Chapter 1 Financial and Economic Concepts 1

Chapter One Objectives 2

Opportunity Costs  The highest value that is surrendered when a decision to invest funds is made. 3

Choices Available for Funds Table 1-1 Expected Financial Returns of Investment Opportunity Investment OpportunityExpected Annual Return (%) Purchase stock11 Purchase home9 Purchase bonds6 Place money in bank savings account2 Purchase new car-15

Examples of Opportunity Cost  Decide to purchase car  Opportunity cost = Stock

 However, if you decided to purchase stock rather than the car  Opportunity cost = Home

Income, Expenditures, and Taxes  Gross income is all of the money received from all sources during the year. Wages Tips Interest earned on savings and bonds Income from rental property Profits to entrepreneurs 7

Basic Income Calculations  Gross income - taxes = Disposable income For most of us, disposable income is take- home pay.  Disposable income - Fixed expenses = Discretionary income Fixed expenses are contractual obligations like rent, utilities, insurance, and car payments. Discretionary income is that we can spend or save. 8

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Taxes  Progressive taxes: larger percentage of tax paid as income increases.  Regressive taxes: larger percentage of tax paid as income decreases.  Proportional taxes: percentage of tax paid remains the same at all levels of income. 10

Example of Progressive Tax  Formula for tax percentage paid:  Income tax is progressive: 11

Example of Regressive Tax  Sales tax is regressive: › Income = $20,000; savings = 0; sales tax = 5% › Sales tax paid = $20,000 x 0.05 = 1,000 › Income = $60,000; savings = $10,000; sales tax = 5% › Sales tax paid = $50,000 x 0.05 = $2,500 12

Example of Proportional Tax  Formula for tax percentage paid: Medicare tax is 1.45% Annual income $30,000 Medicare tax = $30,000 x = $435 Annual income $500,000 Medicare tax=$500,000 x = $7,250 13

Flat Tax Proposal 14

Factors Affecting Interest Rates  The supply of money saved is primarily the total money that is placed in demand deposit (checking) accounts, savings accounts, and money market mutual funds.  The demand for borrowed funds is all of the money that is demanded in our economy at a given price. 15

Factors Affecting Interest Rates (continued)  Federal Reserve Policy The Federal Reserve is the central bank of the United States.  Risk Systematic Risk: Risk associated with economic, political, and sociological changes that affect all participants on an equal basis. Unsystematic Risk: Risk unique to an individual, firm, or industry. 16

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