Economics and Banking

Chapter 2

© 2012 Pearson Education, Inc.Publishing as Prentice Hall 2-1

Better Business

2nd EditionSolomon (Contributing Editor) ·

Poatsy · Martin

Learning Objectives

1. What is economics, and what are the different types of economic systems?

2. What are the principles of supply and demand and the factors that affect each principle?

 3. What are the four degrees of competition, and how does competition affect supply?

 4. How do economic indicators—particularly the gross domestic product (GDP), price indexes, the unemployment rate, and productivity—reflect economic health?

 5. What are the four stages of the business cycle?

 6. How does the government use both fiscal policy and monetary policy to control swings in the business cycle?

© 2012 Pearson Education, Inc.Publishing as Prentice Hall 2-2

Economics Basics• Economics • Microeconomics is the study of how

individual businesses, households, and consumers make decisions to allocate their limited resources in the exchange of goods and services

• Macroeconomics study of behavior of the overall economy

Why do business managers need to be concerned with economics?

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Types of Economic Systems

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Tradit

ional

Planne

d

(

cont

rolle

d)

Mar

ket

Mixed

Comm

unism

Capita

lism

Socialis

m

Determining Price:Supply and Demand

• Currency• Market price

- price at which everyone who is interested can get an item with none left over

• Supply - availability of the item

• Demand - need or desire for the item

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Supply and Demand• Law of supply- supply is derived from a

producer’s desire to maximize profits:- The amount supplied will increase as the price increases- The amount supplied will decrease as the price decreases

• Supply curve- the producers’ desire to supply more, or sell, is affected by price

• Demand refers to how much of a good or service people want to buy at any given time.- As price increases, demand decreases

• Demand curve illustrates that demand increases as prices decrease

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Supply and Demand Curves and Eddie’s Coffee Kiosk

Important terms:• Supply curve• Demand curve• Equilibrium

point• Surplus• Shortage

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2-8

At $2.00, how much coffee do suppliers want to provide? How much coffee do buyers want to buy?

What is the dollar value for the equilibrium price? What does this point mean?

Shifts in Supply and Demand

• Determinants of Supply- Technology changes - Change in resource prices- Price expectations - Number of suppliers

- Price of substitute goods

• Determinants of Demand- Changes in income levels - Population changes- Consumer preferences- Complementary goods- Substitute goods

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Degrees of CompetitionMonopoly Oligopoly Monopolistic

CompetitionPerfect Competition

Number of Providers

One FewMany, but fewer than perfect

Many

Similarity of Goods and Services

Only one product is available

Relatively similar; product differences

Very similar, price and perceived differences

Virtually identical

Ease of Entry into Industry

Government regulated

High investment

Fairly easy Relatively easy

Supplier Control Over Price

Considerable Some Some None

Examples Utility companies

Airlines, automobile industry

Laundry detergent, pizza, colas

Agricultural products

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Economic Indicators: GDP and GNP

• Gross Domestic Product (GDP) - the broadest measure the health of any country’s

economy- Only those goods that are actually produced in the country are counted in the country’s GDP

• Gross National Product (GNP)

- Former system of measurement the United States used to measure the economic health - Switched to GDP in 1991- The GNP attributes earnings to the country where the company was owned, not where the company was manufactured

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Economic Indicators: CPI and PPI

• Inflation

• Disinflation

• Deflation

• Consumer price index (CPI)

• Purchase price index (PPI)

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Economic Indicators: Unemployment

• Unemployment rate- A measurement of the number of workers

who are not working and who are actively looking for work

- Frictional unemployment- Structural unemployment- Cyclical unemployment- Seasonal unemployment

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Economic Indicators: Productivity

• Measurement of the quantity of goods and services that human and physical resources can produce in a given period of time

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Why is it important to measure and track productivity?

Business Cycle

• The state of the economy changes over time- Peak

- Recession

- Trough

- Expansion/ Recovery

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Fiscal Policy

• Fiscal policy relates to government management of revenues (taxes) and spending

Why does the government increase taxes?

Why does the government decrease taxes?

How does government spending help stimulate the economy?

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The Federal Reserve System• “Fed” is central banking system in

the U.S.- Independent government agency- 12 regional Federal Reserve Banks- Board of Governors - Based in Washington D.C.

• The Federal Open Market Committee (FOMC)sets policies of the Fed, including monetary policies

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Monetary Policy• Monetary policy relates to managing the supply

of money - Money supply: is the combined amount of money available within an

economy, but there are different components to the money supply• M-1: Currency, traveler’s checks, and checking accounts

constitute the narrowest measure of our money supply• M-2: M-1 along with the available money for banks to lend out,

such as savings deposits, money market accounts, and certificates of deposit (CDs) less than $100,000

• M-3: M-2 plus less liquid funds

Why is measurement of the money supply important?

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Managing the Money Supply: Open Market Operations

• Open market operations- The primary, and most influential, tool the Fed

uses to alter the money supply

- Consists of buying and selling U.S. Treasury and federal agency bonds in the “open market”

- To stimulate the economy, the Fed buys securities

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Managing the Money Supply: Reserve Requirement

• Determined by the Federal Reserve Bank, is the minimum amount of money banks must hold in reserve to cover deposits

• The Fed dictates what percent of deposits the bank must keep on hand.

• The reserve requirement is the least used monetary policy.

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Managing the Money Supply: Discount Rate

• Discount Rate- Interest rate charged to banks that borrow emergency

funds from the Federal Reserve Bank

• Fed Funds Rate- The interest rate that banks charge other banks when

they borrow funds overnight from one another

• Lowering the discount rate encourages banks to borrow more money, which they in turn lend to businesses. This stimulates the economy.

© 2012 Pearson Education, Inc.Publishing as Prentice Hall 2-21

Chapter Summary: Learning Objectives

1. What is economics, and what are the different types of economic systems?

 2. What are the principles of supply and demand and the factors that affect each principle?

 3. What are the four degrees of competition, and how does competition affect supply?

 4. How do economic indicators, particularly the gross domestic product (GDP), price indexes, the unemployment rate, and productivity, reflect economic health?

 5. What are the four stages of the business cycle?

 6. How does the government use both fiscal policy and monetary policy to control swings in the business cycle?

© 2012 Pearson Education, Inc.Publishing as Prentice Hall 2-22

© 2012 Pearson Education, Inc.Publishing as Prentice Hall 2-23