Download Define the term tax

2.00 Understand operations,
economics, and professional
development.
2.01 Maintain work flow to enhance
productivity (Organize and prioritize
work ).
a. Discuss benefits of organizing and prioritizing one’s
work.
• Knowing how to prioritize work effectively
reduces stress and means you feel on top of
things. You do what matters, when it matters.
• You only need to list things that (a) you want
to do but (b) could forget. So, for example, you
probably don’t need to remind yourself to
have lunch.
b. Explain the need to understand work assignments
and responsibilities before organizing and prioritizing
that work.
• The first step is organization - so you'll know
what your working with and what your tasks
are along with any deadlines you have. Then
you can figure out which are most important
and demand the majority of your attention
and energy.
c. Identify factors to consider when organizing and
prioritizing work (e.g., time and other resource
constraints; expectations of clients, co-workers, and
managers; etc.).
• Start by prioritizing only those things that are deadline driven
• Everything else? Give it equal value and do it according to where you are
and how you feel. This gives you a real sense of freedom and flexibility
when it comes to the moment of choice.
• Consider time constraints - what absolutely needs to get done today and
what can wait until tomorrow or next week.
• Consider people constraints - all things equal, move things that other
people are waiting on to the top of the list. If you know that your manager
can't finish his proposal without your part, that's more important than the
thing that you always do on Wednesday that could just as well be done on
Thursday.
• Consider the consequences - are you going to get fired if you don't do
something? Is another task going to give you the inside track on that
promotion? Those things should be more important than mildly
inconveniencing the sales manager by responding to their email a day late.
d. Discuss ways in which an individual’s physical
environment impacts his/her ability to organize and
prioritize work.
• Ever look at all the work on your desk and feel
overwhelmed? Do you have trouble locating important
papers? Do you find yourself trying to remember what you
were doing and what you're supposed to do next?
• First, assemble all of your work in one place. You may
discover that it's strewn between the office, home, your
car, and other coworker's desks.
• Important tools include a day planner/calendar and post-it
notes or a scratch pad.
• Begin creating file folders and computers folders. Being
organized is half the battle. Use your list to create folders.
Once all your paperwork is delegated to its appropriate
place, the clutter will stop draining your energy.
e. Describe methods used to organize and prioritize
work (e.g., developing a written list of tasks, breaking
work assignments down into smaller tasks, e.g.).
• Create a daily, weekly, and monthly task chart
for yourself.
• Note any and all deadlines or quotas. Now
break down those deadlines and quotas into
weekly and daily goals.
• Determine which is the utmost important and
assign it the number one. Work your way
through until all of your tasks have been
assigned a numerical importance.
2.01 Maintain work flow to enhance
productivity.
Coordinate work with that of team
members (OP:230)
a. Describe ways in which an organization benefits
when its team members coordinate work with each
other (e.g., higher-functioning team members, stronger
team results, etc.).
• The major impetus for organizations to embrace the
team concept is the effort to improve productivity and
quality.
• Some of an organization's major benefits from the use
of teams are improved quality of work life for
employees, reduced absenteeism and turnover,
increased innovation, and improved organizational
adaptability and flexibility. Effective implementation of
teams can also improve office politics by improving the
communication and trust between the team members.
b. Discuss the role of communication when
coordinating work among team members.
• Team members must have a clear picture of their roles
and responsibilities with respect to the project and
deliver accordingly.
• All this is possible only when a team develops and
practices effective communication skills.
• Communication ensures that work is not duplicated;
allows individuals to gain insights, assistance, and
agreement from team members; helps team members
to focus on common goal; etc.
c. Explain methods to coordinate work with that of
team members.
• If you are working on a new team, be aware that the
total time involved in the project will be greater than if
you were working with an established team.
– The coordination time will be much greater, even if the
task time is pretty much the same.
– You'll have to talk it out, and you'll need to do a lot of
talking and sharing.
– This need to coordinate the work will also apply with an
established team that is working on a task variant that is
different for the team.
• If you are working on an established team, where the
task is one that the team members have collectively
done before, it is fair to expect that the coordination
time will be minimal.
Student Activity:
• 2.01-1- f. Demonstrate techniques used to organize and prioritize work.
– Ask each student to read the “how-to” article How to Prioritize Your Work at
http://ezinearticles.com/?How-to-Prioritize-Your-Work&id=219970 and follow
the steps provided to develop an organized, prioritized list of the tasks and
responsibilities that s/he must complete in the coming week. These tasks and
responsibilities could include schoolwork, work duties, extra-curricular and/or
co curricular work, household chores, etc. Then, students should discuss their
lists with partners and explain how they determined which tasks and
responsibilities would take priority.
• 2.01-d-d. Demonstrate methods to coordinate work with that of team
members.
– Ask students to work in pairs to identify activities that require people to work in
teams. (Encourage students to think of the groups that they are part of, either in
or outside of school.) These activities could include classes, sports teams,
musical groups, CTSOs and other organizations, scout troops, work, etc. After
identifying these activities/groups, partners should work together to develop a
list of the methods that these teams use to coordinate their work as well as the
ways in which the organization benefits when its team members coordinate
their work. After sharing these findings, the class should discuss how these
methods to coordinate team work can be used in the workplace.
2.02 Acquire knowledge of the
impact of government on business
activities to make informed
economic decisions.
a. Define the following terms: tax, revenue,
expenditure, excise tax, income tax, property tax, and
sales tax.
Define the term tax:
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Legally mandated payment to the government that is not made in exchange for a good or service
– Examples: income tax, sales tax, property tax, excise tax
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Taxes are used to fund projects that benefit society.
Define the term income tax:
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Tax that is based on the amount of money a person earns or receives
Define the term sales tax:
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Tax placed on the retail sale of almost all goods purchased
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Certain types of goods (i.e., food, medicine) are sometimes excluded from sales tax.
Define the term excise tax:
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Tax placed on a specific good
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Excise taxes can be used to discourage consumption of a product or to raise some easy money on products
that the government knows people will continue to purchase, regardless of the tax.
– Example: gasoline tax, cigarette tax, beer and liquor tax
Define the term property tax:
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Tax placed on real estate, and in some cases, on personal possessions (e.g., boats, vehicles, etc.)
Define the term revenue:
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Income
Define the term expenditure.
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Money paid out; spending
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The term “government expenditures” is often used to refer to spending by the government sector.
b. Explain the importance of taxes in a market
economy.
• Taxes are the primary source of revenue for the
government sector.
• In a market economy, some services such as national
defense, roads, and education can be more efficiently
produced by the government instead of private
individuals.
• In addition, the government is responsible for creating
the infrastructure necessary for commerce. The
banking system, national defense, and the
transportation system are all part of this infrastructure.
• If taxes did not exist, then these services would likely
not exist either.
c. List sources of tax monies paid to different levels of
government.
d. Identify ways that tax monies are used by the
different levels of government.
Federal Government:
• Sources of Tax Monies: Income taxes, Excise taxes
• Expenditures: National defense, Education, Transportation systems,
• Judicial system, Social Security and Medicare, Medicaid, Veterans services, etc.
State Governments:
• Sources of Tax Monies: Income taxes, Sales taxes, Excise taxes
• Expenditures: State police protection, Education, Operation of state government, etc.
Local Governments:
• Sources of Tax Monies: Property taxes, Sales taxes, Income taxes
• Expenditures: Education, Public health and safety (local fire and police protection), Sanitation, etc.
Explain how certain government expenditures are financed through specific taxes.
• Roads, highways, and bridges are financed through the gasoline excise tax.
• Only those people who purchase gasoline—those who use the transportation system—pay the
gasoline tax.
• The Social Security system, which provides income to retired workers, receives its monies from
retirement taxes.
e. Describe tax structures.
Proportional: A tax structure in which everyone pays the
same percentage of income in taxes, regardless of income
level. (Few taxes are completely proportional in nature.)
Progressive: A tax structure in which those who earn more
pay a higher percentage of income in taxes. In other words,
as the income increases, the tax rate increases. The Federal
income tax is a progressive tax.
Regressive: A tax structure in which those who earn more
income pay a lower percentage of income in taxes. As
income increases, the tax rate decreases. Sales and excise
taxes are considered to be regressive taxes, because those
people with lower incomes ultimately pay a larger
percentage of their income in sales and excise taxes.
f. Explain the Internal Revenue Service’s roles.
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To collect federal income taxes
To enforce federal revenue law
To help taxpayers with tax law
To pursue taxpayers who are not in
compliance with tax law
g. Illustrate the impact of taxation on the circular flow
of income model.
• The circular flow model illustrates the constant movement of
production inputs, goods, services, and money in the economy. For
a good introduction on a simple circular flow of income model, have
the students watch the flash movie/tutorial The circular flow of
income model by Manfred Gartner at
http://www.fgn.unisg.ch/eurmacro/tutor/circularflow.html
• (Do NOT continue on to the interactive Java applet—it goes into
much more detail than is required for this lesson.)
• After this short introduction to the circular flow model, consider the
role of the government—specifically, taxes—in the economy. How
does the government fit into the circular flow of income model?
– The government sector can be added to the center of the circular flow
model, and taxes are the flow between the household sector and the
government sector. The government insists that households divert
some monies away from consumption and spending to go toward the
government.
Student Activity:
• Direct your students to the AmosWEB website Taxes at
http://www.amosweb.com/cgibin/awb_nav.pl?s=wpd&c=dsp&k=taxes for a good
illustration of the circular flow model including the
government sector and taxes
• h. Explain how government expenditures are financed.
– Students should search local newspapers to locate articles
in which individuals or groups are opposed to an increase
in taxation. In a written report, each student should
identify the nature of the tax, how the monies are to be
used, and the nature of the opposition to the tax. Each
student should indicate his/her position on the tax
increase and provide a rationale for her/his stance.
2.03 Analyze cost/profit
relationships to guide business
decision-making.
Explain the concept of organized
labor and business
a. Define the following terms: labor union, local,
national, federation, collective bargaining, strikes,
picketing, boycotts, featherbedding, lockouts,
injunctions and strikebreakers.
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A labor union is an organization of wage earners or salary workers established for the
purpose of protecting their collective interests when dealing with employers.
Local unions are the building blocks of the labor movement.
– Most craft unions began as local unions, which then joined together to form national
organizations.
National unions are composed of the various local unions that they have chartered
A federation is an association of unions.
Collective bargaining consists of negotiations between an employer and a group of
employees so as to determine the conditions of employment.
A boycott is an act of voluntarily abstaining from using, buying, or dealing with a person,
organization, or country as an expression of protest, usually for political reasons. It can be a
form of consumer activism.
A picket is a style of protest in which striking workers assemble outside a place of
employment to make the public aware of their cause.
a strike occurs when all the workers in the union stop coming to work
Strikebreakers try to fight back against the union, sometimes through lawsuits and
legislation, sometimes with violent thugs.
Featherbedding used to describe the practice of a labor union requiring an employer to hire
more workers than necessary for a particular task.
A lockout is a work stoppage in which an employer prevents employees from working
An injunction is an equitable remedy in the form of a court order that requires a party to do,
or to refrain from doing, certain acts.
b. Identify reasons that labor unions form.
• The American economy shifted from an agricultural to an industrial base;
industrial workers, who were concentrated in urban areas and increasingly
shared the same language (English), were thus able to create a common
culture that was absent among earlier generations of workers.
• The Depression created a backlash against big business entities, who were
viewed as the chief culprits for the country's economic difficulties.
• Changing political dynamics also played an important role. Active support
for organized labor was an integral part of Roosevelt's New Deal, and the
passage of the National Labor Relations Act (NLRA) in 1935 was a potent
new weapon for union organizers. The NLRA provided a means for official
recognition of labor unions. Once recognized, an employer was legally
bound to bargain with the union, enforceable by government action.
• Economic growth during World War II and in the post-war era was an
important facilitator of union growth.
c. Identify types of labor issues.
• If a worker represented by the union believes his or her rights under
the union contract have been violated, then the union may intervene
on that person's behalf.
– Examples of such situations include the discharge of an employee,
failure to promote an employee according to a contract seniority
clause, or failure to pay an employee for overtime.
– Virtually any provision of a contract can become a source of
contention.
– The local union may try to settle the issue informally. If that effort
is not successful, the union may file what is known as a grievance .
• This is a formal statement of the dispute with the employer;
most contracts set forth a grievance procedure.
d. Classify types of unions.
• Craft unions represent employees in a single occupation or group of
closely related occupations.
– The members of craft unions are generally highly skilled workers.
Examples of craft unions include the various skilled trades in the
construction industry, such as carpentry, plumbing, and electrical
work.
• professional union is generally understood to be an employee with
advanced and highly specialized skills, often requiring some
credentials, such as a college degree and/or a license. Example:
Teachers Union
• An industrial union represents workers across a wide range of
occupations within one or more industries. A good example of a
typical industrial union is the United Automobile Workers (UAW).
• General unions organize workers across all occupations and
industries
e. Describe levels of union organization.
f. Describe types of union organization
• Local unions represent members in a specific geographic
area, such as a city, state, or region. These local unions
make up the base of a national union, which unites all its
affiliated local unions under one constitution.
• The Teamsters and the United Steel Workers of America are
two examples of large national unions, each uniting many
local unions.
• The top level of labor union organization is the federation,
such as the AFL-CIO. Such a federation is made up of many
national and/or international unions. The purpose of the
federation level is to coordinate its affiliated unions, settle
disputes between them, and serve as the political
representative of the union members.
g. Describe the collective bargaining process.
• Collective bargaining consists of the process of
negotiation between representatives of a union and
employers (generally represented by management, in
some countries by an employers' organization) in
respect of the terms and conditions of employment of
employees, such as wages, hours of work, working
conditions and grievance-procedures, and about the
rights and responsibilities of trade unions.
• The parties often refer to the result of the negotiation
as a collective bargaining agreement (CBA) or as a
collective employment agreement (CEA).
h. Explain types of union negotiation strategies.
Distributive Negotiation
• The term distributive means; there is a giving out; or the scattering
of things. By its mere nature, there is a limit or finite amount in the
thing being distributed or divided amongst the people involved
Integrative negotiation
• The word integrative means to join several parts into a whole.
Conceptually, this implies some cooperation, or a joining of forces
to achieve something together. Usually involves a higher degree of
trust and a forming of a relationship. Both parties want to walk
away feeling they've achieved something which has value by getting
what each wants.
– Integrative negotiation process generally involves some form or
combination of making value for value concessions, in conjunction
with creative problem solving. It is often described as the win-win
scenario.
i. Describe types of management negotiation strategies.
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Avoiding Conflict Resolution Style. the manager is not very cooperative in helping the other
individuals to achieve their goals, but neither is he/she aggressively pursuing his/her own preferred
outcomes in the situation. The original problem, conflict, or situation is never directly addressed or
resolved. However, avoiding behavior might be appropriate when the issue is perceived by the
manager to be trivial. It might also be an appropriate approach to use when there is no chance of
winning or when disruption would be very costly.
Competing Conflict Resolution Style. The competing style of resolving conflict is also known as the
win-lose approach. This approach may be appropriate when quick, decisive action is needed, such
as during emergencies. It can also be used to confront unpopular actions, such as urgent cost
cutting.
Accommodating Conflict Resolution Style. A manager using this style subjugates his/her own goals,
objectives, and desired outcomes to allow other individuals to achieve their goals and outcomes.
This behavior is appropriate when people realize that they are in the wrong or when an issue is
more important to one side than the other. This conflict resolution style is important for preserving
future relations between the parties.
Compromising Conflict Resolution Style. Compromise can also be referred to as bargaining or
trading. This behavior can be used when the goals of both sides are of equal importance, when
both sides have equal power, or when it is necessary to find a temporary, timely solution. It should
not be used when there is a complex problem requiring a problem-solving approach.
Collaborating Conflict Resolution Style is often described as the win-win scenario. Both sides
creatively work towards achieving the goals and desired outcomes of all parties involved. The
downside of this approach is that the process of collaborating mandates sincere effort by all parties
involved and it may require a lot of time to reach a consensus.
Student Activity:
• Ask students to search the Internet for information about
unions—their benefits, requirements, pressure strategies,
etc. Each student should evaluate the information obtained
to determine whether s/he would want to be a union
member. Each student should then write a short paper
persuading others to support her/his point of view.
j. Explain the effects of unionism on workers.
• http://www.minneapolisfed.org/publications_papers/pub_
display.cfm?id=2154
• http://www.bls.gov/opub/cwc/cm20050616ar01p1.htm
k. Describe the effects of unionism on businesses.
• http://businessknowledgesource.com/smallbusiness/how_
unions_affect_small_business_025808.html
2.03 Analyze cost/profit
relationships to guide business
decision-making.
Analyze the impact of
specialization/division of labor on
productivity
a. Define the following terms: specialization of labor,
division of labor, depth of jobs and scope of jobs.
Define the term specialization:
• The process of making the best use of resources in the production of goods and services
• We specialize in the production of certain goods and services and exchange them for other goods
and services.
• If you decided to produce all the goods and services you needed, rather than producing some and
trading for others, you would have less time to devote to the production of any one item, resulting
in production of fewer items than if you’d specialized.
Explain the scope of jobs.
• Defined as the number of different operations you do on the job and the frequency with which you
do them
• The lower your task level, the lower the scope of the job
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Low scope: The job is to put doors on cars on an assembly line.
Higher scope: The job is to put doors on cars, put seats in cars, and check the steering mechanism.
Describe the depth of jobs.
• Defined as the amount of control you have over the tasks that you do
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Low depth: There are strict guidelines you must follow, and you make very few decisions.
High depth: You follow general guidelines and set your own pace.
b. Describe how resources are involved in
specialization.
• Natural resources: We locate businesses where they
can be the most successful (e.g., ski lodge in the
mountains close to the slopes, orange groves in states
with warm climates).
• Capital goods: Specialized capital goods contribute to
increased production (e.g., use of robots on assembly
lines).
• Human resources: This occurs when people use their
different skills and abilities in jobs for which they are
best suited. People should do what they do best so
that the most goods and services can be produced.
c. Identify forms of specialization of human resources.
d. Describe specialization by trade or profession.
e. Describe specialization by stage of production.
f. Describe specialization by task.
• Specialization by trade or profession: This is the type of
work you perform to earn a living (e.g., teachers, farmers,
doctors, plumbers, artists, etc.).
• Specialization by stage of production: This form occurs
when more than one state of production is needed to
change a raw material into a finished product.
• Specialization by task: This form occurs when jobs are so
specialized that a worker does only one small part of the
total job (e.g., in a textile mill, one worker cleans wool,
another spins it into yarn, another dyes the yarn, and
another weaves it into a woolen fabric). This type of
specialization is also known as division of labor.
g. Explain the relationship between the depth and
scope of a job.
Example: How a manager’s scope and depth can change
during one day.
– The manager chooses advertising design and layout scheme for
an upcoming promotion (high depth, high scope)
– The manager makes out the weekly work schedule for
employees (high depth, low scope)
– The manager signs employee time cards (low depth, low scope)
– The manager evaluates employee performance according to the
owner’s standards (low depth, high scope)
• The scope and depth of certain jobs within a company can
change more than that of another employee in the same
company.
h. Describe the advantages of specialization.
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Simplified worker training
Increased employee interest and satisfaction
Increased production rates
Increased level of skill
Increased quality of work
Ease of transferring to a similar job
i. Explain the disadvantages of specialization.
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Increased interdependency
Increased boredom on the job
Decreased pride in work
Decreased morale and enthusiasm for the job
Increased chance of obsolescence because of
technological advances
• High degree of specialization may cause
difficulty transferring or obtaining another job
j. Describe ways to overcome the disadvantages of
specialization.
Explain ways that businesses combat the disadvantages associated with
specialization.
• Job enlargement: Management may combine job tasks to restore
wholeness (e.g., instead of limiting salespeople strictly to selling
merchandise, their jobs may be enlarged to help with displays, restocking
merchandise, etc.).
• Job rotation: Managers may also rotate employees periodically so that
they learn new job tasks and see how their old tasks relate to the new
tasks.
• Job enrichment: Managers add interest to a task to increase a job’s
depth, allowing workers to make more decision, set their own pace, and
supervise others.
• Job satisfaction: Managers may ask for and use employee suggestions;
allow flexible or alternative work schedules; praise work well done; and
provide cash incentives, contests, and bonuses.
2.03 Analyze cost/profit
relationships to guide business
decision-making.
Explain the impact of the law of
diminishing returns
a. Define the following terms: stages of production, theory of production,
production function, increasing returns, diminishing returns, law of
diminishing returns, law of variable proportions, marginal product, negative
returns, marginal cost, total revenue, and marginal revenue.
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Stages of production -Production within an economy can be divided into three main stages: primary, secondary and
tertiary.
Theory of Production deal with the relationship between the factors of production and the output of goods and
services
A production function provides an abstract mathematical representation of the relation between the production of a
good and the inputs used. A production function is usually expressed in this general form: Q = f(L, K)
Increasing returns to scale results if long run production changes are greater than the proportional changes in all
inputs used by a firm.
Diminishing Returns - A yield rate that after a certain point fails to increase proportionately to additional outlays of
capital or investments of time and labor.
Law of Diminishing Returns - (Sometimes also referred to as the law of variable proportions) When increasing
amounts of one factor of production are employed in production along with a fixed amount of some other production
factor, after some point, the resulting increases in output of product become smaller and smaller.
Marginal Product - The change in the quantity of total product resulting from a unit change in a variable input,
keeping all other inputs unchanged. Example: marginal product = change in total product/ change in variable input
Negative Returns - This occurs when a company or business has a financial loss or lackluster returns on an
investment during a specific period of time.
Marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the
cost of producing one more unit of a good.
Total revenue is the total receipts of a firm from the sale of any given quantity of output
Marginal revenue (MR) is the extra revenue that an additional unit of product will bring. It is the additional income
from selling one more unit of a good; sometimes equal to price.
b. Explain the stages of production.
Primary Production
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Primary production involves the extraction of raw materials (e.g. coal, iron, agricultural commodities).
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Raw materials can be:
– Extracted – e.g. coal, iron ore, oil, gas and stone
– Harvested / collected – e.g. fish
– Grown – e.g. timber, cereal crops
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There is little value added in primary production. The aim is usually to produce the highest quantity at lowest cost to a
satisfactory standard.
Secondary Production
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Secondary production involves transforming raw materials into goods. There are two main kinds of goods:
– Consumer goods – e.g. washing machines, DVD players. As the name implies, these are used by consumers
– Industrial / capital goods – e.g. plant and machinery, complex information systems. Industrial and capital goods are
used by businesses themselves during the production process.
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In the secondary production sector, value is “added” to the raw material inputs. For example, foodstuffs are transformed
into ready meals for sale in supermarkets; metals, fabrics, and plastics are transformed into motor vehicles.
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There are many different industry sectors in secondary production. For example:
– Construction
– Electronic instruments
– Pharmaceuticals (drugs)
– House-building
Tertiary Production
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Tertiary production is associated with the provision of services (an intangible product). As with the secondary sector, there
are many tertiary production markets.
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Good examples include:
– Hotels
– Private healthcare and education
– Accountants
– Tourism
c. Describe the impact of the law of diminishing returns
on production decisions.
• The law of diminishing returns says that
adding more of one input while holding other
inputs constant results eventually in smaller
and smaller increases in added output.
• What the law of diminishing returns says is
that as one continues to add workers,
eventually one will reach a point where
increasing returns stop and decreasing returns
set in.
d. Explain how total revenue and marginal revenue are
used to determine the amount of output that will
generate the most profit.
• The change in total revenue resulting from a
change in the quantity of output sold.
Marginal revenue indicates how much extra
revenue a firm receives for selling an extra
unit of output.
• marginal revenue = change in total revenue/
change quantity
Student Activity:
• Ask students to participate in a small-group
activity to construct paper boxes following the
instructions on page 5-30 and using the pattern
on page 5-31. Determine the number of boxes
that can be made by a three-member group in
one minute. Continue the construction process,
adding one worker at a time and checking
productivity at one-minute intervals. Find the
point at which the additional person does not
increase productivity. Discuss with the class how
the principle of diminishing returns relates to
productivity.
2.04 Understand economic
indicators to recognize economic
trends and conditions.
Describe the economic impact of
inflation on business
Define the following terms: inflation, inflation rate, deflation,
Consumer Price Index, standard of living, targeted inflation rate,
and price stability.
• INFLATION: A persistent increase in the average price level in the
economy. Inflation occurs when the AVERAGE price level (that is, prices IN
GENERAL) increases over time.
• INFLATION RATE: The percentage change in the price level from one period
to the next. The two most common price indices used to measure the
inflation are the Consumer Price Index (CPI) and the GDP price deflator.
• DEFLATION: An extended decline in the average level of prices. This is the
exact opposite of inflation
• CONSUMER PRICE INDEX: An index of prices of goods and services
typically purchased by urban consumers.
• STANDARD OF LIVING: In principle, an economy's ability to produce the
goods and services that consumers use to satisfy their wants and needs. In
practice, it is the average real gross domestic product per person--usually
given the name per capita real GDP.
• PRICE STABILITY: The condition in which the average price level in the
economy does not change or changes very slowly.
Describe causes of inflation.
• The two basic types (or causes) of inflation:
demand-pull inflation and cost-push inflation.
• Demand-pull inflation, as the name clearly
indicates, results when economy-wide shortages
are created by increases in aggregate demand.
• Cost-push inflation results when an economywide shortages are created by decreases in
aggregate supply, which are so named because
they are more often than not triggered by
increases in production cost.
Explain how inflation impacts the
economy.
• INFLATION PROBLEMS: Two notable problems are
associated with inflation: uncertainty and haphazard
redistribution.
• Inflation, especially inflation that varies from month to
month and year to year, makes long-term planning quite
difficult.
– Prices, wages, taxes, interest rates, and other nominal values
that enter into consumer, business, and government planning
decisions can be significantly affected by inflation.
• Moreover, inflation tends to redistribute income and
wealth in a haphazard manner; some people win and some
people lose. But this redistribution might not that desired
by society, failing to promote any of the basic economic
goals of efficiency, equity, stability, growth, or fullemployment.
Describe the relationship between
price stability and inflation.
• Price stability is commonly indicated by the
inflation rate, calculated as percentage changes in
either the Consumer Price Index (CPI) or the GDP
price deflator. However, price stability is more
generally the ABSENCE of large or rapid increases
or decreases in the price level.
• Inflation results when the AVERAGE of these
assorted prices follows an upward trend. Inflation
is the most common phenomenon associated
with the price level.
Explain problems associated with
deflation.
• Like inflation, deflation occurs when the AVERAGE
price level decreases over time. While some prices
might decrease, other prices could increase or remain
unchanged, so long as the AVERAGE follows a
downward trend.
• Deflation is a rare bird indeed in our economy and
typically happens only when we're in a prolonged
period of stagnation. We might see some deflation
during a fairly lengthy recession, but more than likely
deflation saves itself for the occasional depression that
dots our economic landscape.
Discuss reasons why the inflation rate
should be above zero.
• When the rate falls below zero, as it did briefly
in 1954, average prices actually are falling
(deflation). While lower prices may seem ideal
at first from a consumer's point of view,
deflation leads to rising unemployment and
falling production, a situation from which it is
extremely difficult to recover. An inflation rate
of 1 - 2.5% currently seems to be acceptable
by many economists.
Explain how businesses can use the Consumer Price
Index & Discuss the purpose of the Consumer Price
Index (CPI).
• The CPI is compiled and published monthly by the
Bureau of Labor Statistics (BLS), using price data
obtained from an elaborate survey of 25,000 retail
outlets and quantity data generated by the Consumer
Expenditures Survey.
• The CPI is unquestionably one of the most widely
recognized macroeconomic price indexes, running
second only to the Dow Jones Industrial Average in the
price index popularity contest.
• It is used not only as an indicator of the price level and
inflation, but also to convert nominal economic
indicators to real terms and to adjust wage and income
payments (such as Social Security) for inflation.
Describe how the Consumer Price
Index is determined
• The CPI is calculated by taking price changes for
each item in the predetermined basket of goods
and averaging them; the goods are weighted
according to their importance. Changes in CPI are
used to assess price changes associated with the
cost of living.
http://www.investopedia.com/video/play/whatis-the-consumer-price-index-CPI#axzz1YauKv934
Identify the major kinds of consumer
spending that make up the Consumer
Price
Index.
• The CPI represents all goods and services purchased for consumption by
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the reference population (U or W) BLS has classified all expenditure items
into more than 200 categories, arranged into eight major groups. Major
groups and examples of categories in each are as follows:
FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full
service meals, snacks)
HOUSING (rent of primary residence, owners' equivalent rent, fuel oil,
bedroom furniture)
APPAREL (men's shirts and sweaters, women's dresses, jewelry)
TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle
insurance)
MEDICAL CARE (prescription drugs and medical supplies, physicians'
services, eyeglasses and eye care, hospital services)
RECREATION (televisions, toys, pets and pet products, sports equipment,
admissions);
EDUCATION AND COMMUNICATION (college tuition, postage, telephone
services, computer software and accessories);
OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts
and other personal services, funeral expenses).
Explain how the Consumer Price Index
is used to find the rate of inflation
• The CPI measures the average change over
time in the prices paid by urban consumers for
a representative selection of consumer goods
and services.
• The rate of inflation is a measure of how fast
prices are rising. It is computed as the
percentage increase in the level of prices
between two time periods.
Describe limitations on the use of the
Consumer Price Index
• The CPI is subject to both limitations in application and limitations in
measurement.
• Limitations of application
– The CPI may not be applicable to all population groups. For example, the CPI-U
is designed to measure inflation for the U.S. urban population and thus may
not accurately reflect the experience of people living in rural areas. Also, the
CPI does not produce official estimates for the rate of inflation experienced by
subgroups of the population, such as the elderly or the poor.
– The CPI cannot be used to measure differences in price levels or living costs
between one place and another; it measures only time-to-time changes in
each place.
• Limitations in measurement
– Limitations in measurement can be grouped into two basic types, sampling
errors and non-sampling errors.
– Sampling errors. Because the CPI measures price changes based on a sample
of items, the published indexes differ somewhat from what the results would
be if actual records of all retail purchases by everyone in the index population
could be used to compile the index.
– Non sampling errors. Nonsampling errors are caused by problems of price
data collection.
2.04 Understand economic
indicators to recognize economic
trends and conditions.
Discuss the measure of consumer
spending as an economic indicator
Define the term Consumer Confidence
Index (CCI)
• The Conference Board defines the Consumer
Confidence Survey as “a monthly report
detailing consumer attitudes and buying
intentions, with data available by age, income
and region.”
Describe how consumer spending
reacts to shifts in the well-being of the
economy
• Since consumer spending is so important to the
nation's financial health, the Consumer Confidence
Index is one of the most accurate and closely watched
economic indicators. The index is based on a survey of
five questions posed to 5,000 households, measuring
their optimism on the health of the economy. The CCI,
however, is a lagging indicator, so, whatever the survey
says, remember that it doesn't tell us what is going to
happen, but what has happened and if it can be
expected to continue.
Explain how the Consumer Confidence
Index functions
• Each month the Conference Board surveys 5,000 U.S.
households. The survey consists of five questions that ask
the respondents' opinions about the following:
Current business conditions.
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Business conditions for the next six months.
Current employment conditions.
Employment conditions for the next six months.
Total family income for the next six months. Survey participants
are asked to answer each question as "positive", "negative" or
"neutral".
•
The results from the Consumer Confidence Survey are
released on the last Tuesday of each month at 10am EST.
Describe how businesses use and react
to changes in the Consumer
Confidence
Index
• Manufacturers, retailers, banks and the government
monitor changes in the CCI in order to factor in the data in
their decision-making processes. While index changes of
less than 5% are often dismissed as inconsequential, moves
of 5% or more often indicate a change in the direction of
the economy.
• A month-on-month decreasing trend suggests consumers
have a negative outlook on their ability to secure and retain
good jobs. Thus, manufacturers may expect consumers to
avoid retail purchases, particularly large-ticket items that
require financing. Manufacturers may pare
down inventories to reduce overhead and/or delay
investing in new projects and facilities. Likewise, banks can
anticipate a decrease in lending activity, mortgage
applications and credit card use.
Discuss government’s options when
the Consumer Confidence Index
indicates a decreasing trend
• When faced with a down-trending index, the
government has a variety of options, such as issuing a
tax rebate or taking other fiscal or monetary action to
stimulate the economy.
• Conversely, a rising trend in consumer confidence
indicates improvements in consumer buying patterns.
• Manufacturers can increase production and hiring.
Banks can expect increased demand for credit. Builders
can prepare for a rise in home construction and
government can anticipate improved tax revenues
based on the increase in consumer spending.
2.04 Student Activity
• Ask students to interpret the Consumer Price
Index over a 10-year period and draw conclusions
about the prices of food, clothing, and medical
care. Each student should collaborate with a
classmate to discuss the pair’s findings and
conclusions
• CPI Calculator: Online Consumer Price Index
Calculator
www.cpi.memphiscapital.com/
• http://inflationdata.com/Inflation/Inflation_Calcu
lators/Inflation_Calculator.asp#calcresults
2.04 Understand economic
indicators to recognize economic
trends and conditions.
Explain the concept of Gross
Domestic Product (GDP)
Define the following terms:
• Gross Domestic Product (GDP) : The total market value of all final goods
and services produced within the political boundaries of an economy
during a given period of time, usually one year. This is the official measure
of the aggregate output produced by the economy.
• Personal consumption expenditures: the official government measure of
consumption expenditures undertaken by the household sector. It seeks to
quantify that portion of gross domestic product that is purchased by the
household sector and which is used, in theory at least, to satisfy wants and
needs.
• Gross Private Domestic Investment: The official measure of investment
expenditures on gross domestic product by the business sector. Gross
private domestic investment averages about 15 percent of gross domestic
product. These expenditures come in two broad categories: (1) fixed
investment and (2) changes in private inventories.
• GOVERNMENT PURCHASES OF GOODS AND SERVICES: Expenditures on
final goods and services (that is, gross domestic product) undertaken by
the government sector. Government purchases are used to operate the
government (administrative salaries, etc.) and to provide public goods
(national defense, highways, etc.). These are expenditures on final goods
by all three levels of government: federal, state, and local governments.
Define the following terms:
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Net Exports of Goods and Services: The official measure of net exports of gross
domestic product by the foreign sector, which is the difference between
exports and imports. Net exports of goods and services average about 2
percent of gross domestic product, with exports and imports individually in
the range of about 10 percent.
TRADE DEFICIT: Formally termed a balance of trade deficit, a condition in
which a nation's imports are greater than exports. In other words, a country is
buying more stuff for foreigners than foreigners are buying from domestic
producers.
TRADE SURPLUS: Formally termed a balance of trade surplus, a condition in
which a nation's exports are greater than imports. In other words, a country is
buying less stuff from foreigners than foreigners are buying from domestic
producers.
Uncounted production: Items that do not go through the standard markets
and are not counted.
Underground economy: the exchange of goods and services which are hidden
from official view. Examples of such activities range from babysitting “off the
books” to selling narcotics.
Double counting results if the value of an intermediate good is included in the
gross domestic product more than once. Such double counting would
seriously overstate gross domestic product.
Identify the categories of goods and
services that make up GDP
• The monetary value of all the finished goods and services produced
within a country's borders in a specific time period, though GDP is
usually calculated on an annual basis. It includes all of private and
public consumption, government outlays, investments and exports
less imports that occur within a defined territory.
GDP = C + G + I + NX
where:
"C" is equal to all private consumption, or consumer spending, in a
nation's economy
"G" is the sum of government spending
"I" is the sum of all the country's businesses spending on capital
"NX" is the nation's total net exports, calculated as total exports
minus total imports. (NX = Exports - Imports)
Describe problems encountered in
calculating GDP
• Critics of using GDP as an
economic measure say the statistic does not
take into account the underground economy transactions that, for whatever reason, are not
reported to the government. Others say that
GDP is not intended to gauge material wellbeing, but serves as a measure of a nation's
productivity, which is unrelated.
Explain the importance of a country's
GDP
Describe ways to increase GDP
• There are really only 2 ways you can increase
GDP.
• First, have more people working.
• Second, have people work more efficiently
Describe how the government
responds to changes in GDP
• A significant change in GDP, whether up or down, usually
has a significant effect on the stock market. It's not hard to
understand why: a bad economy usually means lower
profits for companies, which in turn means lower stock
prices. Investors really worry about negative GDP growth,
which is one of the factors economists use to
determine whether an economy is in a recession.
• As a result of such a wide-spread global recession, the
economies of virtually all the world's developed and
developing nations suffered extreme set-backs and
numerous government policies were implemented to help
prevent a similar future financial crisis.
Describe ways that businesses respond
to changes in GDP
• When GDP and other economic indicators are on
the rise, producers become hopeful about the
future, and they buy new equipment, build new
facilities, or expand their current operations.
• This increase in capital-goods investment
encourages the expansion of other economic
activities. Producers continue to encourage this
expansion by increasing their inventory levels to
be prepared for the increase in demand that they
anticipate.
2.04 Understand economic
indicators to recognize economic
trends and conditions.
Discuss the impact of a nation’s
unemployment rates
Define the following terms:
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UNEMPLOYMENT RATE: The proportion of the civilian labor force 16 years or older that is actively seeking
employment, but is unemployed and not engaged in the production of goods and services.
FRICTIONAL UNEMPLOYMENT: Unemployment attributable to the time required to match production
activities with qualified resources. Frictional unemployment essentially occurs because resources,
especially labor, are in the process of moving from one production activity to another. Employers are
seeking workers and workers are seeking employment, the two sides just have not matched up.
STRUCTURAL UNEMPLOYMENT: Unemployment caused by a mismatch between workers' skills and the
skills needed for available jobs. Structural unemployment essentially occurs because resources, especially
labor, are configured (trained) for a given technology but the economy demands goods and services using
another technology.
CYCLICAL UNEMPLOYMENT: Unemployment attributable to a general decline in macroeconomic activity,
especially expenditures on gross domestic product, that occurs during a business-cycle contraction. When
the economy dips into a contraction, or recession, aggregate demand declines, so less output is produced
and fewer workers and other resources are employed.
SEASONAL UNEMPLOYMENT: Unemployment attributable to relatively regular and predictable declines in
particular industries or occupations over the course of a year, often corresponding with the climatic
seasons.
TECHNOLOGICAL UNEMPLOYMENT (e.g. due to the replacement of workers by robots) might be counted
as structural unemployment. Alternatively, technological unemployment might refer to the way in which
steady increases in labor productivity mean that fewer workers are needed to produce the same level of
output every year.
FULL EMPLOYMENT: The state that occurs when all of the economy's resources are engaged in the
production of output. In practice, an economy is considered to be at full employment when the
unemployment rate is around 5 to 5 1/2 percent and the capacity utilization rate of capital is about 85
percent.
Discuss individual costs of unemployment.
• Unemployment creates personal hardships for the owners of the
unemployed resources. When resources do not produce goods, their
owners do not earn income. The loss of income results in less
consumption and a lower living standard.
• The personal hardships suffered by the unemployed are of concern to
government leaders for reasons that are both in the common good and
somewhat more selfish.
– In terms of the common good, the unemployed are members of society just
like everyone else and deserve the opportunities to enjoy the fruits of a
productive economy. An affluent society "should" be able to provide for
everyone. In addition, social problems that cause personal hardships to other
members of society tend to increase with the personal hardships of the
unemployed, including crime, divorce, suicides, etc.
– Government leaders are also concerned with the personal hardships of the
unemployed for more selfish reasons. When the voting public is unhappy, they
tend to elect new leaders and toss the old ones out of office. There are few
things that voters like less than suffering the personal hardships that come
with unemployment. Presidential elections have been decided on a few
million votes. A typical business-cycle contraction can add four to five million
workers to the ranks of the unemployed, enough votes to change the
"employment" status of any incumbent President seeking re-election.
Describe economic benefits of unemployment.
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The general purpose of the unemployment compensation system is the provide
financial assistance to unemployed workers. The modern system, however, has
two interrelated functions.
Financial Assistance: First, it does provide needed financial assistance to workers
who are involuntarily unemployed. This need tends to be most acute during
business-cycle contractions, but it is valuable during all periods. Without such
assistance, workers who are unemployed only temporarily are likely encounter
serious financial and personal hardships (bankruptcy, home foreclosure, etc.) from
which they might never recover.
Economic Stability: Second, it helps stabilize the macroeconomy during businesscycle contractions. Because unemployed workers continue to receive income, they
are able to continue consumption expenditures, which prevents aggregate
production from dropping as much as it might have otherwise. This, as such,
prevents the economy from slipping deeper into a business-cycle contraction.
Unemployment may have advantages as well as disadvantages for the overall
economy. Notably, it may help avert runaway inflation, which negatively affects
almost everyone in the affected economy and has serious long term economic
costs. As in the Marxian theory of unemployment, special interests may also
benefit: some employers may expect that employees with no fear of losing their
jobs will not work as hard, or will demand increased wages and benefit. According
to this theory, unemployment may promote general labour productivity and
profitability by increasing employers monopsony like power (and profits).
Explain theories of the causes of unemployment
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The five key reasons for unemployment are: (1) job losers, (2) job leavers, (3) those of have
completed temporary jobs, (4) re-entrants, and (5) new entrants.
Job Losers: A job loser is an unemployed person who has been involuntarily terminated or
laid off from a job. More specifically, a job loser is:
– A person who has been permanently terminated from a job and is actively seeking
employment.
– A person who has been temporarily laid off from a job and is not actively seeking
employment due to expectations being called back to work within six months.
Job Leavers: A job leaver is a person who has voluntarily quit one job and is actively seeking
employment elsewhere.
Completed Temporary Job: An unemployed person can also be one who has recently
completed a temporary job and is actively seeking employment elsewhere.
Re-entrants: A re-entrant is a person who had previously been classified as an employed
person, but has been out of the labor force for a period of time before actively seeking
employment once again.
New Entrants: A new entrant is a person who has never before been employed and is actively
seeking employment for the first time.
The causes of unemployment are complex. Some kinds are long term: technical
unemployment happens when people's skills are made redundant. Some are medium term:
cyclical unemployment happens because there is inadequate demand to keep production
going. Some are short term: frictional unemployment happens because people change jobs
or locations. Seasonal work, casual employment and subemployment are patterns of work
which lead to people being employed only for short periods at a time.
Exclusion from the labour market takes many forms: some people can opt for early
retirement, further education or domestic responsibility, and others cannot. If poor people
are unemployed more, it is not just because they are more marginal in the labour market; it
is also because they have fewer choices, and because people who become classified as
'unemployed' are more likely to be poor.
Explain why the unemployment rate
understates employment conditions
• A couple of measurement problems exist that could cause the official
unemployment rate to be understated or overstated.
• Understated: Anyone with a paying job is officially counted as being
employed. Unfortunately, this includes those working part-time, who want
to work full-time.
– In theory, a person working 20 hours a week, who is willing and able to work
40 hours a week should be considered as "half employed." The official
unemployment rate calculation only considers such workers as employed.
– Moreover, to be officially counted as unemployed a person must be actively
seeking a job. Unfortunately, this excludes discouraged workers who have
stopped looking for employment. They are willing and able to work, and in
principle should be considered as unemployed, but they have simply stopped
looking.
– The official unemployment rate calculation does not consider these workers as
unemployed nor part of the labor force.
• Including both part-time workers and discouraged workers would tend to
increase the unemployment rate.
Describe the costs of unemployment
for a nation
• We know that high unemployment is not a good thing, but you may not be
aware of all of the reasons. Unemployment clearly has costs for the
person who is jobless, but the true costs extend beyond the individual or
the family affected.
• Unemployment costs the economy as a whole. If we are experiencing
unemployment, then we are not using all of our labor resources.
• Unemployment has a domino effect as well: As people lose their jobs, they
cut back on spending, which causes other workers to lose their jobs.
Unemployed people will likely postpone the purchase of a new car, and
not go out to eat. This may cause auto workers and waiters to lose their
jobs as well.
• Unemployment increases government expenditures on unemployment
benefits, food stamps, etc., while decreasing income tax revenue,
potentially creating a budget deficit.
• Probably the most serious and most difficult to quantify are the personal
costs. Higher unemployment is associated with increasing rates of suicide,
domestic violence, drug abuse, and health problems.
Student Activity
• Ask students to assume that the United States is in a recessionary
period and that consumers are worried about losing their jobs and
experiencing a reduction in wages. Each student should explain in a
brief paragraph how this fear among consumers will be reflected in
GDP.
Or
• Instruct students to determine the current unemployment rate in
their state, and compare this with the national unemployment rate.
Students should then identify ways that the state’s fiscal policy
might account for the differences identified. Engage the students in
a class discussion about their findings.
• http://www.investopedia.com/ask/answers/199.asp
• http://www.search.com/reference/unemployment
2.04 Understand economic
indicators to recognize economic
trends and conditions.
Explain the economic impact of
interest-rate fluctuations
Define the following terms:
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The interest rate is the yearly price charged by a lender to a borrower in order for
the borrower to obtain a loan. This is usually expressed as a percentage of the
total amount loaned.
The nominal interest rate, is one where the effects of inflation have not been
accounted for. Changes in the nominal interest rate often move with changes in
the inflation rate, as lenders not only have to be compensated for delaying their
consumption, they also must be compensated for the fact that a dollar will not buy
as much a year from now as it does today.
Real interest rates are interest rates where inflation has been accounted for.
The interest-rate fluctuation are interest rate changes due to changes in supply
and demand for bonds.
DEFAULT RISK: The probability that a borrowing agent will not pay in full the
agreed interest and/or principal.
liquidity risk is the risk that a given security or asset cannot be traded quickly
enough in the market to prevent a loss (or make the required profit).
Maturity risk refers to the risk that is associated with uncertainty of interest rate.
Discuss causes of interest-rate
fluctuations.
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The Federal Reserve directs interest rates as a means of controlling economic
growth in the U.S. If the economy grows too fast, it will experience inflation. That's
when prices rise so high that no one can afford anything.
The following are some of the factors that affect a country's economic growth:
The financial stability of major companies
The financial stability of consumers and whether or not they feel comfortable
spending money
The amount of national debt
Stock and bond market valuations
The amount of money pouring into investments
Consumer confidence in the current presidential administration
When the Federal Reserve instructs the central banks to raise the Treasury bill or
prime rate, banks make money on the increased margin. However, since
consumers cut back on their spending, banks extend fewer loans and credit lines,
so their profits may experience a decline.
Explain the impact of interest rate
fluctuations on an economy.
• Interest rates are determined by the Federal
Reserve Board, which meets on a regular basis
throughout the year to review how the economy
is performing.
• During slowing economies, or recessions, the
Federal Reserve will lower interest rates to
encourage consumer spending.
• When the economy is booming, the board may
raise rates to capitalize on your spending and
keep inflation in check.
•
Describe the relationship between
interest rates and the demand for
money
Money generally pays very little interest (and in the case of
paper currency, none at all) but it can be used to purchase
goods and services.
• Bonds do pay interest, but cannot be used to make
purchases, as the bonds must first be converted into
money. If bonds paid the same interest rate as money,
nobody would purchase bonds as they are less convenient
than money.
• Since bonds pay interest, people will use some of their
money to purchase bonds. The higher the interest rate, the
more attractive bonds become. So a rise in the interest rate
causes the demand for bonds to rise and the demand for
money to fall since money is being exchanged for bonds.
• So a fall in interest rates cause the demand for money to
rise.
Describe the relationship between
inflation and interest rates
• There is a strong correlation between interest
rates and inflation.
• Interest rates reflect the cost of money, such
as the rate you pay when you borrow money
to buy a house or spend on your credit card.
• Inflation is the cost of things.
• Most of the time, when inflation increases, so
do interest rates.
Discuss factors that create differences in the amount of
interest charged on credit transactions
• Typical credit cards have interest rates
between 7 and 36% in the U.S., depending
largely upon the bank's risk evaluation
methods and the borrower's credit history,
levels and kinds of risk, borrowers’ and
lenders’ rights, and tax considerations).
Describe kinds of risk associated with
variances in interest rates (i.e., default,
liquidity, and maturity).
• Interest rate risk is the risk (variability in
value) borne by an interest-bearing asset,
such as a loan or a bond, due to variability of
interest rates. In general, as rates rise, the
price of a fixed rate bond will fall, and vice
versa. Interest rate risk is commonly measured
by the bond's duration.
Explain how fiscal policies can affect
interest rates.
• Expansionary fiscal policy pushes interest
rates up, while contractionary fiscal policy
pulls interest rates down.
• Expansionary: When output increases, the
price level tends to increase as well.
• Contractionary: When output decreases, the
price level tends to fall as well.
Student Activity
• Direct students to read articles about trends in
interest rates. Students should summarize the
articles, identifying the nature of the trends
and reasons that they are occurring. Students
should also determine the impact that these
trends are having on local businesses and
discuss their findings with the class.
• Websites: CNN Money, Wall Street Journal,
MSN Money
2.04 Understand economic
indicators to recognize economic
trends and conditions.
Determine the impact of business
cycles on business activities
Define the following terms:
• Define business cycles.
– The ups and downs in economic activity
– Business fluctuations
– Periods of expansion and contraction in economic
activities (i.e., production, consumption,
exchange, and distribution)
– They affect all aspects of our economy, including
employment, prices, incomes, and production.
Explain the phases of business cycles.
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Expansion: The growth part of the cycle; a time of economic prosperity; everyone has a hopeful
economic outlook and spends more money (i.e., consumers buy more durable goods; producers
invest in new equipment that enables them to produce more goods and services); demand,
therefore, is increasing which requires more workers to be hired and more factories and businesses
to be built; more money is put into the circulation and interest rates are decreased by the Federal
Reserve System.
Peak: The high point of the economic prosperity that has existed; demand begins to exceed
production capacities, and producers raise prices to offset the high demand; interest rates begin to
rise; demand for all resources exceeds their availability; everyone has a less hopeful economic
outlook, and consumers begin to save more so that their spending decreases; economic activities
level off.
Contraction: The demand for goods/services begins to fall and unemployment rises; a bad time for
businesses since consumers are spending less and saving more; businesses’ bottom lines suffer, and
some are experiencing losses to the point that they are forced to close; demand continues to fall,
and production is decreased; inventories build up causing workers to lose their jobs, thereby
further decreasing the demand for goods and services; prices decrease to attract customers;
interest rates decrease. When a contraction lasts for six months, it’s considered a recession. If a
recession continues and is severe, it’s a depression; many people lose their jobs, and businesses
fail.
Trough: The final phase of a business cycle; reached when economic activities stop their decline.
This is the low point of economic activity when unemployment is very high, and even more
businesses fail. This phase stays in effect until consumers and producers become more hopeful
about the economy and start to buy more goods and services.
Explain that when studying
business cycles, economists
examine fluctuations in the level
of an economy’s total output.
• Total output is based on real
gross domestic product (GDP).
• Real GDP is GDP that has been
adjusted for inflation.
• As a country’s real GDP
increases, economic activities
increase; the
• economy grows.
• As a country’s real GDP
decreases, so do its economic
activities; the economy
declines.
Explain the benefits of a growing
economy.
• Provides a higher standard
of living
• Creates new and additional
jobs
• Enables the government to
fulfill its duties more
thoroughly
• Resolves domestic problems
Describe the unpredictability of
business cycles.
Discuss the importance of
understanding business cycles.
• There’s no exact way to
predict the length or
severity of a business cycle.
• Some have lasted two years,
others 10 years.
• It’s difficult to predict the
beginning and end of cycles.
• This heightens the
uncertainty of producers
and consumers.
• Businesspeople can take
steps to avoid the extreme
ups and downs of the cycle
by anticipating changes
needed in employment,
production, pricing, and
purchasing.
Discuss internal causes of business cycles that
take place within the economic system itself.
• Aggregate demand: This is the total demand for an
economy’s goods and services and can pull GDP up or down
to cause business cycles. When it’s rising, businesses
increase production, more workers are hired, and
employees earn more to spend on goods and services. If
aggregate demand continues to grow to the point that
production can’t meet demand, prices will rise rapidly—
known as inflation, and consumers have to pay more to buy
the same goods and services. If aggregate demand
decreases, production and employment will decrease, and
production will slow. Recessions or depressions result when
aggregate demand stays too low for a long time. Once it
starts rising again, expansion and prosperity return.
Discuss internal causes of business cycles that
take place within the economic system itself.
• Money supply: This is the total quantity of money that exists at one
time in a nation, and as it goes up or down, so does the economy.
The federal government restricts the flow of money by raising taxes,
raising the interest rates to borrow money, and purchasing fewer
goods and services to run the government. The amount of money
in circulation can be increased when the federal government
spends more, lowers interest rates, and lowers taxes. When interest
rates are low, more money can be borrowed to build houses, office
buildings, and industrial plans. Greater production results in more
available work and lowered unemployment rates. This is a period of
expansion. When money is in short supply, unemployment will be
high, business activities slow down, and a period of contraction
begins.
Discuss internal causes of business cycles that
take place within the economic system itself.
• Investment in capital goods: When producers
are hopeful about the future of business, they
buy new equipment and build or expand their
business facilities. This investment encourages
the expansion of economic activities. When
producers decrease their investment in capital
goods, economic activities contract.
Discuss internal causes of business cycles that
take place within the economic system itself.
• Inventory levels: When producers are
optimistic about business activity, they
increase their inventory levels to be prepared
for the increase in demand, thereby
expanding economic activities. When they feel
less hopeful, they decrease their buying of
new goods and try to sell the ones on hand,
thereby causing the economy to contract.
Explain external causes of business cycles that
take place outside the economic system.
• Political changes: A change in the political party in power can cause
changes in economic activities. For example, if the elected officials
support business interests, economic activities are likely to expand.
• Climatic changes: Many jobs are affected by climatic conditions.
Extreme weather conditions, such as droughts, floods, and
blizzards, can negatively affect many economic activities.
• International relations: The interaction of our country with other
countries can expand or contract economic activities. For example,
a war or conflict may increase the production of defense materials,
thereby expanding our economic activities. When the conflict ends,
the same quantity of defense materials will no longer be needed,
thereby contracting economic activities.
• Discoveries and innovations: The discovery of new products,
techniques, and resources can stimulate economic activities. Large
sums of money must be invested to develop and improve the
products, and a variety of new jobs is created. Since these occur
irregularly, they contribute to changes in economic activities.
2.05 Understand and follow
company rules and regulations to
maintain employment
Follow chain of command
Discuss the importance of
following the chain of command.
• Chain of Command – the
line of authority within an
organization
• The Chain of Command
begins with the Chief
Executive Officer (CEO)
followed by senior
managers, mid-level
managers, then lower-level
managers
Discuss the use of the chain of
command to resolve issues or
problems.
• This kind of organization
means that problems are
addressed at the lowest
possible level. Only
problems that cannot be
handled by an immediate
supervisor are brought to
the attention of higher-level
managers.
Explain possible consequences of failing to follow the
chain of command
•
When employees frequently ignore the chain of command, it may affect the morale
of supervisors and managers. Companies without a clear chain of command can
create an atmosphere of uncertainty and chaos, which affects the morale of all
workers in the organization. Poor company morale may lead to high employee
turnover and lower productivity.
The worker may be viewed as:
• having no respect for the structure that is in place.
• is a troublemaker.
• is looking to advance in the company without following procedures or earning the
position.
• is a back-stabber.
Consequences:
• Engenders a lack of trust among co-workers and higher-ups.
• Overlooked for promotions or better assignments.
• Work environment becomes tense.
• Reputation earned is not positive.
• Other department supervisors won't accept a lateral transfer
Describe situations in which bypassing
the chain of command is appropriate
•
•
An abusive manager may be reported through affidavits and documentation to the
human resources personnel, who in turn will pass the information to the
manager's supervisor. If corrective action is not taken in a timely manner, there are
additional steps to document and submit that now involve more people in the
chain of command.
However, if the situation escalates to different levels without resolution, an
employee may be forced to go beyond the company's walls to remedy the
problem.
Going beyond the company's walls:
• For safety violations and endangerment: OSHA
• For discrimination, civil rights violations, sexual harassment: Legal Firm, Attorney
General
• For fraud involving government funding: Department of Justice, U.S. Office of
Special Counsel.
• The Media.
• There are law firms that specialize in serving whistle blowers, but be aware that
not all these firms are created equal, some are a scam and others have serious
conflicts of interest depending on the companies involved.
Student Activity:
• Demonstrate techniques used to follow a chain of
command
• Ask each student to develop a short report about the
chain of command for a school-based enterprise,
her/his employer, or some other local business. S/he
should identify and draw the chain of command,
explain the importance of following it, provide specific
examples of when and how employees should follow
the chain of command at that business, describe
situations in which it might be appropriate for an
employee to bypass the chain of command, and
discuss techniques used to work through the chain of
command on a daily basis.
2.06 Utilize critical-thinking skills to
determine best options/outcomes.
Use time-management skills (PD:019
Define the terms
•
•
•
•
•
•
•
Time management is the act or process of exercising conscious control over the
amount of time spent on specific activities, especially to increase efficiency or
productivity.
Stress - In psychology, a state of bodily or mental tension resulting from factors
that tend to alter an existent equilibrium.
In psychology, procrastination refers to the act of replacing high-priority actions
with tasks of low-priority, and thus putting off important tasks to a later time.
Free time - Freedom from time-consuming duties, responsibilities, or activities.
Weekly Master List - a simple weekly planner to manage and protect your planned
activities; manage your time by managing your activities by protecting the time
slots you plan for your tasks. EXAMPLE:
http://www.businessballs.com/timemanagement.htm
To-Do Lists are prioritized lists of all the tasks that you need to carry out. They list
everything that you have to do, with the most important tasks at the top of the
list, and the least important tasks at the bottom.
ABC principle - “A” section for tasks to be done that day; “B” to be done within the
week; “C” for things within the month.
List benefits of time management.
•
•
•
•
•
•
•
•
•
•
•
•
Be more effective in your work
Organize your life
Make better decisions
Set and achieve inspiring goals
Enjoy a better work-life balance
Create habits that work for you
Manage your workload
Do more... or less
Appreciate the value of your time
Know what matters to you
Do what matters to you
Achieve what you 'keep meaning to'
Explain the time-management process
• The first step to physically managing your time
is to know where it's going now and planning
how you're going to spend your time in the
future.
• You should start each day with a time
management session prioritizing the tasks for
that day and setting your performance
benchmark.
Use time-management principles.
Learn to delegate and/or outsource.
• For effective time management, you need to let other people carry some of the load.
Establish routines and stick to them as much as possible.
• While crises will arise, you'll be much more productive if you can follow routines most of the time.
Get in the habit of setting time limits for tasks.
• For instance, reading and answering email can consume your whole day if you let it. Instead, set a
limit of one hour a day for this task and stick to it.
Be sure your systems are organized.
• Are you wasting a lot of time looking for files on your computer? Take the time to organize a file
management system. Is your filing system slowing you down? Redo it, so it's organized to the point
that you can quickly lay your hands on what you need.
Don't waste time waiting.
• it's impossible to avoid waiting for someone or something. But you don't need to just sit there and
twiddle your thumbs. Always take something to do with you, such as a report you need to read, a
checkbook that needs to be balanced, or just a blank pad of paper that you can use to plan your
next marketing campaign. Technology makes it easy to work wherever you are; your PDA and/or
cell phone will help you stay connected.
• You can be in control and accomplish what you want to accomplish - once you've come to grips with
the time management myth and taken control of your time.
Describe ways to manage time.
'Must have' time management tools
• Planners. Whether they're electronic or paper based, daily planners should form the backbone of
personal organizational skills. Bear in mind that you’ll only ever be as effective as the quality,
planning and execution of the contents in yours.
• Pen and paper. Small enough to keep with you -- you never know when a thought or idea will
strike, so make it a habit to keep them with you. This is particularly true if you're committed to
keeping a time management log. A pocket notepad and pen mean you can jot down pretty much
anything you want to act on, or commit to, later.
• Computer. A double edged sword, this one. Your PC or notebook can do many things, online and
off. How many save you time? As many as you want. Time spent improving your data storage and
access by organizing computer files is time well spent. Manage you computer well and it will serve
you. Don’t, and it will start to own you.
• Timer. Use a timer to establish limits on whatever you want to do more or less of (visual timers are
particularly useful). For example, if you're habitually wasting time online, use a timer to help you
put limits on the amount you do it. On the other hand, when you're having difficulty overcoming
procrastination set it for a short time to get you going.
• Digital voice recorder. When you’re travelling, taking notes isn’t always possible. Using a voice
recorder allows you to capture thoughts and ideas when you’re on the go. These really are
portable, whether you’re waiting, walking, driving, or even running (well you may be able to; you
may end up sounding like a crank caller when you play it back later).
• PDA (Personal Digital Assistant). More a luxury than a necessity? Some say they are. Do they justify
the costs? Many people say they do. Discover the advantages of PDA tools for time managementto
decide for yourself.
Student Activity
• write a one-page essay reflecting on the
results of the quiz.
• In the essay, each student should
– describe his/her time-management strengths and
weaknesses,
– identify ways to improve her/his timemanagement skills,
– and discuss the need for effective timemanagement skills in business.
2.07 Determine global trade’s
impact on business decision-making
to acquire insight into the global
forces affecting business.
Explain the nature of global
Explain the role of imports, exports,
importers, and exporters in
international trade.
• Imports: Goods or services purchased from other
countries
• Exports: Goods and services sold by businesses and
industries in one country to individuals, manufacturers,
or governments in other countries
• Importers: Individuals, businesses, or governments
that purchase and import goods or services
manufactured in other countries
• Exporters: Businesses and industries that sell goods or
services manufactured in one country for delivery to
other counties
Explain the difference between
absolute advantage and comparative
advantage
• Absolute advantage: The advantage achieved
when a nation can produce a good or service
for less than another nation
• Comparative advantage: The advantage
achieved by a nation from specializing in and
producing goods and services at which it is
relatively most efficient
Define the terms domestic trade
and international trade
• Domestic trade: The buying
and selling of goods and
services within a country
• International trade: The
buying and selling of goods
and services between nations
Discuss why nations engage in
international trade
To obtain needed resources
Examples:
o Access to raw materials
o Up-to-date technology
Summarize the benefits of
international trade.
• Increased variety of products
• Access and availability of
scarce resources
• Lower prices for products due
to increased competition §
Possible exchange of ideas and
technology among countries
• Increased income for the
shipping and/or airline
industries due to increased
shipping and tourism
Discuss issues associated with
international trade.
Identify ways that a nation’s balance of
payment affects its balance of trade.
o Components of a nation’s balance of
payment include exports, imports,
foreign aid, business investment
abroad, and money spent by tourists.
o Explain how a trade surplus and a trade
deficit occur.
Discuss techniques (protectionism) that
governments use to control
international trade.
o Tariffs
o Quotas
o Licenses
o Product standards
o Embargoes
Identify methods that governments use to
support international trade.
Organizations:
• The European Union: Unifies European
countries for trading power
• World Trade Organization: Handles disputes
and facilitates negotiations
Trade agreements to reduce trade barriers:
•
North American Free Trade Agreement
(NAFTA) § General Agreement on Tariffs and
Trade (GATT)
Other:
•
Trade centers
• Trade missions
• Trade talks
Explain why multinational corporations (MNCs)
engage in international trade and how they
facilitate it.
o Lower labor costs
o Geographic location
o Natural resources
o Hold influence in host countries
2.07 Determine global trade’s
impact on business decision-making
to acquire insight into the global
forces affecting business.
Discuss the impact of cultural and
social environments on global trade
Describe Hofstede's dimensions of
national cultures
• Understanding cultural differences is essential for companies involved in
international business. Countries vary across several dimensions, affecting
workplace values.
• When it comes to international business, understanding cultural
differences and promoting cultural sensitivity will help ensure that
communication across borders is effective and that business transactions
are successful.
• Each country has its own cultural standards of being, thinking, and acting,
and these cultural differences strongly influence workplace values and
business communication. What may be considered perfectly acceptable
and natural in the workplace of one country, can be considered confusing
or even offensive in the workplace of other country.
• Business representatives involved in the international business arena
should be aware of how other cultures differ across the following
dimensions. Many of these dimensions are based on Geerte Hofstede's
framework for assessing culture.
Describe Hofstede's dimensions of
national cultures
Power Distance
• In some countries, such as the Arab nations and many Latin American countries, people recognize
and respect differences in power. In these high power distance cultures, bypassing a supervisor or
any other superior would be considered insubordination. In low power distance countries, such as
America, the lines between superiors and subordinates are often blurred. It is perfectly acceptable
in America, for example, that supervisors can mingle with subordinates as equals within a social
setting.
Explicit Versus Implicit
• In some countries, such as America and Germany, people tend to be explicit in communication.
Ideas are fully spelled out, and when trying to understand a message, people will depend on what
has been actually said or written. In other countries, such as Japan, people tend to speak and
communicate in an implicit and indirect manner. In this case, people depend on common
understanding in knowledge and etiquette to extract the underlying message.
Monochronic Versus Polychronic
• Monochronic cultures prefer to focus on one task at a time. They emphasize order and do not favor
interruptions. For these people, time is a precious commodity. Schedules and timetables are greatly
valued and are meant to be strictly followed. Polychronic cultures, on the other hand, like to multitask and are generally less stringent when it comes to establishing or following an agenda. In this
setting, the concept of time is more fluid, and the pace of life is more relaxed.
Describe Hofstede's dimensions of
national cultures
Individualism Versus Collectivism
• In individualist cultures, such as America, individuality, independence, and self-determination are
valued. In collectivist cultures, such as Japan, people are expected to identify with and work well in
groups. In exchange for their loyalty and compliance, people receive a sense of security, protection,
and shared responsibility.
Masculinity Versus Femininity
• The cultures that are more masculine, such as Japan, value competitiveness, assertiveness,
ambition, and the accumulation of wealth. On the other hand, feminine cultures, such as Sweden,
place more emphasis on relationships, compassion, and the general quality of life.
Uncertainty Avoidance
• This dimension concerns the level of uncertainty and ambiguity that members of a culture are
comfortable with. Cultures that are high in uncertainty avoidance prefer rules and structured
circumstances. Within their structured environment, these people tend to be more emotional and
expressive. Cultures that are comfortable with uncertainty avoid rules and in general are less
emotionally expressive and pragmatic.
•
Every culture possesses a unique mixture of attitudes, values, and social expectations. When
conducting business across countries, it is vital that business representatives are provided with an
understanding of the cultural differences and are able to be sensitive to them.
Explain why business subcultures shape
the behaviors of businesspeople.
•
•
•
•
•
•
In North America, we have traditionally been more comfortable doing business with people
we don’t know than with people from other world regions. In some local situations, we may
have no personal relationship with our customer, it is “strictly business.” In others, we may
develop a more personal relationship once we have been doing business for a while.
Much of the world’s population however, is used to personal relationships preceding any
business relationship. Internet-based business would seem to be as about impersonal as it
can get.
Yet one Alberta-based business claims that its growth in international business coming via
their Internet site is precisely due to personal customer service. This company makes a point
of making telephone contact with everyone who contacts them via their web site. Needs are
better understood, rapport is built and a personalized customer relationship is developed.
They have figured out how essential working on building a relationship is to continued
business success worldwide.
Alberta’s business style is also rule-based. Legal contracts once drawn up and are considered
the cornerstone of the business relationship. Success is seen to come from following the
contract to the letter.
This objective and rational approach is seen to serve everyone’s interest the best. In many
other countries, while rules are important, it is the relationship that is viewed as more
important. Contracts may be seen as helpful guidelines that can easily be modified as
circumstances change. Success is seen to come from placing the relationship first.
This process can be very subjective.
Explain how language impacts
knowing when and how business will
be
conducted.
• It would be convenient for us if our global customers would
communicate with us and do business with us in English.
But the golden rule in business is not what is best for us,
but rather what is best for the customer. What does the
customer want? If s/he has a choice of 5 suppliers for a
product or service, what will the decision-making criteria
be? Price, quality and service will all be factors. But so will
less tangible qualities like comfort, satisfaction and trust.
• According to analysts from Forrester Research “people are
twice as likely to stay at a given site, and three times as
likely to do business there if the site communicates content
in their own language and culture.”
Explain how culture influences
communication.
Direct and Indirect Communication
• Of the world’s cultures, Canada tends to line up on the more direct end of the
communication continuum. While we may be proud of “getting to the point” and
not “beating around the bush” as a sign of effective communication, others may
find us blunt to the point of rudeness.
• Doing global e-business, the balance must be found between being politely clear
and concise in our message versus sounding blunt and aggressive.
Expressiveness of Communication
• Some of the world’s people prefer expressive, personal communication, while
others use a more controlled and impersonal style. In face-to-face conversation, an
expressive approach might include voices raised in joy or anger, large arm gestures
and a smaller distance separating two speakers.
Formal and Informal Communication
• This is reflected in dropping official titles, using first names and preferring a round
of golf with a
• client rather than a fancy dinner. Following protocol is much more important in
many parts of the world. Showing respect by using proper titles and greetings
provide an important foundation for a business relationship.
Student Activity
•
•
•
•
Using the following sites groups will research:
http://www.cyborlink.com/
http://www.celt.iastate.edu/international/CulturalDifferences3.html
http://www.kwintessential.co.uk/resources/country-profiles.html
– Group # 1 - India
• Discuss how the interrelationship of business law and religion impacts international business activities.
• Identify ways to overcome issues with the crossover of business law and religion in international business
activities.
• Describe how corruption impacts international business activities.
• Explain how a country's level of involvement impacts international trade.
– Group #2 – India
• Discuss how culture can hamper international trade.
• Explain how culture can impact trade partner selection.
• Describe how culture can impact negotiations in international trade.
• Discuss how culture can impact product delivery in international trade.
– Group #3 - Egypt
• Discuss how the interrelationship of business law and religion impacts international business activities.
• Identify ways to overcome issues with the crossover of business law and religion in international business
activities.
• Describe how corruption impacts international business activities.
• Explain how a country's level of involvement impacts international trade.
– Group #4 – Egypt
• Discuss how culture can hamper international trade.
• Explain how culture can impact trade partner selection.
• Describe how culture can impact negotiations in international trade.
• Discuss how culture can impact product delivery in international trade.
Student Activity (con’t)
–
–
–
Group # 5 - Japan
• Discuss how the interrelationship of business law and religion impacts international business activities.
• Identify ways to overcome issues with the crossover of business law and religion in international business
activities.
• Describe how corruption impacts international business activities.
• Explain how a country's level of involvement impacts international trade.
Group #6 - Japan
• Discuss how culture can hamper international trade.
• Explain how culture can impact trade partner selection.
• Describe how culture can impact negotiations in international trade.
• Discuss how culture can impact product delivery in international trade.
Group #7
• http://www.theglobalist.com/StoryId.aspx?StoryId=3490
• Explain how positive/negative experiences with a culture can update one's beliefs.
• Describe how culture can impact the selection of trade goals in international trade.
2.07 Determine global trade’s
impact on business decision-making
to acquire insight into the global
forces affecting business.
Describe the determinants of
exchange rates and their effects on
the domestic economy
Define the terms
•
•
•
•
•
•
•
Exchange Rate - The exchange, also termed foreign exchange rate, is the price of
one currency in terms of another. The currencies of different nations are regularly
traded for each other over foreign exchange markets. The price established for this
exchange of currencies is the exchange rate.
Exchange rate quotation - is given by stating the number of units of a price
currency that can be bought in terms of 1 unit currency. For example, in a
quotation that says the EUR-USD exchange rate is 1.2 USD per EUR, the price
currency is USD and the unit currency is EUR.
Free Floating Currency - a currency that uses a floating exchange rate as its
exchange rate regime.
Pegged Currency - A currency that is controlled by the central bank in a country so
that it keeps the same value against other currencies
Foreign exchange market - is a market that trades the domestic currency of one
nation for the domestic currency of another nation.
Weak dollar - is weak in comparison to other paper currencies
Strong dollar – is strong compared to other currencies. (They're all WEAK, since
none of them are backed by anything, and are mere pieces of paper with ink on
them.)
Distinguish between direct and
indirect exchange-rate quotations.
• Direct quotation is where the cost of one unit
of foreign currency is given in units of local
currency
• Indirect quotation is where the cost of one
unit of local currency is given in units of
foreign currency.
Your local currency is EUR:
- Direct exchange rate: 1USD = 0.92819 EUR
- Indirect exchange rate: 1EUR = 1.08238 USD
Interpret exchange rates.
• If, for example, someone in the United States is willing to pay two
dollars to purchase one British pound, making the price of a British
pound $2, then the exchange rate between dollars and pounds is 2
dollars for 1 pound.
• These assorted currency exchange rates indicate the relative values
of the currencies exchanged. A British pound price of $2, and
exchange rate of 2 for 1, generally indicates that the one British
pound is twice as valuable as one U.S. dollar. Currency traders give
up TWO dollars for ONE pound.
• Compare this to the "exchange rate" between a U.S. dime and U.S.
nickel. Two nickels can be exchanged for one dime, an exchange
rate of 2 nickels per dime, and generating a "price" of 2 nickels. This
price clearly indicates that a dime is twice as valuable and can
purchase twice as many goods and services, as a nickel. The
exchange rate between different national currencies has much the
same interpretation.
Identify factors that increase demand
for currencies
•
•
•
•
•
•
•
•
•
A reduction in the interest rate.
A rise in the demand for consumer spending.
A rise in uncertainty about the future and future opportunities.
A rise in transaction costs to buy and sell stocks and bonds.
A rise in inflation causes a rise in the nominal money demand but
real money demand stays constant.
A rise in the demand for a country's goods abroad.
A rise in the demand for domestic investment by foreigners.
A rise in the belief of the future value of the currency.
A rise in the demand for a currency by central banks (both domestic
and foreign).
Explain factors that cause a currency
to lose value relative to other
currencies.
• A currency will tend to become more valuable
whenever demand for it is greater than the available
supply. It will become less valuable whenever demand
is less than available supply (this does not mean people
no longer want money, it just means they prefer
holding their wealth in some other form, possibly
another currency).
• A currency will tend to lose value, relative to other
currencies, if the country's level of inflation is relatively
higher, if the country's level of output is expected to
decline, or if a country is troubled by political
uncertainty.
Discuss how economic factors affect
exchange rates
An exchange rate is determined by supply and demand factors. These are the various factors which determine the demand and
supply of a currency.
•
1. Inflation
If inflation in the UK is lower than elsewhere, then UK exports will become more competitive and there will be an increase in
demand for pounds. Also foreign goods will be less competitive and so UK citizens will supply less pounds to buy foreign
goods. Therefore the rate of pound will tend to increase.
•
2. Interest Rates
If UK interest rates rise relative to elsewhere, it will become more attractive to deposit money in the UK
•
3. Speculation
If speculators believe the pound will rise in the future, they will demand more now to be able to make a profit. This increase
in demand will cause the value to rise.
Therefore movements in the exchange rate do not always reflect economic fundamentals, but are often driven by the
sentiments of the financial markets.
•
For example, if markets see news which makes an interest rate increase more likely, the value of the Pound will probably rise
in anticipation.
•
4. Change in competitiveness
If British goods become more attractive and competitive this will also cause the value of the Exchange Rate to rise. This is
important for determining the long run value of the Pound.
•
5. Relative strength of other currencies
Between 1999 and 2001 the pound appreciated because the Euro was seen as a weak currency.
•
6. Balance of Payments
A large deficit on the current account means that the value of imports is greater than the value of exports. If this is financed
by a surplus on the financial / capital account then this is OK. But a country who struggles to attract enough capital inflows
will see a depreciation in the currency. (For example current account deficit in US of 7% of GDP was one reason for
depreciation of dollar in 2006-07)
Explain how market psychology can
affect exchange rates.
Market psychology along with the perception of currency traders are also one of the important
determinants of currency market rates. These factors influence the currency trading market in
following ways.
1.Flights to quality: This phenomenon of currency exchange market states that the various international
events taking place in different nations of the world affect the foreign exchange rates. A ‘flight to
quality’ means the traders moving their capital away from the risky investments to the safer
investment options. In other words, traders look forward to safer economic currencies and prefer
that currency investment where the demand is on higher side thus resulting in a higher price for
currencies. The safest currency is considered to be The Swiss franc during the times of political or
economic uncertainty.
2. Long-term trends: The foreign exchange currency trading markets usually move in visible long-term
trends. These trends are analyzed and studied by currency exchange professionals to predict the
effect of these events on the future currency rates.
3. Economic numbers: The economic numbers are determinants of currency market rates as they are
based on economic reports of a country thus indicating the economic condition of a particular
company. These economic numbers greatly influence the market psychology and they may affect
the short-term market moves.
4.Technical trading considerations: Technical trading considerations such as the price charts are also
determinants of market exchange rate. Because many investors analyze these price charts in order
to identify various pattern over the period of time. It is an important foreign exchange currency rate
determinant.
Describe how political conditions can
influence exchange rates
• Political conditions are important determinants of currency
market rates of foreign exchange rates. International
political conditions, internal and regional events within a
country affect the currency markets greatly. All exchange
rates are sensitive to political instability and speculations
about the new ruling party. Political upheaval and
instability can play a negative role in a nation's economy.
• Similarly, any country facing financial difficulties, is
perceived to be fiscally responsible can have the opposite
effect. Also, events in one country in a region may initiate
positive or negative interest in a neighboring country. And
in the process, affect its currency rates.
Distinguish between free-floating and
pegged currency
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A fixed, or pegged, rate is a rate the government (central bank) sets and maintains as the
official exchange rate. A set price will be determined against a major world currency (usually
the U.S. dollar, but also other major currencies such as the euro, the yen or a basket of
currencies). In order to maintain the local exchange rate, the central bank buys and sells its
own currency on the foreign exchange market in return for the currency to which it is
pegged.
Unlike the fixed rate, a floating exchange rate is determined by the private market through
supply and demand. A floating rate is often termed "self-correcting", as any differences in
supply and demand will automatically be corrected in the market. Take a look at this
simplified model: if demand for a currency is low, its value will decrease, thus making
imported goods more expensive and stimulating demand for local goods and services. This in
turn will generate more jobs, causing an auto-correction in the market. A floating exchange
rate is constantly changing.
In reality, no currency is wholly fixed or floating. In a fixed regime, market pressures can also
influence changes in the exchange rate. Sometimes, when a local currency does reflect its
true value against its pegged currency, a "black market", which is more reflective of actual
supply and demand, may develop. A central bank will often then be forced to revalue or
devalue the official rate so that the rate is in line with the unofficial one, thereby halting the
activity of the black market. In a floating regime, the central bank may also intervene when it
is necessary to ensure stability and to avoid inflation; however, it is less often that the central
bank of a floating regime will interfere.
Describe factors that influence freefloating currency.
• A free-floating system has the advantage of being self-regulating.
There is no need for government intervention if the exchange rate
is left to the market.
• Market forces also restrain large swings in demand or supply.
• Suppose, for example, that a dramatic shift in world preferences led
to a sharply increased demand for goods and services produced in
Canada. This would increase the demand for Canadian dollars, raise
Canada’s exchange rate, and make Canadian goods and services
more expensive for foreigners to buy. Some of the impact of the
swing in foreign demand would thus be absorbed in a rising
exchange rate.
• In effect, a free-floating exchange rate acts as a buffer to insulate an
economy from the impact of international events.
Identify institutions that utilize the
foreign exchange market
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Governments
Banks
Importers
Exporters
Investors
Consumers
Discuss types of financial instruments
used in foreign exchange markets
Spot
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A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian
Dollar, Turkish Lira, EURO and Russian Ruble, which settle the next business day), as opposed to the futures
contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has
the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon
transaction.
Forward
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One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money
does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate
for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then.
The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties.
Then the forward contract is negotiated and agreed upon by both parties.
Swap
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The most common type of forward transaction is the FX swap. In an FX swap, two parties exchange currencies for
a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts
and are not traded through an exchange.
Future
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Futures are standardized and are usually traded on an exchange created for this purpose. The average contract
length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.
Option
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A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right
but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed
exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for
options of any kind in the world.
Explain the advantages/disadvantages
of a strong U.S. dollar
Strengthening Dollar
• Advantages
• Consumer sees lower prices on foreign products/services
• Lower prices on foreign products/services help keep inflation low
• U.S. consumers benefit when they travel to foreign countries
• U.S. investors can purchase foreign stocks/bonds at "lower" prices
• Disadvantages
• U.S. firms find it hard to compete in foreign markets
• U.S. firms must compete with lower priced foreign goods
• Foreign tourists find it more expensive to visit U.S.
• More difficult for foreign investors to provide capital to U.S. in time
of heavy U.S. borrowing
Describe the
advantages/disadvantages of a weak
U.S. dollar
Weakening Dollar
• Advantages
• U.S. firms find it easier to sell goods in foreign markets
• U.S. firms find less competitive pressure to keep prices low
• More foreign tourists can afford to visit the U.S.
• U.S. capital markets become more attractive to foreign investors
• Disadvantages
• Consumers face higher prices on foreign products/services
• Higher prices on foreign products contribute to higher cost-of-living
• U.S. consumers find traveling abroad more costly
• Harder for U.S. firms and investors to expand into foreign markets
Explain the risks of speculating on the
price of foreign currency
• Speculation is an attempt to profit by trading
on expectations about prices in the future.
–In the foreign exchange market, one speculates
by taking position on a currency and then
closing that position after the exchange rate
has moved.
–A profit results only if the rate moves in the
direction that was expected
Student Activity
• Ask the students to imagine that they are U.S. importers
who are trying to decide among three countries from which
to obtain goods. Each student should select a product and
the three countries of interest. The product that each
student selects should be one of interest to her/him, and
the countries identified should actually export the item.
Each student should write a memorandum to the
company’s owner recommending one of the countries
based on exchange rates. After completing his/her
memorandum, each student should compare and discuss it
with a classmate
• http://www.x-rates.com/cgi-bin/cgicalc.cgi?value=1&base=USD
• Test next class