14 - Chapter 14 Economics and the External Environment...

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Unformatted text preview: Chapter 14 Economics and the External Environment Chapter 14 Copyright© 2011 Money Education, LLC External Environment 2 Macroeconomics is the study of economic factors that are reflective of the entire economy such as gross domestic product (GDP), the unemployment rate, and the inflation rate. Microeconomics is the study of factors that impact small or individual economies, such as supply and demand for a product. Copyright© 2011 Money Education, LLC Chapter 14 Economic Output 3 Gross National Product (GNP) measures the total final output by the citizens of a country, whether produced domestically or in a foreign country. Gross Domestic Product (GDP) represents the total final output of a country, by its citizens and foreigners in the country, over a period of time. A positive GDP is generally a sign that the economy is expanding, a negative GDP is a sign that the economy is contracting. Chapter 14 Copyright© 2011 Money Education, LLC Gross Domestic Product 4 Nominal GDP measures the value of goods and services in current prices. Real GDP measures the value of goods and services at a base year price. The GDP deflator measures the current price of goods and services (nominal GDP) relative to a base year (real GDP). The formula for the GDP deflator is: GD Deflator = Nominal GDP Real GDP • The GDP deflator could also be thought of as a measure of price increases or decreases. Copyright© 2011 Money Education, LLC Chapter 14 Gross Domestic Product 5 GDP in billions of current dollars 16,000.0 14,000.0 12,000.0 10,000.0 8,000.0 6,000.0 4,000.0 2,000.0 0.0 Source: http://www.bea.gov/national/ Copyright© 2011 Money Education, LLC Chapter 14 Inflation 6 Inflation represents an increase in the general level of prices of goods and services. The biggest risks inflation presents are the loss of purchasing power. Inflation causes a decline in the real value of money. A primary cause of inflation is when the money supply increases faster than the growth in real GDP. Disinflation is a slowdown in the rate of inflation. Deflation is a decrease in overall price levels of goods and services. Chapter 14 Copyright© 2011 Money Education, LLC Measures of Inflation 7 The Consumer Price Index (CPI) measures the overall price levels for a basket of goods and services. • The CPI is the most widely quoted and relied upon measure of inflation. The Producer Price Index (PPI) measures the inflation rate for raw materials used in the manufacturing process. Inflation Rate = P1 – P0 P0 Copyright© 2011 Money Education, LLC Chapter 14 Interest Rates 8 An interest rate is the price that a borrower pays to borrow money. The nominal interest rate represents the real rate of return plus an adjustment for anticipated future inflation. Interest rates are influenced by the demand for and the supply of loanable funds. Interest rates can be influenced by fiscal and monetary policy. Copyright© 2011 Money Education, LLC Chapter 14 Unemployment 9 Unemployed refers to those individuals who are 16 years of age and older, not working, and are making an effort to seek employment. Frictional unemployment occurs when people are voluntarily unemployed. Structural unemployment occurs when there is inequality between the supply of adequately skilled workers and the demand for workers. Cyclical unemployment occurs when there is an overall downturn in business activity. Full employment is defined as the rate of employment that exists when there is efficiency in the labor market. Full employment is approximately 95% employment of the labor force. Chapter 14 Copyright© 2011 Money Education, LLC Business Cycle 10 The Business Cycle • Expansion • Peak • Contraction or Recession • Trough Copyright© 2011 Money Education, LLC Chapter 14 Business Life Cycle 11 Copyright© 2011 Money Education, LLC Chapter 14 Business Cycle 12 Expansion GDP Inflation Interest Rates Unemployment Chapter 14 Peak Contraction Trough Increasing High Decreasing Low High Decreasing Low High Decreasing Low Low Increasing High Increasing Increasing Decreasing Copyright© 2011 Money Education, LLC Economic Indicators 13 The Index of Leading Economic Indicators • The Index of Leading Economic Indicators is relied on to predict changes in the economy. The Index of Trailing Economic Indicators • The index of lagging economic indicators summarizes past performance. • It does not predict future trends in the economy. • It validates current assessments of the economy. The Index of Trailing Economic Indicators • This index is comprised of economic variables that change along with the business cycle. Copyright© 2011 Money Education, LLC Chapter 14 Monetary Policy 14 Monetary policy represents the intended influence on the money supply and interest rates. Monetary policy is established by the Chairman of the Federal Reserve and the Federal Open Market Committee (FOMC). The Federal Reserve has three primary goals: • Maintain price levels • Maintain long-term economic growth • Maintain full employment Copyright© 2011 Money Education, LLC Chapter 14 Monetary Policy 15 The Federal Reserve has four tools that it uses to implement monetary policy. The four tools are: • Reserve Requirement • Discount Rate / Federal Funds Rate • Open Market Operations • Excess Reserve Deposits Chapter 14 Copyright© 2011 Money Education, LLC Reserve Requirement 16 The Federal Reserve requires that banks maintain a certain percentage of their deposits on hand, in the form of cash known as their reserve requirement. Monetary Policy Reserve Requirement Money Supply Tighten Increase Decrease Increase Ease Decrease Increase Decrease Interest Rates Copyright© 2011 Money Education, LLC Chapter 14 Discount Rate 17 The discount rate is the interest rate that the Federal Reserve charges financial institutions for short-term loans. The bank to bank lending rate is the federal funds rate, which is also known as the overnight rate. The Federal Open Market Committee (FOMC) will set the discount rate and also a target for the federal funds rate. The Federal Reserve does not directly control the federal funds rate. Copyright© 2011 Money Education, LLC Chapter 14 Open Market Operations 18 Open market operations is the process by which the Federal Reserve will buy or sell U.S. Treasury securities such as T-bills, notes, and bonds. Chapter 14 Copyright© 2011 Money Education, LLC Excess Reserves 19 Excess reserves represent the amount of cash or deposits with the Federal Reserve in excess of the minimum amount required. Financial institutions have an incentive to keep excess reserves on deposit with the Federal Reserve. Copyright© 2011 Money Education, LLC Chapter 14 Fiscal Policy 20 Congress has the same three goals: • Maintain price levels • Maintain long-term economic growth • Maintain full employment Copyright© 2011 Money Education, LLC Chapter 14 Taxes 21 Fiscal Policy Tax Impact Taxes Expand Increase Chapter 14 Fiscal Policy Decrease Contract Copyright© 2011 Money Education, LLC Spending 22 Spending by the federal government can directly impact aggregate demand. Copyright© 2011 Money Education, LLC Chapter 14 Deficit Management 23 Deficit spending is a financial circumstance that is avoided by most consumers, individuals and first alike. Copyright© 2011 Money Education, LLC Chapter 14 Demand 24 Demand is the quantity consumers are willing to purchase of a good or service, at a particular price. Demand is inversely related to price. Chapter 14 Copyright© 2011 Money Education, LLC The Demand Curve 25 It is important to differentiate between shifts in the demand curve and movements along the demand curve. Copyright© 2011 Money Education, LLC Chapter 14 The Demand Curve 26 Examples that cause the demand curve to shift up and to the right include: • Increase in disposable income • Decrease in tax rates • Decrease in unemployment rate • Decrease in savings rate • Increase in price of a substitute product • Decrease in price of a complement product Copyright© 2011 Money Education, LLC Chapter 14 The Demand Curve 27 Examples that cause the demand curve to shift down and to the left include: • Decrease in disposable income • Increase in tax rate • Increase in unemployment rate • Increase in savings rate • Decrease in price of a substitute product • Increase in price of a complement product Chapter 14 Copyright© 2011 Money Education, LLC Substitutes and Complements 28 Substitutes are products that serve a similar purpose. Complements are products that are consumed jointly. Copyright© 2011 Money Education, LLC Chapter 14 Substitutes and Complements 29 If the price for chicken suddenly increases, the demand for pork may suddenly increase. This is an example of a substitute. If peanut butter is on sale, demand for jelly may increase. This is an example of a complement. Copyright© 2011 Money Education, LLC Chapter 14 Price Elasticity of Demand 30 Elasticity = Percentage Change in Quantity Demanded Percentage Change in Price Demand is elastic if a small percentage change in price, results in a large percentage change in the quantity demanded. Chapter 14 Copyright© 2011 Money Education, LLC Elastic Demand 31 Copyright© 2011 Money Education, LLC Chapter 14 Inelastic Demand 32 If a one percent change in price leads to a one percent change in quantity demanded, then elasticity is one, which is defined as unit elasticity. Copyright© 2011 Money Education, LLC Chapter 14 Factors that Impact Elasticity 33 There are three primary factors that impact the elasticity of demand: • Substitute products • Consumer’s income • Time Chapter 14 Copyright© 2011 Money Education, LLC Supply 34 Supply represents the quantity of goods or services that firms are willing to produce and sell at a particular price. Copyright© 2011 Money Education, LLC Chapter 14 The Supply Curve 35 Copyright© 2011 Money Education, LLC Chapter 14 The Supply Curve 36 The examples below cause the supply curve to shift up and to the left: • Decreased competition • Outdated technologies • Increased price of an input used in the manufacturing process Chapter 14 Copyright© 2011 Money Education, LLC The Supply Curve 37 The examples below cause the supply curve to shift down and to the right: • Increased competition • Improved technology to increase efficiency • Decreased price of an input used in the manufacturing process Copyright© 2011 Money Education, LLC Chapter 14 Equilibrium Graph 38 Copyright© 2011 Money Education, LLC Chapter 14 Opportunity Costs 39 Opportunity cost represents the value of the best foregone alternative. Chapter 14 Copyright© 2011 Money Education, LLC Diminishing Returns 40 The law of diminishing returns is an economic production concept that states that as additional units of a variable input are applied to a fixed input, output will eventually increase by smaller and smaller amounts. Copyright© 2011 Money Education, LLC Chapter 14 The External Legal Environment 41 Bankruptcy Laws • Chapter 7 – For wage earners to discharge debts by liquidation • Chapter 11 – For companies to reorganize and adjust debts • Chapter 13 – For wage earners to repay a portion of debts with income Copyright© 2011 Money Education, LLC Chapter 14 Bankruptcy 42 Some assets and property are exempt from the bankruptcy court and creditors, such as: • Traditional and Roth IRAs up to $1 million (as indexed). • Rollover IRAs for an unlimited amount. • Qualified retirement plans, deferred compensation, and tax–deferred annuities. • Some personal property including one car, one television, etc. • Education funds contributed to a qualified tuition plan. Chapter 14 Copyright© 2011 Money Education, LLC Bankruptcy 43 Certain debts are not discharged in bankruptcy, and include: • All student loans • Property liens • Three years of back taxes • Child support • Alimony • Debts obtained through fraud Copyright© 2011 Money Education, LLC Chapter 14 Federal Trade Commission 44 The Federal Trade Commission (FTC) protects the consumer and prevents unfair, anti-competitive business practices. Copyright© 2011 Money Education, LLC Chapter 14 Fair Packaging and Labeling Act 45 The purpose of the Fair Packaging and Labeling Act (FPLA) if to prevent unfair or deceptive packaging and labeling. Chapter 14 Copyright© 2011 Money Education, LLC Equal Credit Opportunity Act 46 The Equal Credit Opportunity Act prohibits discrimination, when evaluating a decision to grant consumer credit. The most popular method of determining a credit score is the Fair Isaac Credit Organization (FICO) method. The best ways to increase a FICO score are to: • Pay all bills on time • Keep outstanding balances low on revolving credit accounts • Take on new credit obligations sparingly and only when really needed Copyright© 2011 Money Education, LLC Chapter 14 Fair Credit Reporting Act 47 The Fair Credit Reporting Act protects consumer’s information collected by the major credit bureaus. Copyright© 2011 Money Education, LLC Chapter 14 Fair Debt Collection Practices Act 48 The Fair Debt Collection Practices Act prevents third-party debt collectors from using deceptive or abusive methods. • Appropriate times to contact the debtor are from 8:00 a.m. – 9:00 p.m. • Debt collectors cannot threaten legal action. • Debt collectors cannot disclose the debt to employers, co-workers, other family members, or anyone else. • Debt collectors may not contact the debtor at their place of employment, if they know that the debtor’s employer prohibits the contact. Chapter 14 Copyright© 2011 Money Education, LLC Truth in Lending Act 49 The Truth in Lending Act was written to protect consumers so that they fully understand the terms of a loan. Copyright© 2011 Money Education, LLC Chapter 14 Fair Credit Billing Act 50 The Fair Credit Billing Act requires timely, written verification to a consumer disputing a billing error. Copyright© 2011 Money Education, LLC Chapter 14 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 51 The BAPCPA of 2005 amends the Truth in Lending Act requiring certain creditors to disclose on the front of billing statements a minimum monthly payment warning for consumers. Chapter 14 Copyright© 2011 Money Education, LLC Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009 52 The CARD Act of 2009 prevents credit card companies (and banks) from charging hidden fees and extraordinary interest rates. The CARD Act of 2009 addressed the following issues: Prevent certain rate increase practices Prevent hidden fees and confusing payment due dates Easy to understand disclosures Protection for young adults A co-signer is required to issue a card to anyone under 21. Copyright© 2011 Money Education, LLC Chapter 14 Federal Deposit Insurance Corporation (FDIC) 53 In 2008, the FDIC insurance amount for insured deposits was increased from $100,000 to $250,000. The FDIC insures up to $25,000 per depositor, per legal account ownership, per financial institution. Legal account ownership includes four distinct categories: • Individual • Joint • Testamentary • Retirement Copyright© 2011 Money Education, LLC Chapter 14 Example Chapter 14 - 54 - Copyright© 2011 Money Education, LLC Securities Investor Protection Corporation (SIPC) 55 The Securities Investor Protection Corporation (SIPC) was formed in 1970 as a statutorily created nonprofit membership corporation funded by its member securities broker dealers, with the goal of returning cash and securities to investors, in the event a brokerage firm becomes insolvent. When a broker-dealer becomes insolvent, the SIPC will step in and return the investor’s cash and securities, up to $500,000 in securities. The $500,000 limit includes up to $100,000 in cash. Copyright© 2011 Money Education, LLC Chapter 14 Securities Regulation 56 The Securities Act of 1933 regulates the primary market. The Securities Act of 1934 created the SEC to regulate the secondary market. The Investment Company Act of 1940 set standards to regulate investment companies. The Investment Advisers Act of 1940 requires investment advisers to register with their state or the SEC. The term Registered Investment Adviser must be spelled out, and the adviser is not permitted to use the letters “RIA” after their name. The Financial Industry Regulatory Authority (FINRA) is a self regulatory organization for all security firms. The Sarbanes-Oxley Act of 2001 established new or enhanced standards for all U.S. public company boards, management, and public accounting firms. Regulation Full Disclosure (or Regulation FD) was implemented to level the playing field between investment analysis and the general public. Regulation FD requires companies to disclose all material information simultaneously to both the investment community and individual investors. Copyright© 2011 Money Education, LLC Chapter 14 Worker Protection Laws 57 ERISA • The Employee Retirement Income Security Act (ERISA) was designed to protect employee retirement savings accounts from creditors. Workers’ Compensation is designed to protect employees if they are injured while at work. Unemployment benefits provide an unemployed worker with income for a period of time. OSHA (Occupational Safety and Health Administration) was created by Congress to promote safe and healthy working conditions. Chapter 14 Copyright© 2011 Money Education, LLC ...
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This note was uploaded on 02/27/2012 for the course FIN 132 taught by Professor Afda during the Spring '12 term at Centenary College New Jersey.

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