Microeconomics: 2 Elements in the Marketplace

Personal Finance EconomicsThis is the study of how individuals make decisions with their money and how they are impacted by actions of the government and financial institutions.

1Rational Decision MakingIncentives-any factor, goal, ambition, etc. that leads a person to act in a particular way.Positive incentive-a reward that a person is likely to receive if they behave in a certain manner.Negative incentive-a punishment or negative consequence that one wants to avoid for failing to behave in a certain manner.Households, businesses and governments are motivated to behave in a fashion that rewards them economically, while avoiding behavior that will hurt them economically.2Rational Decision MakingThe Rational Decision Making Model1-Define the Problem-money is scarce; therefore you have to decide how to spend it.2-List the Alternatives-what are your choices?3-State the Criteria-What is important? Or What is your incentive?4-Evaluate the Alternatives-What choice will get you closest to your goal?5-Make a Rational Decision-this is choosing the alternative that best meets your criteria.Read the example on pg. 953How Financial Institutions Work(Banks, Credit Unions, and Savings and Loans)Commercial Banks-financial institutions that receive deposits of money, extend credit and provide loans.Banks make money by providing loans and charging interest on those loans. They also pay interest to depositors for the use of their money in loans. Banks must charge more interest than they pay out in order to make money.Loans are given for a variety of reasons: mortgages (buying a house), purchase cars, start a business, home repairs, etcBefore granting loans the bank checks an individuals credit worthiness (their ability to repay the loan).This can include collateral-anything of worth that could be used to cover the value of the loan should it not be repaid.This protects financial institutions against financial loss.

4How Financial Institutions Work(Banks, Credit Unions, and Savings and Loans)Credit Unions-like banks, they offer checking and savings accounts and give out loans; but only serve their members.Credit Unions can offer higher rates on personal accounts because they are exempt from some to the taxes that commercial banks must pay due to their non-profit status.They are also exclusive, in that only certain people can join.

5How Financial Institutions Work(Banks, Credit Unions, and Savings and Loans)Savings and Loan Associations-these are financial institutions designed for people to save money to buy a house.People save their money in S&Ls and the money is loaned to others for mortgages.Because of a failure of S&Ls in the 1980s and the fact that banks and credit unions offer the same services they have declined in number.

6How Investments Work (Risk and Return)People generally invest because they expect some sort of return on their investment.Risk is the chance that an investment might actually end up losing money rather than making money.Normally with a higher risk there is a possibility of a higher reward, because of this some people are willing to make risky investments.The key to risk and reward is to determine how much risk you can afford.

7How Investments Work (Stocks, Bonds, and Mutual Funds)Stocks are shares in a company that an individual/organization purchases giving that person/entity part ownership in the company.Stocks are purchased in hopes that over time they will become worth more than they purchased them for.Stocks can be good investments but are risky and some people have become wealthy because of stock while others have lost a lot of money in the Stock Market.

8How Investments Work (Stocks, Bonds, and Mutual Funds)Bonds are loans to either a company or the government.Bonds, unlike stock, do not give you part ownership, they are simply a loan.They are an investment however, because they offer a higher return than what was paid in by the investor.

9How Investments Work (Stocks, Bonds, and Mutual Funds)Mutual Funds are less risky than stock because money is pooled from a number of investors to buy a range of stock.An investors money is spread out among several companies, thus reducing risk.They are normally managed by a financial expert, so the investor does not have to constantly worry about their investments.These do generally have a lower rate of return to investors and the investor has to pay part of what they earn to the manager of the fund. (remember risk=reward)

10How Investments Work (Reasons to Save and Invest)People tend to save when interest rates are high and invest when the potential return outweighs the loss of immediate gratification.People save and invest because there is something they want in the future that they may not be able to afford immediately.House, car, vacations (travel), luxury items, childrens education etc11How Investments Work (Reasons to Save and Invest)Most people who save and invest are doing so for retirement.Retirement is when someone stops working a paying job because they simply dont want to work anymore or because they are physically unable to, due to their age or health.Because they no longer have a steady income from a job they need money coming in from somewhere (savings and investments).12Workers EarningsYour earnings determine how much you are able to save and invest.Earning potential refers to how much a person is likely to make in the labor market due to skills, training, education etcThe more skills and education you have the more money you have the ability to make.13PracticePractice 5.2 Pg. 100Diagnostic Test #s 3,24,3814Impact of Fiscal Policy on IndividualsFiscal policy refers to how the government chooses to tax and spend.The amount of taxes taken from an individuals paycheck every week determines how much he can spend, save or invest.People feel like taxes hurt them; but they may benefit from the government services provided by the tax revenue. (education system, health care, unemployment benefits, roads, police etc)15Impact of Fiscal Policy on Individuals (Types of Taxation)Progressive Tax-the amount, by percentage, of tax one pays increases with their income.If you make more money than someone else, you will pay a higher percentage of tax on your income than they will.An example of this is our income tax in the United States. 16Impact of Fiscal Policy on Individuals (Types of Taxation)Regressive Tax-a tax where you pay a higher percentage of tax the less money you make.Many people consider the sales tax a regressive tax because if two people are buying the same good they will be taxed on its value and one is paying a higher percentage of his income in taxes.17Impact of Fiscal Policy on Individuals (Types of Taxation)Proportional Tax-a tax in which everyone pays the same amount proportional to their income.18Impact of Fiscal Policy on Individuals (Inflation)The government uses fiscal policy to impact price levels.When taxes are high inflation decreases.High taxes mean that people have to pay more of their income to the government, leaving less disposable income.Businesses then have to lower their prices so people can afford to buy things.When taxes are low inflation increases for the opposite reason.19Impact of Monetary Policy on IndividualsMonetary Policy refers to actions taken by the FED to control the money supply.#1 Reserve Requirement.If the FED raises the reserve requirement, banks have less disposable money to loan to people and visa versa.Example on pg. 103-104

20Impact of Monetary Policy on Individuals#2 The Discount RateIf the FED raises the discount rate, banks will not borrow as much money from them, leaving banks with less money to loan to people and visa versa.Example on pg. 104#3 Open Market OperationsWhen the government sells bonds, it is allowing people to save money by loaning it to the government in exchange for interest. The individuals buying power has lessened and visa versa.Example on pg. 104-105.

21PracticePractice 5.3 Pg. 105Diagnostic Test Questions #13,37&79

22CreditThis is an agreement under which the buyer receives goods and services at the present time in exchange for a promise to pay for them at a future time.People buy on credit for a couple reasons:Their future income may be more promising than their current income (student loans).Some items are so expensive that it is hard to save the entire amount necessary to purchase the item (house or car).Some people buy on credit to have things that they cannot afford, which gets them into unnecessary debt.23Credit WorthinessThis refers to your worthiness of being loaned money. Your current amount of debt can affect your CW.If you owe a lot of people money then you are less likely to be able to pay the loan you are attaining.Your credit score can affect your CW.Credit score is determined by your past history of paying for loans.A bad credit score can keep you from getting a loan as well as raise the interest you have to pay on the loan.CW also takes into account how much money you make, how much money you have in savings, and how much property you own.Lenders are more likely to give loans to people who have property to put up as collateral.

24Advantages and Disadvantages of CreditAdvantageCredit allows people to pay for items and obtain goods that they otherwise could not afford.DisadvantagesBorrowers have to pay interest in addition to the cost of the good.The good ends up costing more than it would have had you paid for it up front.People have gone bankrupt as a result of credit cards because the interest accumulates faster than they can pay back the loan.25InterestThis is the amount of money that a lender charges a borrower in exchange for the use of their money.In general, the higher the risk to the lender, the higher the interest rate.Home loans (mortgages) carry lower interest rates than car and consumer loans because homes cannot be stolen and a lender always knows where the house is if they need to take it back.Larger loans also require the borrower to meet stricter standards (have a higher credit worthiness).26Simple Interest Simple Interest is a rate that is applied only to the value of the principle.The principle is the amount of money being borrowed.EX. Principle+(percentage of principle X amount of time to be paid off)=amount to be repaid.$10,000+(5% of $10,000 X 10yrs)=total loan cost$10,000+($500X10)=total loan cost$10,000+$5,000=$15,00027Compound Interest Compound Interest is interest applied to both the principle and the accrued interest.A=P X (1+r/n)ntA=total value to be repaidP=principle ($10,000)r=interest rate (5%)n=number of compounding periods per year (in this example we are going to only compound it once)=1t=number of years of the loan=1028Compound Interest Cont.Compound Interest is a bad thing if you are borrowing money because it can drastically increase the amount you have to pay back, but is a good thing if you are saving or investing money.A=P X (1+r/n)ntA=$10,000X(1+.05/1)1x10A=$10,000X(1.05)10A=$10,000X1.62889A=$16,288.95So the interest paid under compound is $16,288.95-$10,000=$6,288.9529InsuranceInsurance is transferring risk to others. Normally you buy insurance to protect something of great value.#1 Life Insurance is meant to provide money to ones family if they die.Term Life Insurance is purchased for a certain amount of time and if the person covered dies during that period the money is paid to the persons beneficiary.Whole Life Insurance is paid for over time and like an investment, it gains cash value. This is more expensive than term because it is more risky for the insurance company.30InsuranceCont.#2 Health/Medical Insurance is paid for monthly and is meant to cover health and medical expenses.#3 Disability Insurance provides a policy holder with income in the event that they become disabled and unable to work.#4 Liability Insurance pays for something if you are held financially liable for an accident.31InsuranceCont.#5 Homeowners Insurance covers a policy holders house in the event that it is damaged or destroyed.These policies often have liability attached to them so if someone is hurt in your yard and sues for payment for their injuries then your liability insurance will cover it.32InsuranceCont.#6 Comprehensive Liability Insurance covers a much wider range of catastrophes.Injuries on a businesss property.Accidents due to employee negligence.Property damage caused by company workers.Losses or injuries caused by defective products.Any professional mistakes i.e. medical malpractice.33PracticePractice 5.4 Pg. 110Diagnostic Test Questions #12,18,6434