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Economics and
Banking
Better Business
3rd Edition
Solomon (Contributing Editor) ·
Poatsy · Martin
© 2014 Pearson Education, Inc.
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Economics Basics
Economics – the study of how individuals and
businesses make decisions to best satisfy wants,
needs, and desires with limited resources
Microeconomics - the study of how individual
businesses, households, and consumers make
decisions to allocate their limited resources in the
exchange of goods and services
Macroeconomics - the study of behavior of the
overall economy
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Economic Systems
Economic system – the financial and social system through which a
country allocated its resources (factors of production) – aka the structure
for how resources are used to meet the needs of society
Types of economic systems:
– Planned economies (Socialism and Communism)
– Market economies (Capitalism)
– Mixed economies (Blend of Market and Planned…Hybrid)
Economic systems differ depending on the answers to four basic economic
questions
1. What and how much will be produced?
2. How will it be produced?
3. For whom will it be produced?
4. Who owns/controls factors of production?
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Capitalism
•
Capitalism
– An economic system in which individuals own and operate the majority of
businesses that provide goods and services
– Commonly referred to as a FREE ENTERPISE (MARKET) SYSTEM or
PURE CAPITALISM or LAISSEZ-FAIRE CAPITALISM
• System in which individuals are free to decide what to produce, how to
produce it, and at what price to sell it
– Derived from Adam Smith’s laissez-faire capitalism (“Wealth of Nations,”
1776) in which a society’s best interests are served by individuals
pursuing their own self-interest (called “Invisible Hand”)
• Creation of wealth is the concern of private individuals, not
government
• Resources used to create wealth must be privately owned
• Economic freedom ensures the existence of a Free Market System
• Limited role of government (protection only)
– Pure or Laissez-faire capitalism doesn’t exist anywhere; it’s just a theory
– What do we have in America?
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The Fundamental Rights
of Capitalism
1. The right to own a business and
keep after-tax profits
2. The right to private property
3. The right to free choice
4. The right to fair competition
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Types of Economic Systems
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US=Mixed Economy
“
• …an economy that exhibits
elements of both capitalism and
socialism.
“
In what ways does our government “interfere”
with private interests and individual freedoms?
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Planned Economies: Socialism
and Communism
Communism
Public Ownership of Enterprise
Strong Central Government
Father of Communism = Karl Marx
Examples: North Korea, Cuba, Old China and USSR
Socialism
Government Control Key Enterprises
Higher Taxes
Main Goal = Social Equality
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Determining Price:
Supply and Demand – The Fundamental
Principles of a Free Market System
The Foundation of the Free
Market
 How much can we
make/sell?
 How much will
consumers buy?
 At what price?
Interaction of buyers &
sellers
 Impact prices
 Competition
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Supply
• Supply: the relationship between
the price of a good and the
quantity sellers are willing/able to
offer
Sellers tend to supply a greater
quantity as the price rises.
• Supply curve: a graph of the
supply relationship
The supply curve slopes upward
to the right showing that
quantity supplied increases as
price rises.
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Demand
• Demand: the relationship
between the price of a good and
the quantity buyers are willing
and can afford to buy
When price falls, consumers
tend to buy more.
• Demand curve: a graph of the
demand relationship
The demand curve slopes
downward showing that
quantity demanded increases
as price falls.
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Supply and Demand: Determining
the Market Price
• Forces of supply and
demand drive
equilibrium price
• The point where
supply and demand
intersect
• Market price adjusts
to the equilibrium
price
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Degrees of Competition

Pure competition
A) a market situation in which there are A LOT of buyers along with a relatively
large number of sellers; B) Sellers have NO control over price (market determines
price, Supply and Demand); C) Identical products with NO differentiation (cotton,
wheat?)

Oligopoly
A) a market (or industry) situation in which there are FEW sellers; B) Strong
barriers to entry (for seller, it’s hard to enter into market); C) Similar products
(cereal, cars, airlines); D) relatively higher prices for consumers

Monopolistic competition
A) a market situation in which there are many buyers along with a relatively large
number of sellers; B) Sellers look for a COMPETITIVE ADVANTAGE by promoting
PRODUCT DIFFERENTIAION (real or perceived differences by consumers with
sellers’ products); C) Seller retains some control over price

Monopoly
A) a market (or industry) with only one seller, and there are barriers to keep other
firms from entering the industry; B) Seller has complete control over price; C)
Illegal; D) Some legal exceptions – NATURAL MONOPOLY and LIMITED
MONOPOLY
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Degrees of Competition
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Economic Indicators:
Measuring Economic Performance
 Economic Indicators
• Gross domestic product (GDP)
– The total dollar value of all goods & services
produced within a country’s borders during
a one-year period
– Real GDP (RGD) – GDP that adjusts for
inflation
– Nominal GDP (NGDP) – GDP measured in
current year’s prices
• Inflation
– A general rise in the level of prices
• Productivity
– The average level of output per worker per
hour
• Unemployment rate
– The percentage of a nation’s labor force
unemployed at any time
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RGDP vs. NGDP
Year
2012
2013
Product
Chips
Chips
Price
$1
$2
Q
5
10
2012
2013
Beer
Beer
$3
$4
4
6
•NGDP2012? NGDP2013?
• RGDP2012? RGDP2013?
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Business Cycle
The state of the economy changes over time
- Peak
- Recession
- Trough
- Expansion/
Recovery
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Managing The Economy Through
Fiscal and Monetary Policy
Fiscal Policy – Government efforts to influence the economy:
 Taxation
  Taxes,  Economy
 Government Spending
  Gov’t Spending,  Economy
 Controlled by Congress/Budget Process
Monetary Policy – Federal Reserve actions to shape the economy:
 Supply of Money
  Money Supply,  Economy
 Influencing Interest Rates
  Interest Rates,  Economy
 Controlled by Fed
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Fiscal Policy
Fiscal policy relates to government management of
revenues (taxes) and spending
The federal government budget outlines
Revenue and Expenses (i.e. Gov’t Spending)
• When Tax Revenue is higher than Gov’t
Spending, there is a budget surplus
• When Gov’t Spending is higher than Tax
Revenue, the government incurs a
budget deficit (FEDERAL DEFICIT)
• The sum of all the money borrowed is
the federal debt (NATIONAL DEBT)
• What is our current National Debt?
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Monetary Policy and
the Federal Reserve System
“Fed” - central banking system in the U.S.
- Independent government agency
- 12 regional Federal Reserve Banks
- Board of Governors
Federal Open Market
Committee (FOMC)
- sets policies of the Fed,
including monetary policies
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Monetary Policy
Monetary policy relates to managing the supply of money
The money supply is the combined amount of money
available within an economy, but there are different
components to the money supply
– M-1: Currency, traveler’s checks, and checking accounts
– M-2: M-1 along with the available money for banks to lend out,
such as savings deposits, money market accounts, and
certificates of deposit (CDs) less than $100,000
– M-3: M-2 plus less liquid funds
Why is measurement of the
money supply important?
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Managing the Money Supply:
Reserve Requirement
Reserve requirement
• the minimum amount of money banks must hold
in reserve to cover deposits
• set by the Fed
Decrease in
reserve
requirement
More
money for
lending
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Stimulates
the
economy
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Managing the Money Supply:
Discount Rate
Discount Rate - Interest rate charged to banks
that borrow emergency funds from the Federal
Reserve Bank
Decrease in
discount rate
More money
for lending at
lower rates
Stimulates
the economy
Fed Funds Rate - Interest rate that banks charge
other banks when they borrow funds overnight
from one another
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Managing the Money Supply:
Open Market Operations
Open market operations
- Primary, and most influential, tool the Fed
uses to alter the money supply
- Consists of buying and selling U.S. Treasury
and federal agency bonds in the “open
market”
Fed buys
securities
through OMO
More money for
lending
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Stimulates the
economy
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