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- Chapter 17
Background Topics
1
- Chapter Goals
Better apply key economic concepts.
Determine the contribution and regulation of major
financial institutions.
Assess the advantages and disadvantages of
alternative forms of business entities.
Recognize important concepts of business law.
2
- Demand and Supply Analysis
The amount of output produced for any commodity is
a function of the demand and supply for that item.
In the simplest form, demand comes from the
consumer.
For example, consider the demand for a particular
type of personal computer.
A plot can demonstrate that demand varies with
price; the lower the price, the greater the quantity
demanded.
At higher prices consumers will substitute.
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- Demand and Supply Analysis, cont.
An example of demand and supply curves are as
follows:
4
- Demand and Supply Analysis, cont.
Supply comes from businesses seeking to make the
most money possible.
The amount business will supply is a function of
price; in this case, the greater the price, the greater
the amount supplied.
This is true because more profits are possible, at
least up to the point at which costs per unit rise and
ultimately exceed the benefits of higher prices.
Equilibrium is set where quantity demanded is equal
to quantity supplied.
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- Inflation
Inflation: The increase in price for a given good or
service or the growth of overall costs in the economy
over time.
Inflation can be caused by any number of factors:
– Excess of demand for a good or goods as compared with
the supply.
– Increases in the cost of items needed to produce a good.
– Lack of competition arising from few producers for that item
and barriers to new companies entering the market.
– An excess supply of money in the economy.
6
- Inflation, cont.
Inflation has been present in our economy from time
to time since our country was first established.
It has been omnipresent since World War II, as our
government has placed more emphasis on limiting
weak economic periods and maintaining high overall
employment rates.
However, the rate of inflation has varied, with high
rates recorded in the 1950s at the time of the Korean
War and the 1970s when oil prices moved up
sharply.
Inflation, particularly when it is accelerating, is a
7 problem for our economy and for many households.
- Inflation, cont.
Inflation’s effects include:
– Redistribute wealth.
Owners of large amounts of property and borrowers on fixed
interest loans benefit. People on fixed incomes lose.
– Change economic behavior and bring about inefficient
economic activity.
When inflation is high, consumers may purchase goods today
to avoid higher prices tomorrow. Businesses may raise prices
in anticipation of higher costs.
– Action by the Federal Reserve to stop the inflationary spiral.
Often the resultant moves by the Fed can bring about a
recession, which limits activity relative to the economy’s
potential and brings about higher unemployment.
– Increased uncertainty about the future, which can reduce
8 the amount of long-term investment.
- Inflation, cont.
The rate of inflation is measured by:
Price in Previous
Current Price Period
Rate of Inflation 100
Price in Previous
Period
Average inflation by decade:
9
- Inflation, cont.
Real items are figures adjusted for inflation, as
follows:
Where n = number of periods
10
- Inflation, cont.
For example, the following table details the
purchasing power of $100,000 at alternative inflation
rates over time.
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- Inflation, cont.
Disinflation: A period in which inflation is rising but at
a rate of increase that is declining.
– Often a period of disinflation not accompanied by recession
is positive for many sectors of the economy and for
investments.
– The period from 1982 to 2002 was a disinflationary period.
Deflation: A period in which the absolute level of
prices declines.
– In many areas of the economy its effects are the opposite of
inflation’s impact.
– A problem with deflation for our economy can be the
reluctance of consumers to spend money as they expect
products to become cheaper in the future.
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- The Business Cycle
Business cycle: The periodic ups and downs in total
economic activity over time. One traditional pattern:
– Acceleration in consumer demand or other factors results in
production that begins to reach capacity.
– Producers strain to put on new units of production and do
so at an ever-increasing cost, boosting household income
and spending.
– The economy enters into expansion which a period of two-
quarter or longer increase in real overall economic output of
a country.
– Prices rise to reflect the robust demand and higher costs.
– Producer’s profits decline as the marginal cost to produce
an extra unit accelerates and exceeds the marginal
revenues from the next unit sold.
– Higher inflation brings about a moderation in demand as the
13 purchasing power of consumers is squeezed.
- The Business Cycle, cont.
– A peak in economic activity followed by a decline occurs.
– Business capital expenditures turn down businesses lay off
workers, and real household incomes drop, leading to a
further cutback in demand.
– The economy enters a recession (a two-quarter or longer
decline in real overall output for the nation).
– The government attempts to influence the economy through
outlays and tax cuts. Interest rates decrease as weak
business conditions result in a decline in demand for funds
and Federal Reserve actions increase the supply.
– The economy reaches a trough and begins to turn up.
– Outlays by businesses and consumers enable the economy
to pick up its pace.
– The economy continues to progress and establishes normal
growth until the next shock to the system.
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- The Business Cycle, cont.
For example:
15
- Economic Indicators
Economic indicators: Statistics that represent where
our economy, or parts of it, has been, is going, or is
expected to be headed.
Gross National Product (GNP): Overall U.S.
economic activity produced by U.S. businesses.
Gross Domestic Product (GDP): All activity by U.S.
or foreign businesses produced solely in the U.S.
Most commonly expressed in real dollars, which is a
measure of output in units.
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- Economic Indicators, cont.
Average real GDP by decade:
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- Economic Indicators, cont.
One common use of indicators is to attempt to
forecast where our economy is headed.
The Index of Leading Indicators measures 11 factors
such as:
– Stock Prices.
– Consumer Expectations.
– Manufacturers’ New Orders.
– Money Supply.
– Changes in Selected Prices of Materials.
– Initial Unemployment Claims.
Net progress is announced publicly and can
influence decisions.
The Index can give false readings and the lead-time
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to actual changes in the economy can also vary.
- Fiscal Policy
Fiscal policy: The role played by government in
attempting to favorably influence the course of
economic activity through changes in government
receipts and disbursements. Two major tools and
increased spending and tax cuts.
Increased spending, through:
– public works spending.
– spending to improve our educational system.
– increases in military programs to improve preparedness.
– programs to benefit certain age and income brackets .
With increased spending, the government is
relatively assured that the money will result in a
change in economic output. But implementation is
19 often delayed.
- Fiscal Policy, cont.
Tax cuts: The government can institute temporary or
permanent declines in tax rates.
The expectation is that households will spend it.
Advantage: The relatively brief time it takes to
implement the cut.
Disadvantage: Uncertainty as to whether the
household will actually spend the money.
– If the households are pessimistic about the future, they may
save the money instead.
– The tax cut would then have little influence on economic
weakness at that time.
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