Financial Fundamentals - Ch 15 Flashcards
What is Microeconomics ?
Focuses on the decisions of individuals and firms, such as those that affect supply and demand and the resulting pricing of products and services.
What is Macroeconomics ?
Entire or broader economy and uses measurements such as the Gross Domestic Product, inflation, unemployment, and investment in order to determine the performance of the overall economy
What is GNP ?
Gross National Product (GNP)
Total final output by the citizens of a country, whether produced domestically or in a foreign country. GNP does not include the output of foreigners in a country.
What is GDP ?
Gross Domestic Product (GDP)
Total final output of a country, by its citizens and foreigners in the country, over a period of time. GDP is typically measured on a quarterly and annual basis.
What is Nominal GDP ?
Value of goods and services in current prices.
The disadvantage of nominal GDP is that if the price of goods and services increases, nominal GDP will increase even though there was not an increase in the amount of goods and services produced.
If the quantity of goods and services produced remains constant but the price increases, nominal GDP may be misleading because it reflects inflation rather than a quantitative increase in goods and services
- What is Real GDP ?
- A recession is characterized by what ?
Value of goods and services at a base year price.
-Real GDP only changes when the quantity of goods and services produced changes, not when prices change.
-Better measure of economic output than nominal GDP since prices are held constant when calculating real GDP.
A recession is characterized by a decline in real GDP for at least six months (two quarters).
- What is the GDP inflator ?
- Formula for GDP infaltor ?
- Measures the current price of goods and services (nominal GDP) relative to a base year (real GDP).
- Only measures price of goods and services produced domestically.
- It’s a measure of price increases or decreases.
-GDP deflator will change over time as the economic output of a country changes.
- Formula for :
Nominal GDP
——————– = GDP Defaltor
Real GDP
What is inflation ?
Increase in the general level of prices of goods and services representing the economy as a whole over a period of time and without a corresponding increase in productivity.
The biggest risks is loss of purchasing power and price instability
- What is the primary cause of inflation ?
- Who controls the money supply ?
- When the money supply increases faster than the growth in real GDP.
- Federal Reserve is responsible for controlling the money supply to keep inflation at reasonable levels, typically targeted at 2-3% / year
What is disinflation ?
Slowdown in the rate of inflation or a slowdown in the rate of price increase of goods and services.
- Inflation is continuing, but at a declining rate
- What is deflation ?
- Does the money supply increase or decrease during periods of deflation ?
- Will GDP increase or decrease as a result a period of deflation ?
- Decrease in overall price levels of goods and services.
-As a result of deflation, there is a transfer of wealth from borrowers (like homeowners) to holders of cash. - Periods of deflation, the real value of money INCREASES s as the dollars consumers hold are able to buy more goods and services as prices, such as homes, continue to decrease.
- A deflationary spiral is likely to lead to DECREASE GDP
- What is CPI ?
- Does CPI measure good and services made overseas but sold in the US ?
- Measure of prices at the retail level relative to the price levels of the same ( FIXED BASKET ) basket of goods and services in some base year.
- YES> CPI measures changes in prices of goods manufactured overseas and sold in the U.S.
What is the Producer Price Index ?
(PPI) measures the inflation rate for RAW MATERIALs used in the manufacturing process.
-Important measure of inflation, since inflation in the manufacturing process will likely lead to inflation at the retail level
How is the inflation rate calculated ?
The inflation rate is calculated as follow:
P1 - P0
———- = Inflation rate
Po
P1 = current price
Po = prices during a prior period
What is Nominal Interest Rate ?
Represents the “real rate of return “ plus an adjustment for anticipated future inflation.
- When lenders loan funds, the real rate of return represents their income.
Nominal Interest Rate - Inflation = Real Rate of Return
- Do Interest rates influence the demand for he supply of loanable money ?
- What happens when excess money is no longer held ?
- Interest rates are influenced by the demand for and the supply of loanable funds.
- When excess money is NO longer held
- interest rates Fall
-consumers make purchases because the cost of borrowing (the interest rate) has decreased.
How the “unemployed” defined within the unemployment measure?
- People 16 years of age and older who are NOT working
- Making an effort to seek employment.
- does NOT include those individuals who are underemployed (overqualified for a job such as a PhD waiting tables) or those who are discouraged and have discontinued their job search
Economists have divided unemployment into three categories as follows ?
- Cyclical unemployment
- When there is an overall downturn in business activity and fewer goods are being produced causing a decrease in the demand for labor (related to changes in the business cycle).
- Frictional unemployment
- When people are voluntarily unemployed because they are seeking other job opportunities and they haven’t found the desired employment yet.
- Structural unemployment
-When there is inequality between the supply of adequately skilled workers and the demand for workers.
What is full employment ?
full employment is defined as
-Rate of employment that exists when there is EFFICIENCY in the labor market.
-Full employment can include both frictional and structural unemployment when there is efficiency in the labor market that results in approximately 95 % employment.
If product and labor markets are in balance, then the employment will be called________________________ rate of employment .
-economic policy is to sustain a natural rate of unemployment, being the lowest unemployment rate where labor and product markets are in balance.
-At the natural rate of unemployment both price and wage inflation is stable
What is Utility in respect to company or individual financial resources ?
Utility is the benefit firms and consumers receive when allocating or spending financial resources.
Firms maximize their utility by making decisions on how to best use their resources to maximize profits. Firms are constrained by the capacity of their workforce, products they offer, and the level of competition
Consumers maximize their utility by making decisions on employment, spending for today, and saving
How is Full employment defined ?
-Rate of employment that exists when there is efficiency in the labor market.
-Full employment can include both frictional and structural unemployment when there is efficiency in the labor market that results in approximately 95 % employment of the labor force
How is natural Employment defined
-The lowest unemployment rate where labor and product markets are in balance.
-Both price and wage inflation is stable.
What the 4 phases of the Economy’s business cycles ?
- Expansion
- Peak
- Contraction or Recession
- Trough
What are the characteristics when the economy is in Contraction ?
- Consumer spending slow down
- Firms have lower output
- GDP decreases
- Unemployment rate increases ( as firms reduce staff to offset the lower demand for their products and services.)
- Inflation begins to decrease (as consumers are demanding fewer goods and services, which may lead to lower prices )
- Interest rates decreasing
What are the characteristics when the economy is in the Trough Phase ?
- GDP reaches its LOWEST levels
- Unemployment reaches its highest point,
- Inflation lower
- Interest Rates are lower
What are the characteristics when the Economy is in the Expansion phase ?
- GDP increasing
- Unemployment Low, consumers have more money to spend
Consumer spending drives corporate earnings and corporate earnings drive equity prices and investment returns. - Inflation Increasing
-Interest rates increasing
What are the characteristics when the Economy is in the PEAK phase ?
- GDP HIGH
- Inflation HIGH
- Interest Rates HIGH
- Unmployment LOW
What are the 3 types of economic indicators that describe the current and future economy and business cycle ?
- Index of Leading Economic Indicators
- Index of Lagging Economic Indicators
- Index of Coincident Economic Indicators
What are 10 data points within the The Index of Leading Economic Indicators that are relied on to predict changes in the economy ?
LEADING economic indicators :
* Average weekly hours, manufacturing
* Average weekly initial claims for unemployment insurance
* Manufacturers’ new orders, consumer goods and materials
* ISM® Index of New Orders (supplier deliveries, imports, production, inventories, new orders)
* Manufacturers’ new orders, non-defense capital goods
* Building permits, new private housing units
* Stock prices, 500 common stocks
* Leading Credit IndexTM (credit conditions, including yield curve data)
* Interest rate spread, 10-year Treasury bonds less federal funds
* Average consumer expectations for business conditions
What the Lagging economic indicators ?
LAGGING economic indicators: (summarizes past performance)
* Average duration of unemployment
* Inventories to sales ratio, manufacturing and trade
* Labor cost per unit of output, manufacturing
* Average prime rate
* Commercial and industrial loans
* Consumer installment credit to personal income ratio
* Consumer price index for services
What are the Index of Coincident Indicators ?
Coincident Indicators variables change along with the business cycle. - reflects where the economy is in the business cycle.
- Number of employees on non-agricultural payrolls (payroll employment)
- Index of Industrial Production or industrial output
- Level of manufacturing and trade sales which measures total spending in real dollars
- Personal income measured in real dollars, excluding transfer payments (Social Security)
What is the Monetary Policy ?
Intended influence on MONEY SUPPLY & INTEREST RATES by the Central bank of a country.
-Central bank is the Federal Reserve.which is composed of the Board of Governors and twelve regional Federal Reserve Banks.
- Monetary policy is established by:
* Chairman of the Federal Reserve and the Board of Governors,
* The Federal Open Market Committee (FOMC)
What are the Federal Reserve four tools that it uses to implement monetary policy ?
- Excess Reserve Deposit
- Discount Rate / Federal Funds Rate
- Open Market Operations
- Reserve Requirement
What is the Federal Reserve’s Reserve Requirement ?
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.
If Federal Reserve’s monetary policy is to tighten the money supply, -it can increase the reserve requirement which causes banks to maintain more deposits in the form of cash and have less funds available for loans. Since there are fewer funds available for loans, the money supply will decrease and interest rates will increase
- What is the Federal Reserve’s Discount rate ?
If monetary policy is to TIGHTEN is the discount rate increased or decreased ?
If monetary policy is to EASE is the discount rate increased or decreased ?
Interest rate that the Federal Reserve charges financial institutions for short-term loans.
Loan borrowing from the Federal Reserve institutions go to the discount window, which is the term used from when financial institutions would send a representative to the Federal Reserve’s bank window to borrow funds.
When the Federal Reserve tightens monetary policy, the discount rate increases.
If the Fed eases monetary policy, they are going to decrease the discount rate
What is the Federal Funds rate ?
What can can happen to federal funds rate if banks have low reserves?
What can happen to the federal funds rate if banks have high reserves ?
Does the Federal Reserve control the Federal Funds rate?
Bank to bank lending rate (also known as the overnight rate) set by the Federal Reserve.
if Banks have low reserves >the federal funds rate might increase since the demand for funds is higher than the supply.
If Banks have high reserves > the federal funds rate might decrease.
The Federal Reserve does not directly control the federal funds rate, because banks negotiate the federal funds rate between themselves
How does the Federal Reserve influence the open Market Operations ?
Federal Reserve will buy or sell U.S. Treasury securities such as T-bills, notes, and bonds. This process is done electronically.
What will the Federal Reserve do with US Treasuries if they want to TIGHTEN the economy ?
Sell U.S. Treasury securities & reduce the deposits held by banks at the Federal Reserve.
- Deposits decreased
- money supply decreases
- interest rates will increase
What will the Federal Reserve do with US Treasuries if they want to EASE the economy ?
If Federal Reserve’s monetary policy is to ease,
- Buy U.S. Treasury securities and increase the deposits held by banks at the Federal Reserve.
- Deposits increase
- Money supply increase
-interest rates will decrease.
- What is Excess Reserves Deposits ?
- What is the impact of the Federal Reserve paying interest on the Excess Deposits ?
- If federal Reserve wants to EASE the economy what will they do with the rate on the Excess reserves ?
- If federal Reserve wants to TIGHTEN the economy what will they do with the rate on the Excess reserves ?
- 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. The Federal Reserve now has the ability to increase or decrease the interest rate paid on excess reserves to help control the money supply
- Decrease the interest rate paid on excess reserves. This creates an incentive for financial institutions to lend money and grow the money supply
4.Increase the interest rate paid on excess reserves. This creates an incentive for financial institutions to HOLD money and lower the money supply
What is the Congress Fiscal Policy ?
What are its goals ?
Congress uses the Fiscal Policy as a means of expanding or contracting the economy.
-Uses taxes & government spending to implement fiscal policy.
Same 3 goals the Federal Reserve:
* Employment - Maintain Full
* Growth - maintain long term
* Price Levels - maintain
What effect do raising Taxes have on the economy (expand and contract ?
Taxes decrease to expand the economy
Taxes Increase to contract the economy
What is Demand in microeconomics ?
Represents the quantity consumers are willing to purchase of a good or service, at a particular price.
The quantity consumers are willing to demand is known as the quantity demanded and is inversely related to price:
- As price increases, quantity demand decreases.
- As price decreases, quantity demand will increase.
- What does the aggregate demand curve show ?
- If consumers have more money to spend where does the demand curve shift ?
- If consumers have less money to spend where does the Demand Curve shift ?
- Graphical representation of the quantity of goods and services consumers are willing to BUY > at any given PRICE level.
- Demand curve will shift up and to the right.
- If consumers have less money to spend, the demand curve will shift down and to the left.
What are events that can cause the demand curve to shift up and to the left,,,when consumers have more money to spend ?
Below are events that cause the demand curve to shift up and to the right, which means consumers are willing to demand more of a good or service, at a higher price:
* 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
What are Substitutes and Complements products within the economy ?
-Substitutes are products that serve a similar purpose
-Complements are products that are consumed jointly.-
( like Peanut butter and Jelly )
-For substitutes and complements, when the price of one product changes, it will impact the quantity demand for both the original product and the substitute or complement product.
Can consumer demand change with price and how is this calculated?
The elasticity of demand is measured by the following formula:
Consumer demand will change with price. As price decreases, the quantity demanded will increase. The question is, how much will demand increase, based on changes in price?
% Change in Quantity Demanded
———————————————– = Elasticity
% change in price
-Demand is elastic if a small percentage change in price, results in a large percentage change in the quantity demanded.
-Anytime elasticity is greater than 1, demand is considered to be elastic. Like with a Luxury car.
What are the 3 factors that impact the “elasticity of demand “ ?
Substitute products
Consumer income
TIme
What is supply ?
Supply represents the quantity firms are willing to produce and sell of a good or service, at a particular price.
-The quantity firms are willing to supply is known as the quantity supplied and is directly related to price,
- As price increases, quantity supplied increases.
- As price decreases, quantity supplied will decrease.
What is the Opportunity Cost ?
Represents the value of the best foregone alternative.
-What a resource could earn, using its best alternative use.
-Client’s opportunity cost is subjective
What is the law of diminishing demands in economic production ?
States, as more and more additional units of a variable input are applied to a fixed input, output will eventually increase by smaller and smaller amounts.
