Lesson 4 of Fundamentals: Economic Business Cycle, Consumer Protection Flashcards
Interest rates
(Impact on investment returns and purchasing powers)
Investment Returns are INVERSELY related to changes in interest rates
- Examples: When an interest rate increases, stock prices and bond prices decrease in value.
- Companies will not want to borrow money as it becomes more expensive. This will decrease their profitability as this will cut into their profit. Investors will take note.
Purchasing Power is INVERSELY related to interest rates.
Represent the cost of “buying” or borrowing money.
Taxes
(Impact of redistribution of wealth)
Redistribution of wealth is DIRECTLY related to changes in tax rates.
- As tax rates increase, there is a redistribution of wealth from the higher tax brackets to the lower tax brackets.
Inflation
(Impact on the cost of goods, services, and money)
The cost of goods, services, and money is DIRECTLY related to inflation.
- When inflation increases all three also increase.
The cost of money is measured by interest rates.
Unemployment
(Impact on wage rates)
Wage rates are INVERSELY related to the unemployment rate.
- As the unemployment rate decreases, wage rates (wages paid to employees) increase because firms are competing for workers.
- When the unemployment rate increases, the wage rate decreases.
Monetary & Fiscal Policy
(Impact on economic
expansion/contraction)
Economic expansion and contraction are DIRECTLY related to fiscal and monetary policy.
- Loosening Policy = Economic Expansion
- Tightening Policy = Economic Slowdown
Demand
- Reflects the quantity of a good or service that consumers are willing to pay.
- Heavily dependent upon price.
- As Price increases, consumers demand less.
- As price decreases consumers demand more.
Quantity Demanded
- How much consumers are willing to demand at certain price levels.
- Anytime there is a change in price
- It’s a movement along the demand curve or a change in QD
Discretionary Income
The extra income you have after paying for basic necessities, like taxes, everyday expenses, and household bills.
Increase / Decrease in Demand Curve
Anything that causes discretionary income to go up will shift the demand curve up and to the right.
Anything that causes discretionary income to go down will shift the demand curve down and to the left.
Reasons for a shift in demand:
- Income,
- Taxes,
- Savings rate,
- Disposable Income
Examples of Increase in Demand Curve
- Consumer income increases
- Government lowers tax rates
- Consumers lower their savings rates
- Cosumers have more disposable income
This will all lead to consumer spending going up.
Examples of Decrease in Demand Curve
- Consumers’ income decreases
- Government increases tax rates
- Consumers increase their savings rate
This will all lead to consumer spending going down.
Supply
- Reflects the quantity of a good or service that businesses are willing to supply at a given price.
- The higher the price, the MORE suppliers are willing to supply.
- The lower the price the LESS suppliers are willing to supply.
EXPLANATION: The higher the prices the more profit suppliers can get.
Change in Quantity Supplied
- Anytime there is a change in price, there is a movement along the supply curve due to a price change which is called a change in QS.
- As Price decreases, consumers are willing to pay less for it, so firms are inclined to supply less (Profit Reasons, Dimishing Incentive to Produce)
- As Prices increase, firms are inclined to supply more. (Better profit-maximizing, increase profit-maximizing).
A supply curve will shift to the left or right because of a change in?
- Technology
- Competition
- Anything other than price
Increase in Supply Curve
Anything that causes PRODUCTION to improve will shift the supply curve down and to the right.
Examples:
- As MORE FIRMS enter the marketplace
- If TECHNOLOGY IMPROVES efficiency
- Goods used in the manufacturing process DECREASE in price
Decrease in Supply Curve
Anything that causes an increase in production costs or supply to decrease, the supply curve will shift up and to the left.
Examples:
- As LESS firms enter the marketplace, (supply decreases because less firms are making goods and services)
- If goods used in the manufacturing process INCREASE in price
Equilibrium
Is the price at which the QD = QS
Substitutes
Are products that serve a similar purpose
A price change in one product changes the QD for another product.
EXAMPLES:
- If the price of movie tickets suddenly increases, demand for movie rentals may suddenly increase. Movie rentals would be considered this for movie tickets.
- If the price for chicken suddenly increases, the demand for pork may suddenly increase.
Complements
Are products that are consumed jointly.
A price change in one product changes the QD for another product.
EXAMPLE:
- If razors are put on sale, demand for razor blades may increase. Razors and Razor blades are considered this.
- If peanut butter is put on sale, demand for jelly may increase.
Price Elasticity
Measures the change in QD, relative to changes in price.
Elastic Demand
QD responds significantly to changes in price.
EXAMPLES:
- Airline Tickets
- Movie Tickets
- Alcohol
- Luxury Goods
Exam Tip:
- An elastic demand curve is horizontal, sloping down and to the right.
Inelastic Demand
QD changes very little to changes in price.
- Life’s necessities respond very little to changes in price.
Examples:
- Milk
- Gasoline
Exam Tip:
- Inelastic demand curve is almost vertical, sloping town and to the right.
- Remember the “I” in Inelastic to help remember the same of the elastic demand curve.
Inflation
Peak: Highest
Recession: Decreasing
Trough: Lowest
Expansion: Increasing
Interest
Peak: Highest
Recession: Decreasing
Trough: Lowest
Expansion: Increasing
Unemployment
Peak: Lowest
Recession: Increasing
Trough: Highest
Expansion: Decreasing
GDP
Peak: Highest
Recession: Decreasing
Trough: Lowest
Expansion: Increasing
GDP 4 Main Areas:
Make a falshcard of this.
- Consumer Spending
- Government Spending
- Business Investing
- Net Imports and Exports
Expansion
Should be in short-term duration bonds and equities.
- Characterized by increasing GDP, inflation, and interest rates.
- Unemployment is decreasing.
Peak
Since interest rates are increasing to cut off inflation, bonds, preferred stock, and other high-duration or fixed-income assets should be sold.
- Equities and hard assets, such as gold and real estate tend to perform well in this environment.
- GDP at its highest
- Inflation and interest rates are peaking, and the unemployment rate is at its lowest level.
- Interest rates are a lagging indicator, and will continue to climb for a short time after the peak.
Recession/Contraction
- GDP Slowing
- Inflation and interest rates are beginning to decline.
- Unemployment rates begin to increase during the contraction phase.
- Equities and hard assets should be sold and reinvested into short-term cash and bonds until the market settles out.
- Supply of goods and services would be decreasing.
Trough
- GDP, Inflation, and Interest Rates being at their lowest levels
- Unemployment is highest
- High-duration bonds will perform well as bond yields drop and interest rates continue to fall.
- Stock purchases late in the cycle should be considered if the valuation seems appropriate.
Business Life Cycle
Average GDP Growth: Approx 3%
Average Cycle Time: 60 months
Consumer durables and capital goods are cyclical in nature and fluctuate directly with the business cycle.
Gross Domestic Product (GDP)
Measures the amount of goods and services produced in the US, regardless of ownership.
EXAMPLE:
- Mexican beer made in Texas is included; however, a Big Mac in France is not.
Gross National Product (GNP)
GNP measures the amount of goods and services produced by a country’s citizens, regardless of where the goods and services are produced.
EXAMPLE:
- Ford Production in Mexico is included in GNP.
Recession
Consists of 6 consecutive months (or two-quarters of declining GDP.
Depression
A recession becomes a depression if the recession last for 18 months or 6 consecutive quarters.
Inflation
In an increase in price
A loss of purchasing power is the risk that inflation impacts
EXAMPLES:
- The couple age 62, receives a pension per year of $50,000. Annual expenses are $45,000 per year. With inflation just 3% per year, living expenses will increase to $64,000 per year in 12 years. At age 74, the pension will still be $50,000 per year, but living expenses will exceed income by $14,000 per year.
Formula to Measure Inflation
= (Price level(year x) - Price Level( year x-1))
/ Price level (year x -1)
EXAMPLES:
Coffee beans cost $2.20 per pound this year and $2.00 per pound last year. The inflation rate is
(2.20 - 2.00) / 2.00 = 0.10 or 10%
Moderate Inflation
Is when prices are slowly increasing.
- Historic inflation has been 3% over the past 60 years,
- so moderate inflation would be 1-2% per year.
Galloping Inflation
Is when money loses value very quickly.
Deflation
- Is the opposite of inflation, so when prices are falling.
- During periods of inflation, individuals prefer to hold cash because cash becomes more valuable, as it can buy more goods and services, and prices decrease.
Disinflation
A decline or a slowdown in the rate of inflation.
EXAMPLE:
- If annual inflation has been running at 4% each year for the past three years, then slows to 3.0 - 3.5%, that would be a slowdown in the rate of inflation.