CH.4-Economic Principles Flashcards
Economics
understanding the choices individuals make and how the sum of those choices determines what happens in market economy
Market economy
all the activities related to producing and consuming goods and services + how the decisions made by individuals, firms, governments, determine proper allocation of resources
Microeconomics
market behaviors of individual consumers and firms
Macroeconomics
performance of economy as a whole, broader picture, challenges facing society as result of limited natural resources, human effort, skills, technology
3 main groups interact with economy-Decision makers
CONSUMERS
FIRMS
GOVERNMENTS
Market
any arrangement that allows buyers and sellers to conduct business with each other
fixed income market
network of investment professionals, distribution channels, suppliers, wholesalers who develop and trade products to meet various investor needs
2 GENERAL ECONOMIC PRINCIPLES EXPLAIN SUPPLY AND DEMAND
QUANTITY DEMANDED
QUANTITY SUPPLIED
Quantity demanded
amount consumers willing to buy at a particular price during given time period
-higher price= lower quantity demanded
quantity supplied
amount producers willing to supply at particular price during given time period
-higher price= greater quantity supplied
equilibrium price
prie that matches what someone willing to pay for products with price at which someone willing to supply it
Gross domestic product (GDP)
Market value of all final goods/servicfes produced in country in given time period
How is GDP measured
Expenditure approach
Income approach
Expenditure approach
Looks at total spending on final goods (finished product) and services produced in the economy
GDP=C + I +G + (X-M)
Income approach
looks at total income earned by producing those goods and services measures GDP by: -wages for labor -rent for land -interest for capital goods -profits for entrepreneurs
Nominal GDP
Dollar value of all Goods and services produced in a given year at prices that prevailed same year
Real GDP
constant dollar value of all goods and services produced in a given year at prices that prevailed in same base year
Business cycles
Expansion Peak Contraction trough recovery
Expansion
in times of normal growth, economy steadily expanding
Peak
At top of cycle
Contraction
- economy passes peak, enters downturn or contraction
- longer than 2 quarters = recession
Trough
Contraction continues, falling demand, excess capacity, growth cycle reaches lowest point
Recovery
GDP returns to previous peak, typically starts with renewed buying of interest sensitive things like houses, cars
Economic indicators that analyze business conditions
Leading indicators
coincident indicators
lagging indicators
economic indicators
statistics or data series that are used to analyze business conditions and current economic activity
Leading Indicators
peak and trough before overall economy, anticipate emerging trends in economic activity
coincident indicators
change at approx same time adn in same direction as rest of economy
Lagging indicators
change after economy as whole changes, can confirm that a business cycle pattern occuring
Popular definition of recession
2 consecutive quarters of declining GDP
STATISTICS CANADA DEFINITION OF RECESSION
recession by depth, duration, diffusion of the decline in business activity:
- decline must be of substantial depth
- decline must be more than couple months
- decline must be feature of whole economy
Labour force
sum of working age population who are either employed ot unemployed
key indicators of labour market
- Participation rate
- Unemployment rate
Participation rate
working age population in labor force
- shows willingness of ppl to enter work force and take jobs
Unemployment rate
labor force that is unemployed, but looking for work
Discouraged workers
Individuals that are available and willing to work, but cant find job
- they are not incl as part of labor force
3 types of unemployment
Cyclical
frictional
structutral
Cyclical unemployment
tied directly to fluctuation in business cycle
-rises when economy weak
Frictional Unemployment
Result of normal labor turnover- ppl entering and leaving work force from ongoing job creation, and destruction of jobs
- normal part of healthy economy
Structural Unemployment
workers unable to find work b/c lack of skills, don’t live where jobs available, don’t want to work at wage rate offered
- tied to changes in technology, international competition, government policy
- lasts longer than frictional unemployment b/c workers must retrain or relocate
Natural Unemployment
minimum level of unemployment, economy thought to be operating at close to full potential or capacity- all resources (incl labor) fully employed.
Determinats of interest rates
- Demand and supply of capital
- default risk
- Foreign interest rates and exchange rate
- central bank credibility
- infaltion
Default premium
if central government at risk defaulting on debt, rate rise for everyone
How interest rates affect economy
- may raise cost of capital for business investments, which reduces possibility of profitable investments
- increases cost of borrowing, discourages consumers from spending, encourages more saving
- increases portion of income required to pay debt, which reduces amount of money to spend on other things
Nominal Interest rates
Effects of inflation have not been removed
-i.e rate charged on loan
real interest rates
nominal interest rate- expected inflation rate
Nature of money
as:
- medium of exchange
- unit of account
- store of value
Inflation
money growth, too much money chasing too few products
Consumer price Index (CPI)
one of the most widely used indicators of inflation, considered a measure of cost of living in Canada
Inflation rate calculation
(CPI current period - CPI previous period/CPI previous period) X 100
Causes of inflation
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Output gap
difference between real GDP, what economy actually produces, potential GDP gap, what economy capable of producing when existing input of labor, capital, technology fully employed
Negative output gap
actual output below potential
- space capacity in economy
- can produce more b/c resources not flly employed
Positive output gap
Output above potential output
- operating above capacity
- trying to produce more than it can with existing resources
Demand pull inflation
- companies raise prices in response to strong demand
- higher continued consumer demand, pushes inflation higher
Cost push inflation
higher costs PUSH inflation higher
Disinfaltion
decline in rate at which prices rise, decrease in rate of inflation
- Phillips curve
- sacrifice ration
Phillips curve
- Lower unemployment rate achieved in long run by increasing inflation rate faster
- lower inflation rate achieved at the cost of possibly increased unemployment and slower economic growth
Sacrifice ratio
used to describe the extent to which GDP must be reduced with increased unemployment to achieve 1% decrease in inflation rate
Deflation
Sustained fall in prices where annual change in CPI is negative year after year- OPPOSITE OF INFLATION
Balance of payments
detailed statement of country’s economic transactions with rest of world in given period of time
- current account- what we spend
- capital and financial account- what we use to finance this spending
exchange rate
price of one currency in terms of another
commodity prices
countries around the world that buy cdn products need cdn dollars to finance purchase
-Positive correlation- as demand for commodities increase, demand for cdn dollar also increases- puts upwards pressure on cdn dollar
Inrerest rate differentials
higher domestic interest rates increae the return to lenders relative to other countries
-attracts capital, lifts exchg rate
Inrerest rate differentials
higher domestic interest rates increase the return to lenders relative to other countries
-attracts capital, lifts exchg rate
Inflation differentials
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Fixed exchange rate
domestic currency at fixed level against another currency or composite of other currencies
floating exchange rate
central bank allows market forces to determine value of currency
