supply of money

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Debt Ceiling and Fiscal Cliff

Debt Ceiling – Maximum amount Congress lets the government borrow

Limits amount that government can borrow

Fiscal cliff – Package of across-the-board spending cuts and sharp tax hikes

Aimed to decrease the U.S. budget deficit

Not beneficial if the U.S. economy goes over the fiscal cliff

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Budget

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Outlines expected revenue from taxes and fees, and expected spending

• Revenue is higher than expenses over a given period

Budget surplus

• Expenses are higher than revenue over a given period

Budget deficit

• Sum of all the money borrowed and not yet repaid by they federal government

Federal debt

©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Federal Reserve Banks

Execute Fed policies

Perform banking services for commercial banks in their districts

Commercial banks: Privately owned financial institutions

Accept demand deposits

Make loans

Provide other services for the public

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Money Supply

Total amount of money within the overall economy

Money: Medium of exchange, a measure of value, or a means of payment

Commonly used definitions

M1: All currency plus checking accounts and traveler’s checks

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Money Supply

M2: M1 money supply plus most savings accounts, money market accounts, and certificates of deposit

When economy contracts, Fed increases the money supply

When prices rise, Fed reduces the money supply

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Open Market Operations

Federal Reserve function of buying and selling government securities

Includes treasury bonds, notes, and bills

Federal Deposit Insurance Corporation (FDIC): Federal agency that insures deposits in banks and thrift institutions for up to $250,000 per customer, per bank

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Discount Rate and Reserve Requirement

Discount rate: Rate of interest that the Federal Reserve charges when it loans funds to banks

Reserve requirement: Rule set by the Fed which specifies minimum amount of reserves a bank must hold

Expressed as a percentage of the bank’s deposits

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Capitalism: Free Market System

Economic system based on private ownership, economic freedom, and fair competition

Known as the private enterprise or free market system

Economic system: Structure for allocating limited resources

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Fundamental Rights of Capitalism

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Degrees of Competition

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• Market structure with many competitors selling virtually identical products
• Barriers to entry are quite low

Pure competition

• Market structure with many competitors selling differentiated products
• Barriers to entry are low

Monopolistic competition

• Market structure with only a handful of competitors selling products that can be similar or different
• Barriers to entry are typically high

Oligopoly

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Monopoly

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One producer completely dominates the industry, leaving no room for any significant competitors

• Barriers to entry tend to be virtually insurmountable

Natural monopoly: Market structure with one company as the supplier of a product

• Reason – Nature of that product makes a single supplier more efficient
• Government sanctioned and regulated

©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Capitalism: Supply & Demand

Explains the dynamic interaction between buyers and sellers that directly affects:

• Range of products
• Prices

Supply

• Quantity of products that producers are willing to offer for sale at different market price

Demand

• Quantity of products that consumers are willing to buy at different market prices

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Supply

To make profits, businesses produce:

More of a product that commands a higher market price

Less of a product that commands a lower price

Supply curve: Graphed relationship between price and quantity from a supplier standpoint

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Exhibit 2.3 – Supply Curve

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Demand

To get the products at the lowest possible prices consumers buy:

More products with lower prices

Fewer products with higher prices

Demand curve: Graphed relationship between price and quantity from a demand standpoint

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Exhibit 2.4 – Demand Curve

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Equilibrium Price

Associated with the point at which the quantity demanded equals the quantity supplied

Constant interaction between supply and demand determines the market price

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Exhibit 2.5 – Equilibrium

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Socialism

Economic system based on the principle that the government owns and operates key enterprises that directly affect public welfare

Has higher taxes, designed to distribute wealth more evenly through society

Cause of slump in socialist economies

High taxes and lavish social programs

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Communism

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System that calls for public ownership of all enterprises, under a strong central government

Did not thrive due to following reasons

Authoritarian governments suspended individual rights and choices

Developed crippling shortages and surpluses

Corruption at every level of government

©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Mixed Economies

Embody elements of both planned and market-based economic systems

Federal government partly owns number of financial institutions

Government intervenes in the free market by creating regulations

Privatization: Converting government-owned businesses to private ownership

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Evaluating Economic Performance

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Gross Domestic Product (GDP)

Total value of all final goods and services produced within a nation’s physical boundaries over a given period of time

Used to:

Measure the economic performance of individual nations

Compare the growth among nations

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Employment Level

Tracked through unemployment rate

Unemployment rate: Percentage of people in the labor force over age 16 who do not have jobs and are actively seeking

Categories of unemployment

Frictional – Temporary unemployment

Structural – Long term unemployment

Cyclical – Layoffs during recessions

Seasonal – Job loss related to the time of year

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Business Cycle

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Periodic contraction and expansion that occur over time in every economy

• Recession: Decrease in the GDP for two consecutive quarters
• Depression: Long and deep recession

Contraction: Period of brief economic downturn

Recovery: Period of rising economic growth and employment

Expansion: Period of robust economic growth and high employment

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Price Levels

Inflation: Period of rising average prices across the economy

Hyperinflation: Average monthly inflation rate of more than 50 percent

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Price Levels

Disinflation: Period of slowing average price increases across the economy

Deflation: Period of falling average prices across the economy

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Price Indexes to Evaluate Inflation

Consumer price index (CPI): Evaluates the change in the weighted-average price of goods and services that the average consumer buys each month

Producer price index (PPI): Evaluates the change over time in the weighted-average wholesale prices

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©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Productivity

Relationship between:

Output – Production of goods or services

Input – Resources required to produce goods or services

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Productivity = Output/Input

©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Define economics and discuss the evolving global economic crisis

Analyze the impact of fiscal and monetary policy on the economy

Explain and evaluate the free market system and supply and demand

*

2-1

2-2

2-3

©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Explain and evaluate planned market systems

Describe the trend toward mixed market systems

Discuss key terms and tools to evaluate economic performance

*

2-4

2-5

2-6