Economics and Banking Chapter 2 © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-1 Better Business 2nd Edition Solomon (Contributing Editor) · Poatsy · Martin

Learning Objectives 1. What is economics, and what are the different types of economic systems? 2. What are the principles of supply and demand and the factors that affect each principle? 3. What are the four degrees of competition, and how does competition affect supply? 4. How do economic indicators—particularly the gross domestic product (GDP), price indexes, the unemployment rate, and productivity—reflect economic health? 5. What are the four stages of the business cycle? 6. How does the government use both fiscal policy and monetary policy to control swings in the business cycle? © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-2

Economics Basics Economics Microeconomics is the study of how individual businesses, households, and consumers make decisions to allocate their limited resources in the exchange of goods and services Macroeconomics study of behavior of the overall economy Why do business managers need to be concerned with economics? © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-3

Types of Economic Systems © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-4 Traditional Planned (controlled) Market Mixed Communism Capitalism Socialism

Economic Systems: Related Ideas Privatization -conversion of government production and services to privately-owned, profit-seeking enterprises -privatization possibilities: water, utilities, transportation, other Generally, privatization moves an economic system from ___________ to ___________. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-5

Determining Price: Supply and Demand Currency Market price - price at which everyone who is interested can get an item with none left over Supply - availability of the item Demand - need or desire for the item © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-6

Supply and Demand Law of supply- supply is derived from a producer’s desire to maximize profits: - The amount supplied will increase as the price increases - The amount supplied will decrease as the price decreases Supply curve- the producers’ desire to supply more, or sell, is affected by price Demand refers to how much of a good or service people want to buy at any given time. - As price increases, demand decreases Demand curve illustrates that demand increases as prices decrease © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-7

Supply and Demand Curves and Eddie’s Coffee Kiosk Important terms: Supply curve Demand curve Equilibrium point Surplus Shortage © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-8 At $2.00, how much coffee do suppliers want to provide? How much coffee do buyers want to buy? What is the dollar value for the equilibrium price? What does this point mean?

Shifts in Supply and Demand Determinants of Supply -Technology changes - Change in resource prices -Price expectations -Number of suppliers -Price of substitute goods Determinants of Demand - Changes in income levels -Population changes -Consumer preferences - Complementary goods - Substitute goods © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-9

Degrees of Competition MonopolyOligopoly Monopolistic Competition Perfect Competition Number of Providers OneFew Many, but fewer than perfect Many Similarity of Goods and Services Only one product is available Relatively similar; product differences Very similar, price and perceived differences Virtually identical Ease of Entry into Industry Government regulated High investment Fairly easyRelatively easy Supplier Control Over Price ConsiderableSome None Examples Utility companies Airlines, automobile industry Laundry detergent, pizza, colas Agricultural products © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-10

Economic Indicators: GDP and GNP Gross Domestic Product (GDP) - the broadest measure the health of any country’s economy - Only those goods that are actually produced in the country are counted in the country’s GDP Gross National Product (GNP) - Former system of measurement the United States used to measure the economic health - Switched to GDP in The GNP attributes earnings to the country where the company was owned, not where the company was manufactured © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-11

Economic Indicators: CPI and PPI Inflation Disinflation Deflation Consumer price index (CPI) Purchase price index (PPI) © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-12

Economic Indicators: Unemployment Unemployment rate - A measurement of the number of workers who are not working and who are actively looking for work - Frictional unemployment -Structural unemployment -Cyclical unemployment -Seasonal unemployment © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-13

Economic Indicators: Productivity Measurement of the quantity of goods and services that human and physical resources can produce in a given period of time © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-14 Why is it important to measure and track productivity?

Business Cycle The state of the economy changes over time - Peak - Recession - Trough - Expansion/ Recovery © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-15

Fiscal Policy Fiscal policy relates to government management of revenues (taxes) and spending Why does the government increase taxes? Why does the government decrease taxes? How does government spending help stimulate the economy? © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-16

The Federal Reserve System “Fed” is central banking system in the U.S. - Independent government agency - 12 regional Federal Reserve Banks -Board of Governors - Based in Washington D.C. The Federal Open Market Committee (FOMC) sets policies of the Fed, including monetary policies © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-17

Monetary Policy Monetary policy relates to managing the supply of money - Money supply: is the combined amount of money available within an economy, but there are different components to the money supply M-1: Currency, traveler’s checks, and checking accounts constitute the narrowest measure of our money supply M-2: M-1 along with the available money for banks to lend out, such as savings deposits, money market accounts, and certificates of deposit (CDs) less than $100,000 M-3: M-2 plus less liquid funds Why is measurement of the money supply important? © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-18

Managing the Money Supply: Open Market Operations Open market operations - The primary, and most influential, tool the Fed uses to alter the money supply - Consists of buying and selling U.S. Treasury and federal agency bonds in the “open market” - To stimulate the economy, the Fed buys securities © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-19

Managing the Money Supply: Reserve Requirement Determined by the Federal Reserve Bank, is the minimum amount of money banks must hold in reserve to cover deposits The Fed dictates what percent of deposits the bank must keep on hand. The reserve requirement is the least used monetary policy. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-20

Managing the Money Supply: Discount Rate Discount Rate - Interest rate charged to banks that borrow emergency funds from the Federal Reserve Bank Fed Funds Rate - The interest rate that banks charge other banks when they borrow funds overnight from one another Lowering the discount rate encourages banks to borrow more money, which they in turn lend to businesses. This stimulates the economy. © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-21

Chapter Summary: Learning Objectives 1. What is economics, and what are the different types of economic systems? 2. What are the principles of supply and demand and the factors that affect each principle? 3. What are the four degrees of competition, and how does competition affect supply? 4. How do economic indicators, particularly the gross domestic product (GDP), price indexes, the unemployment rate, and productivity, reflect economic health? 5. What are the four stages of the business cycle? 6. How does the government use both fiscal policy and monetary policy to control swings in the business cycle? © 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-22

© 2012 Pearson Education, Inc. Publishing as Prentice Hall 2-23