LO 7.1.1: Interpret the interaction of supply and demand associated with a product or service.

Question 1

What is economics?

Answer 1

• the study of production, distribution, and consumption, or
• the study of choices in the presence of scarce resources.
• divided into two areas: micro and macro

Question 2

What is microeconomics?

Answer 2

• the study of how individuals and companies make decisions to allocate scarce resources
• helps understanding how individuals and companies prioritize their wants.

Question 3

What is macroeconomics?

Answer 3

• the study of the economy as a whole.

* for example, macroeconomics examines factors that affect a country’s economic growth.

Question 4

What do macroeconomic conditions and analyses affect?

Answer 4

• the actions and behavior of businesses, consumers, and governments.
• macroeconomic analyses affect decisions made by investment firms:
  
  • some investments benefit from slow economic growth and low inflation, whereas others do well during periods of relatively strong economic growth with moderate inflation.

Question 5

How can financial planners use macroeconomic data?

Answer 5

To forecast the earnings potential of companies and to determine which asset classes may be more attractive.

Question 6

What is basic economic theory based upon?

Answer 6

• The relationship between supply and demand.
• The supply and demand equation are most easily expressed in graphic form cf. 231.
  
  • Supply curve — positive slope.
  • Demand curve — negative slope.

Question 7

What is equilibrium?

Answer 7

• The intersection of the supply and demand curves.

* This indicates the relationship between price (price of a good or service) and quantity (how much produced).

Question 8

What is the general movement of price?

Answer 8

Prices should always move toward equilibrium unless restricted by outside sources, such as government regulation or by collusion between manufacturers, as in the case with cartels.

Question 9

What is price elasticity?

Answer 9

Price elasticity is how responsive the quantity of a good demanded is to changes in price, all else (economic forces) constant.

Question 10

Inelastic good

Answer 10

• Goods that respond relatively little to price changes;

* Example: demand for necessities, like food or gasoline.

Question 11

Elastic good

Answer 11

• Goods that respond relatively more to price changes;
• Demonstrate a great deal of price elasticity.
• Example: demand for luxuries, such as a new motorboat, responds relatively more to price changes.

Question 12

What is the point of determining price elasticity of a good?

Answer 12

To determine how many units of quantity are changed for every unit of price change.

Question 13

Complimentary goods

Answer 13

• Related to each other — demand for one will impact the other;
• Example: increasing demand for peanut better subsequently increases the demand for jelly.

Question 14

Product substitutes

Answer 14

• Similar to complimentary goods, if the price rises on one product, another similar product can serve as a substitute.
• Example: the price of pork rises, so chicken is then purchased as a substitute.

Question 15

U.S. gross domestic product (GDP)

Answer 15

• Is the total monetary value of all goods and services produced within the domestic United States over the course of a given year;
  
  • Includes income generated domestically by a foreign form (e.g., Toyota Motor Corp.)

Question 16

What is GDP measured in?

Answer 16

• Constant, non-inflation adjusted dollars;

* Translates into a real GDP after accounting for inflation (subsequent to a predetermined based or index year).

Question 17

What is the purpose of Real GDP?

Answer 17

Allows statisticians, economists, and investors to determine the true production year-to-year.

Question 18

GDP formula

Answer 18

• GDP = C + I + G + NE
• where:
  
  • C = consumption
  • I = investment
  • G = government spending, including federal, state, and local
  • NE = net exports

Question 19

What is C in the GDP formula?

Answer 19

• Consumption: generally spending by individuals on durable and nondurable goods and services.
• Largest component of the GDP of the U.S., represents 2/3 of the number.

Question 20

What is I in the GDP formula?

Answer 20

Investment: generally business spending on inventory, plants, and equipment, but including new housing purchases by consumers.

Question 21

What is G in the GDP formula?

Answer 21

Government spending, including federal, state, and local.

Question 22

What is NE in the GDP formula?

Answer 22

Net exports: total exports less total imports.

Question 23

What are the four components of GDP?

Answer 23

The four components are Consumption, Investment, Government spending, and Net exports (CIGNE).

Question 24

If Toyota builds an auto assembly plant in the U.S., will it show up in U.S. GDP?

Answer 24

• Yes, even though it is a foreign company, GDP measures the value of all goods and services produced within the domestic United States over the course of a year, including income generated domestically by a foreign firm.
• GDP represents what is happening in a given country/within own borders, which is why it is so widely followed.

Question 25

If General Motors builds an auto assembly plant in China, will it show in GDP?

Answer 25

No, it would be reflected in China’s GDP since it is not creating jobs and activity here in the U.S.

Question 26

Gross National Product (GNP)

Answer 26

• Measures activity by ownership and takes into account any production by a company both in- and outside the home country. As such, it’s not as widely followed by as GDP.
• E.g., If General Motors (a U.S. company) builds a plant in China, it will show up in China’s Gross National Product (GNP), and NOT U.S. Gross Domestic Product (GDP).