BEC 1 - Economic Concepts & Strategy Flashcards
Economics is the study of
study of allocating scarce resources to satisfy unlimited wants
Microeconomics
decisions of, interactions among, various individual economic agents (household and firms)
Demand Curve Slope
Slopes Down
Demand Curve P & Q relationship
inverse relationship between P & Q of a product/service that a group of consumers are willing to buy at a particular time
Demand Curve Shift Outward
Shifts outward because Q-Demanded becomes larger for each and every price demanded
Demand Curve shifts inward
Shifts inward because Q-Demanded becomes smaller for each and every price demanded
Reasons for Direct Relationship (Increase Demand Curve)
- Price of Substitute Good
- Expectations of Price Changes
- Income (Normal Goods)
- Extent of the Market
Reasons for Inverse Relationship (Decrease Demand)
Price of a complement good
Income (inferior goods)
Consumer Boycotts
Indeterminate relationship (demand)
changes in consumer tastes affects demand depending on favor or disfavor of the specific product
Elasticity
measures sensitivity of something to changes in something else
Total Revenue From Price Change depends on
Price Elasticity of Demand
Price Elasticity of Demand
Measures how responsive the Q-Demanded is to a change in Price
Price Elasticity of Demand Formula
%Q-Demand / %Price É. ABSOLUTE VALUES
If E>1, it is
Elastic
Price Elasticity of Demand (ARC METHOD)
(Change in Q Demanded / Avg Q Demanded) / (Change in Price / Avg Price)
Income Elasticity of Demand
measures the effect of changes in consumer income on changes in Q demanded of a product
Income of Elasticity of Demand
(%Change in Q Demanded) / (%Change in Income)
Positive Income Elasticity indicates
NORMAL GOOD, (as I increases, Q-Dem of normal good also increases)
Negative Income Elasticity indicates
INFERIOR GOOD (As I increases, Q-med decreasesÉ. Used car vs New Car)
Inelastic Goods are normally
necessities (cancer drug)
Price Elasticity > 1.0
ElasticÉ If Price Increases, Total Revenue Decreases (vice versa)
Price Elasticity < 1.0
InelasticÉ If Price Increases, Total Revenue Increases (vice versa)
Price Elasticity = 0
Unit ElasticÉ If Price Increase, Total Revenue remains constant
Income Elasticity Point of Inflection
Zero
IE>+0 - Normal GoodÉ. If IE
Supply Curve Shifts (Direct Relationship)
of Producers
Government Subsidies
Price Expectations
Reductions if Costs/Tech Advance
Supply Curve Shifts (Indirect Relationship)
Increases in Production costs, Price of Other Products
Cross Elasticity of Demand
(%Change in Qd X / %Change in Price of Y)
Cross Elasticity of Demand Point of Inflection
Zero (Positive # = Substitute, Negative # = Complement)
Elasticity of Supply
%Change in Qs / %Change in Price É. ABSOLUTE VALUES
Economic Profit
Excess of normal profit rate (suppliers entering the market)
Price Ceiling
Below Equilibrium, creates a shortage
Price Floor
Above Equilibrium, creates a surplus
Economic Rents
The Difference between Chosen Route and Opportunity Cost
If Demand and Supply BOTH increase (decrease)
Equilibrium Price is INDETERMINATE (either way)
Q-Purchased increases (decreases)
If Demand INCREASES and Supply DECREASES
Equilibrium Price INCREASES (follows Demand)
Q-Purchased is INDETERMINATE
Total Utility is Maximized When
MUa = MUb
If MUa > MUb
MUa Q-demanded will INCREASE & MUb Q-demanded will DECREASE until MUa=Mub
Consumer Utility is Maximized when
Budget Constraint and Indifference Curve Tangent
Profit Maximization
MR = MC
Personal Disposable Income
Income - Taxes + Govt Benefits
Marginal Propensity to Consume (MPC)
Change in Spending / Change in Income
Marginal Propensity to Save (MPS)
Change in Saving / Change in Income
MPC + MPS =
1
Increase in GDP (multiplier Effect)
(1/MPSaving) x (Change in Spending)
Marginal Revenue Product
increase in total revenue received from sale of one more unit of input/resource
If MR > MC (operating below capacity)
Price Decreases to Total Revenue Increases (Sales Increases and MR Decreases)
Operating Below capacity
in excess of VCÉ when capacity is reached (MR=MC), any additional unit will also increase Fixed Costs
Long Run Costs (By Definition)
Total Costs = Variable Costs (no fixed costs)
Returns to Scale Formula
%Increase in Output / %Increase in Input
Increasing Returns to Scale indicates
Falling price per unit (RTS>1.0)
Decreasing Returns to Scale indicates
Increasing Price Per Unit (RTS<1.0)
Constant Returns to Scale indicates
No Effect on Price (RTS=1.0)
Pure/Perfect Competition (traits)
- Large # of Buyers/Sellers
- Same Products (Homogenous)
- No Non-Price Competition (IE No Ads)
- No Barriers to Entry/Exit
- No Price Contracts
- Demand Curve is Elastic (Horizontal)
Monopolistic Competition (traits)
NAME?
Oligopoly (traits)
- Small # of large Producers
- Homogenous/Heterogenous Products
- Significant barriers for entry ($$, Time, Licenses)
- Non-Price Competition
- Rival Actions are observed
- Kinked D-Curve
Pure Monopoly (Traits)
NAME?
Competition Analysis
Data analysis for understanding/predicting competition
Target market
who are our customers and why are they our customers
Strategic Planning
SWOT (Strengths, Weaknesses, Opportunities, and Threats)
or
Mission Statement, Goals/Objectives, Actions (Assessment and Data Analysis)
Product Differentiate Strategies
physical, perceived, and customer service for:
- makes the firms sales less responsive to changes in the prices charged by other competitors
- allows to charge different prices for different products
- charge higher prices
Cost Leadership Strategies
cutting costsÉ
- Process reingineering (redesign processes)
- lean manufacturing (ID misuse of resources)
- supply chain management
Supply Chain Management
Part of Cost Leadership StrategiesÉ might be able to operate with leaner inventories if all parts of the Supply Chain shared information
Aggregate Demand
relationship between:
1. total expenditures by consumers, firms, govt, & the foreign sector
AND
2. the Price level at a given point
US increase of Inflation on Aggregate Demand
- Interest Rate Effect (Interest Rates Increase, then Financing Consumption Decreases)
- Wealth Effect (Fixed Income decreases in Value, Buy Less Elastic (Luxury Items))
- International Purchasing Power Effect (US Good and Svc’s are more expensive, Consumers Buy Imported or Q demanded for Foreign Goods INCREASES And Q-demanded for domestic DECREASES)
Aggregate Supply
relationship between:
1. total goods and services produced (output)
AND
2. the Price level at a given point of time
Demand Pull Inflation
Increase in aggregate spending causes no change in Q but Price Increases (D shifts to right)É excess demand bids up costs and results from improved exceptions OR Loose policy
Phillips Curve
(Short Term) there is a trade off between unemployment and inflation (needs to be balanced because of NAIRU implications)
Cost Push Inflation
supply curve shifts to the left and costs are “pushed” to the consumerÉ producers are faced with increases in costs of inputs (higher price and less quantity AKA Negative Supply shock)
Negative Supply Shock
sudden decrease in aggregate supply curve. Price increases and quantity decreases
NAIRU
Non Accelerating Inflation Rate of UnemploymentÉ if actual level of UE < NAIRU, BOOM in ST but problems eventually follow (high inflation)
The Sherman Act (1890)
prohibited price fixing, boycotts, market division, and restrict resale agreements among suppliers
The Clayton Act (1914)
prohibited stock mergers that reduce competition, price discrimination, and common directorships among competing firms
Robinson- Patman Act (1936)
prohibited discounts to large purchases NOT based on cost differentials
The Celler-Kefauver Act (1950)
prohibits acquisition of the assets of a competitor if it would reduce competition
Macroeconomics Key concepts
UE, Inflation, and LT economic Growth
GDP Income Approach
Sum of All income earned in the production of FINAL goods and services
GDP Expenditure Approach
Consumption of Personal + Businesses (Gross Private Investment) + Government + Net Exports (- Net Imports)
Actual Real GDP < Potential Real GDP
underutilized resources (UE% Higher)
Actual Real GDP > Potential Real GDP
overheating, which results in:
- LOW unemployment rates
- BOOM conditions
- eventuallyÉ.. PRICE INFLATION
TIPS (and inflation)
larger payouts if CPI increases (if inflation is low, negative returns)
Price Inflation measures
- CPI (Year10 CPI / Year1 CPI) * Year1 USD
- PPI - fixed basket at the wholesale level for producers (not retail)
- GDP Deflator
“First Pass” Macroeconomic Model
Focuses on shifts in Agg. Demand depends on:
- expectations about the future (confidence = Increase)
- countercyclical policy by the govt (loose Fiscal & monetary policy = increase)
Business Cycles
Recession, Trough, Expansion, Peak
Expansion Stages
Early (“Recovery”): declines in UE and GDP>Potential
Final: booming, higher inflation rates
Recessions
Early: 2 Consecutive Quarters of negative growth in Real GDP (decreased economic production and increased unemployment
Final Stages: GDP< Potential, decreased aggregate spending (Shift Demand Curve to the Left)
Trade Wars Impact on Aggregate Supply Curve
Shift Supply Curve to the left (also cause decline in GDP)
Leading Indicators of Future Econ. Conditions
stocks, average hours worked per week, new orders for durable goods, average initial claims for UE, building permits, and housing starts
Coincident Indicators of Economic Conditions
simultaneous movement with expansions and recessions
IE Industrial productions, manufacturing and trade sales
Lagging Indicators of Economic Conditions
NAME?
4 Types of Unemployment
Frictional, Structural, Cyclical, and Institutional
Nairu Unemployment
Friction and Structural only included
What are interest rates determined by?
the Supply and Demand of funds (firms, households, government, and financial institutions)
What are the indicators of Risk Free Rates?
the rates paid on conventional treasurys securties and TIPS
Expected Inflation Rates Calculation
Difference between Conventional Securities Yield and TIPS yield (plus difference in small liquidity premiums)
Federal Funds Rates
AKA discount rateÉ those that commercial banks charge and pay one another for ST loans
Prime Rate
banks charge their most creditworthy business customers on short term loans (usually 3% + federal funds rate)
Fiscal Policy
GOVERNMENT involvement in taxes, subsidies, and govt spending
When should the govt use deficit spending?
Use it as an expansionary FISCAL Policy when”
1. GDP
Deficit Spending
- Lowering tax rates (revenues) without lowering spending to an equivalent amount
or - Increasing spending (expenses) without increasing tax rates to an equivalent amount
Govt Deficit vs Debt
Deficit is the period of time when expenses exceed revenues
Debt is the TOTAL amount of outstanding US treasurys or PAST Deficits
When should the govt run a budget surplus?
As a CONTRACTIONARY FISCAL Policy to reduce aggregate demand (increase taxes)
- GDP > Potential
- Unemployment rates are too low (
Monetary Policy
FEDERAL RESERVE managing:
- credit conditions
- Interest Rates
- the Money Supply
Monetary Policy Key Goals
MAXIMIZE economic growth, stability
MINIMIZE unemployment rates, inflation rates, and financial fluctuations
Federal Reserve Tools for Monetary Policy (Contractionary and Expansionary)
- Reserve Requirements
- Federal Funds Rate (aka “Discount Rate”)
- Open Market Operations
Open Market Operations
Fed Reserve Monetary policy tool by setting a TARGET discount rate & using the buy/sell of short term US Treasury’s
ensure that the EFFECTIVE RATE = TARGET RATE
How can Monetary Policy affect high unemployment rates?
the Federal reserve can implement EXPANSIONARY monetary policy.
The Fed will BUY US Treasurys (open market operations) to lower the federal funds rate (discount rate) or lower the Federal Funds rate alone which will stimulate the economy.
Lower Discount Rate = Lower Interest Rates = More Money the Economy = More Jobs
How can Monetary Policy affect concern for Boom conditions or HIGH inflation rates?
The Federal reserve can implement CONTRACTIONARY monetary policy.
The Fed can increase the reserve requirements ratio, increase the federal funds rate, or SELL US Treasurys which will decrease the money supply and dampen the economy.
What was the federal funds rate after the recent financial crisis?
approx. 0.00%
What is Quantitative Easing?
It is when the Federal Reserve increases the Money Supply (Quantity) but it has no effect on the Federal Funds Rate (Price)
How can Monetary Policy affect aggregate demand?
(The FED) Via Credit Conditions which may have an affect on individual economic agents
Looser = Stimulates the economy by encouraging spending (Therefore increasing aggregate demand)
Tighter = Dampens the economy by discouraging spending (Therefore decreasing aggregate demand)
Monetary Aggregates and their Contents
M0: Currency
M1: M0 + Travelers Checks + Demand Deposits
M2: M1 + Time Depots$100K
Regulatory Policy
Government influence economic activity through environmental issues, labor issues, occupational health and safety, energy policy, healthcare, bank capital, lending practices
How does regulatory policy affect the economic activity?
Regulations will channel resources from disfavored sectors to favored sectors
Also, can prevent financial crises by implementing bank regulations (minimum down payment, thicker capital cushions, etc)
What do economic theories seek to explain?
Private (confidence and borrowing excess) and Government (poor timing & incentives) sectors role in recurring business cyclesÉ whether the Government is alleviating or worsening them and how they are.
Classic Economic Theory
NO GOVT INTERVENTION - The economy is self stabilizing without government induced distortions but with small fluctuations in UE and Inflation. Distortions include price and wage controls, note issuance and lending restrictions
Keynesian Theory
(FISCAL POLICY) Argues that the economy does not self-stabilize quickly enough. Therefore, the Government must use FISCAL POLICY (run deficit spending or surplus budgets)
Monetarists Theory
(MONETARY POLICY - OPEN MARKET OPS) argues that in order to MINIMIZE fluctuations in both UE and Inflation rates, the FED should focus on STABLE MONETARY GROWTH (not interest rates).
Therefore, the fed allows interest rates to CLIMB if Lending > LT Monetary Growth Rate (opposite for Falling rates).
Argues that increasing Monetary Growth > LT AVG is more likely to cause instability
Supply Side Theory
Govt Policy should focus less on short term fluctuations and more on removing impediments in economic production (SUPPLY CURVE SHIFTS RIGHT in the LONG TERM)….i.e. Reduce Taxes, Increase Savings, Investment, Innovation
Investigates which govt laws and regulations may be counterproductive. Think about the Laffer curve.
The Laffer Curve
REDUCING tax rates may INCREASE tax revenues (i.e. incentive to work more is increased)
New Keynesian Theory
- Combines Elements from Monetarists and Keynesian Theory (Monetary + Fiscal)
- argues that the relationship between monetary aggregates and economic conditions have been too loose to rely on a constant rate of monetary growth to minimize UE And Inflation fluctuations
- Monetary and Fiscal Policy should BOTH be loosened in response to Higher UE Rate
Austrian Theory
- insight on how monetary policy can lead to resource dislocations, bubble formations, and instability (boom-bust cycles)
- I.E. Low interest rates may lead to producers overestimating actual consumer demand, which leads to oversupply and higher UE in that sector
Absolute Advantage
a country able to produce a good a lower cost (nothing else considered) than another country
Comparative Advantage
- a county able to produce a good at lower RELATIVE cost than another country (in a pair of countries, there is always comparative advantage for both countries in Product A or B)
- opportunity costs of producing 1 more unit of A and 1 Less unit of B
International Trade: Natural Barriers
NAME?
Explain Govt. Barriers on International Trade
Tariffs cause:
- Domestic Producers (positive effect, less substitute goods, Higher Price, Less Quantity. Demand Curve Shifts Right)
- Domestic Consumers (negative effect, prices increased, Supply Curve to the Left)
- Foreign Producers (negative effect - forced to sell at a lower price in a smaller market, Demand Curve to the Right)
- Foreign Consumers (positive - lower prices and higher quantity in their country, Supply curve to the right)
Less Transparent Forms of Trade Protection
- Import Quotas
- Embargoes (think CUBA)
- Voluntary Export Restraints (Toyota in USA)
- Foreign Exchange Controls (favored parties)
- Dumping (unjustifiably low price of a foreign good)
- Dual Pricing (diff currencies = different prices depending on the market)
- Export Subsidies (outright payments to tax benefits)
Balance of Trade
- Part of the Current account in the Balance of Payments
- Difference between GOODS exported and GOODS imported
- Net Exports = Trade Surplus (Net Imports = Trade Deficit)
Balance of Goods and Services
NAME?
Net Interest and Dividends
NAME?
Net Unilateral Transfers
NAME?
The Current Account
focuses on the flow of goods and services in the balance of payments during a specific period of time
The Capital Account
- focuses on the flow of fixed and financial assets ($$, stocks/bonds) in the balance of payments during a specific Period of time
- mirror image of the current account (Current account deficit = Capital Account Surplus)
Foreign Company Advantage In Domestic Market
when the foreign currency weakens. Therefore domestic consumers will purchase more of their goods because it is cheaper
Forward Exchange Rate Formula (Annual Terms)
[(FWD Rate - SPOT Rate)/ SPOT Rate] * (Months in 1 Year / Months in FWD Period)
IF the Forward Rate < Spot Rate
There is a DISCOUNT since the foreign currency will be worth less in the future
Foreign Inflation Effect on Foreign Currency
Foreign Higher Inflation rates, currency DEPRECIATES relative to others
Foreign Interest Rates on Foreign Currency
Foreign Higher Interest Rates, currency APPRECIATES relative to others (demand for the currency rises)
Balance of Payments on Foreign Currency
Net Exporter Countries currency APPRECIATES relative to others (net importers cause demand of those currencies to rise)
Government Intervention on Exchange Rates
NAME?
Long Term Stability on Foreign Exchange Rates
currencies from countries with more stability tend to endure fewer ST fluctuations. Change in factors does not effect the value as much as countries with a LT record of instability.
Safe Haven Effect
During international crises, international investors tend buy currency of stable countries
Floating Exchange Rates
(rarely used)
- central bank rarely or never buys/sells foreign currencies to influence exchange rates
- exchange rates are set by supply and demand by PRIVATE PARTIES and the actions of other Foreign central Banks
Fixed Exchange Rates
NAME?
How does a Country forgo its own monetary policy in relation to exchange rates?
If it allows individuals and firms to freely buy/sell foreign currency AND wants to maintain a FIXED exchange rate
- they are having to match the monetary policy of the country against which its fixed it currency
Managed Exchange Rates
Fall between floating and fixed exchange rates.
- Formal Pegs: closer to FIXED exchange rates
- Dirty Floats: closer to pure FLOATING exchange rates
How to manage translation risk?
Hedging Principle: Matching assets and liabilities in each market of operation
i.e. using the foreign operations local currency
How to manage transaction risk?
- by matching as many revenues and costs as possible in each market of operation
- Derivative or Hedging Contracts: Options, Forwards (commitment) Futures (commitment), Currency Swaps, Money Market Hedges (loan removes unfavorable outcome)
Explain the Interest Rate Risk for Financial Institutions
Banks have ASSETS with longer Maturities & LIABILITIES with shorter maturities.
Therefore, an INCREASE in interest rates will leave them with assets that reprice SLOWLY (low interest rates) and liabilities that recipe QUICKLY (higher interest rates)
How Can Financial Institutions manage interest rate risk?
- Reduce Assets with LT maturities and increase Liabilities with Long Maturities
- Reduce fixed rate LT assets and increase VARIABLE rate LT assets
- Derivatives
How Can financial institutions manage credit risk?
- Diversifying customers
- Selling future streams of payment: Moving from “originates to hold” to “originates to distribute” for profits
- Internal Controls for tight credit standards
- Greater guarantees from borrowers (down payments, collateral)
- Derivates (credit default swaps)
Credit Default Swaps
form of insurance that protects against credit defaults on bonds in exchange for premiums
- can also purchase portfolio of CDS (protection against economy-wide defaults
How Can Financial Institutions manage liquidity risk?
- Matching maturities of their assets and liabilities, assets could be liquidated @ full amount (not in “fire sale” of depressed value)
- maintain cushion “emergency fund” of liquid assets (forgoes potential returns)
- Maintain a variety of LT lines of credit with a variety of providers (fees involved)
How can financial institutions manage Market Risk?
- Shift financial sources from debt to EQUITY (accommodates easier to temporary declines)
- diversify income streams and assets held (could reduce managerial focus)
- Hedging Strategies (I.e. Shorting the S&P 500)
How does an OPTION reduce transaction risk?
You can Call at spot rate. If the cost does rise, you can use the call to buy at the spot rate. If the cost declines, you can let the option expire and purchase at the lower cost.
How has international markets created deeper connections?
- Increased Foreign Direct Investment (operations, networks, research)
- Increase Foreign Indirect (or Portfolio) Investment (financial assets denominated in foreign currency)
- Decreased Natural and Artificial Barriers (transportation, information, communication costs, and tariffs)
- Increased Modernization of Developing Countries (living standards, societal norms, consumer homogenization)
How are Developed Countries able to Compete with Developing Countries costs?
- Efficient equipment and labor
- Sophisticated Mgmt Techniques
- Continuous innovation, research, value adding for current and new products
- Product Quality control
- Customer Service and Support
- Leverage Financial resources to adopt financial services
Transfer Pricing
companies operating across countries may complete inputs in several countries. For tax laws, different prices must assigned be to those inputs when transfers to another country.
Tax calculations based on the difference between the input price and transfer price.
