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The Economy

 CHAPTER 4: Economic Principles




CSI Global Education Inc.
Economics in General
  The performance of the securities markets is strongly tied to the
               overall performanc...
Overview
Microeconomics versus macroeconomics


Microeconomics:
• The market behaviour of individual consumers and firms.
...
Overview
Microeconomics versus macroeconomics


Macroeconomics:
• The performance of the overall economy – the ‘big pictur...
Overview
The main decision makers in the economy:
• Consumers
• Firms
• Government

What role do each play and how do they...
Overview
Goods Markets:
• firms decide what to produce
• sell their output of goods and services

Factor Markets:
• consum...
Demand & Supply
The interaction between demand and supply leads to market
equilibrium in the economy.
Market Demand
• cons...
Demand & Supply - Discussion

What role do price and quantity play for the:
 - Law of Demand
 - Law of Supply


Explain ea...
Demand & Supply
Law of Demand
• as the price of a product rises, quantity demand falls
• as the price of a product falls, ...
Measuring Economic Growth

Measuring the Economy
• Gross Domestic Product (GDP):
  Value of all goods and services produce...
Measuring Economic Growth
GDP versus GNP
  ABC, a Canadian company, manufactured $70m of output last
  year in the followi...
Measuring Economic Growth
GDP versus GNP
What amount will be recorded as part of Canada’s GDP? GNP?


Canada
GDP = $50m pr...
Measuring Economic Growth
Components of the expenditure approach:
• Consumption
• Investment
• Government Spending
• Net E...
Measuring Economic Growth
How does an economy grow?

Causes of GDP Growth:
• Population growth
• Rising productivity
• Tec...
Real GDP versus Nominal GDP
• What does nominal GDP represent?

• How does Nominal GDP differ from Real GDP?

• Is an incr...
Real GDP versus Nominal GDP
• Nominal GDP is based on current prices, or the prices that
  prevailed in the same year
  - ...
A Typical Business Cycle
 GDP

                       Rising Trend in GDP

                                               ...
The Business Cycle
  Describe the key features of each phase of the cycle:
• Expansion
• Peak
• Contraction
• Trough
• Rec...
The Business Cycle
Expansion
       –     Stable inflation, and the economy steadily expands
       –     Adequate invento...
The Business Cycle
Recession
       –     Level of economic activity declines
       –     Businesses postpone capital inv...
Economic Indicators
Leading Indicator:          Peak and trough before the overall
                            economy – a...
Interest Rates
Interest is:
• Economic rent for a scarce resource (money)

• For business owners it is a component in the ...
Interest Rates
Interest rates vary by:
• Duration/term of loan
• Conditions of the loan
• Creditworthiness




 How do hig...
Interest Rates
 How do higher rates impact the economy?
• Increases the cost of capital for businesses and leads to lower
...
Determinants of Interest Rates
• Demand and Supply of Capital
• Default Risk
• Central Bank Activities/Credibility
• Forei...
Inflation
A generalized, sustained trend of rising prices.
- usually an indication of growth in the money supply
- economi...
Inflation & the Consumer Price Index
Using the CPI to measure inflation:
• Tracks the retail price of a basket of goods to...
Inflation
Costs of Inflation
• Erodes standard of living for those on a fixed income
• Erodes purchasing power or forces i...
Growth in the Money Supply
• In the short-run, higher money growth lowers interest rates, and
  increases economic activit...
Growth in the Money Supply
The Output Gap
• The difference between real GDP and potential GDP
• Potential GDP = what the e...
Growth in the Money Supply
Positive Output Gap:
• Economy is operating above its potential:
  - actual output (GDP) > pote...
Disinflation vs. Deflation
                  Disinflation                      Deflation

   A decline in the rate at whic...
Labour Markets
Economic performance directly affects the labour market.

Indicators:
• Labour Force: sum of the working ag...
Types of Unemployment
Cyclical
• fluctuates with the business cycle
Frictional
• result of normal labour turnover
• have t...
Labour Markets

• Is an unemployment rate of 0% possible? Why or why not?
• What stops the economy from moving to such a p...
The External Sector
• Exports accounted for just over 44% of GDP in 2006.
• Interestingly:
       –     Canada exported ab...
Current Account
• Records the exchanges of goods and services between
  Canadians and foreigners, the earnings from invest...
Capital Account
• Records the financial flows between Canadians and foreigners
  related to investments by foreigners in C...
The Exchange Rate
Why it’s important:
• The external value of a nation’s currency impacts the volume of
  trade.
• As the ...
The Exchange Rate
Determinants of the Exchange Rate:
• Inflation differentials
• Interest rate differentials
• Current acc...
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Transcript of "Csc2 The Economy Ch 4"

  1. 1. The Economy CHAPTER 4: Economic Principles CSI Global Education Inc.
  2. 2. Economics in General The performance of the securities markets is strongly tied to the overall performance of the economy. • A growing and stable economy over time has a positive impact on the equity markets. • Bond market activity is strongly tied to the level and uncertainty of inflation and interest rates. • The economy has an impact on how many people work, how much they spend, how much product companies sell, and how high inflation and interest rates will be. • These are the factors that determine investment returns. CSI Global Education Inc. 2
  3. 3. Overview Microeconomics versus macroeconomics Microeconomics: • The market behaviour of individual consumers and firms. • How the price levels creates or leads to market equilibrium. • The impact of minimum wage laws on the supply of labour and company profit margins. • Taxes on imports and the impact on industry profitability. CSI Global Education Inc. 3
  4. 4. Overview Microeconomics versus macroeconomics Macroeconomics: • The performance of the overall economy – the ‘big picture’. • Measuring output through GDP and GNP. • How changes in unemployment or inflation impact economic performance. • How a nation’s standard of living has changed over the last business cycle. CSI Global Education Inc. 4
  5. 5. Overview The main decision makers in the economy: • Consumers • Firms • Government What role do each play and how do they interact? CSI Global Education Inc. 5
  6. 6. Overview Goods Markets: • firms decide what to produce • sell their output of goods and services Factor Markets: • consumers sell their ‘factors of production’ labour • earn wages used to buy goods & services Where are these decisions coordinated? CSI Global Education Inc. 6
  7. 7. Demand & Supply The interaction between demand and supply leads to market equilibrium in the economy. Market Demand • consumers, all purchasers of goods and services Market Supply • suppliers of goods and services CSI Global Education Inc. 7
  8. 8. Demand & Supply - Discussion What role do price and quantity play for the: - Law of Demand - Law of Supply Explain each using a real world example. CSI Global Education Inc. 8
  9. 9. Demand & Supply Law of Demand • as the price of a product rises, quantity demand falls • as the price of a product falls, quantity demand rises Law of Supply • as the price of a product rises, quantity supplied rises • as the price of a product falls, quantity supplied falls What is the main trigger for market equilibrium to occur? CSI Global Education Inc. 9
  10. 10. Measuring Economic Growth Measuring the Economy • Gross Domestic Product (GDP): Value of all goods and services produced within Canada’s borders • Gross National Product (GNP): Value of all goods and services produced by Canadians anywhere in the world What was Canada’s GDP for the most current year? CSI Global Education Inc. 10
  11. 11. Measuring Economic Growth GDP versus GNP ABC, a Canadian company, manufactured $70m of output last year in the following way: • $50m was manufactured in Canada • $20m was manufactured in Sweden What amount will be recorded as part of Canada’s GDP? GNP? CSI Global Education Inc. 11
  12. 12. Measuring Economic Growth GDP versus GNP What amount will be recorded as part of Canada’s GDP? GNP? Canada GDP = $50m produced within Canada’s borders GNP = $50m + $20m CSI Global Education Inc. 12
  13. 13. Measuring Economic Growth Components of the expenditure approach: • Consumption • Investment • Government Spending • Net Exports GDP = C + I + G + (X – M) CSI Global Education Inc. 13
  14. 14. Measuring Economic Growth How does an economy grow? Causes of GDP Growth: • Population growth • Rising productivity • Technological innovation CSI Global Education Inc. 14
  15. 15. Real GDP versus Nominal GDP • What does nominal GDP represent? • How does Nominal GDP differ from Real GDP? • Is an increase in Nominal GDP always good for the economy? CSI Global Education Inc. 15
  16. 16. Real GDP versus Nominal GDP • Nominal GDP is based on current prices, or the prices that prevailed in the same year - reflects the change in the size of GDP and the impact of price changes • Real GDP corrects for the effects of inflation - a better measure of the overall performance - a purer measure of changes in the amount of output produced during the year - isolates the change in output attributed to price changes (or inflation) CSI Global Education Inc. 16
  17. 17. A Typical Business Cycle GDP Rising Trend in GDP Expansion Peak Contraction Recovery Expansion Trough Time CSI Global Education Inc. 17
  18. 18. The Business Cycle Describe the key features of each phase of the cycle: • Expansion • Peak • Contraction • Trough • Recovery CSI Global Education Inc. 18
  19. 19. The Business Cycle Expansion – Stable inflation, and the economy steadily expands – Adequate inventory levels to meet consumer demand – Rising corporate profits and stronger stock market activity – Steady or falling unemployment rate Peak – Demand begins to outstrip capacity and inflation increases – Rising wages and interest rates – Business sales decline, and inventory levels rise – Stock prices fall and general market activity declines CSI Global Education Inc. 19
  20. 20. The Business Cycle Recession – Level of economic activity declines – Businesses postpone capital investments and profits fall – Consumers spend less and increase saving Trough – Bond market rallies as rates begin to fall – Consumers start spending again Recovery – GDP returns to its previous peak, & business investment rises – Unemployment may remain high, but inflation is set to fall further CSI Global Education Inc. 20
  21. 21. Economic Indicators Leading Indicator: Peak and trough before the overall economy – anticipate emerging trends Example: housing starts Coincident Indicator: Change at same time and in same direction as the economy – info on the current position of the economy Example: GDP, retail sales Lagging Indicator: Change after the economy changes – used to confirm a business cycle pattern Example: Unemployment rate CSI Global Education Inc. 21
  22. 22. Interest Rates Interest is: • Economic rent for a scarce resource (money) • For business owners it is a component in the cost of capital for production • For consumers it is the “price” of credit for consumption CSI Global Education Inc. 22
  23. 23. Interest Rates Interest rates vary by: • Duration/term of loan • Conditions of the loan • Creditworthiness How do higher rates impact the economy? CSI Global Education Inc. 23
  24. 24. Interest Rates How do higher rates impact the economy? • Increases the cost of capital for businesses and leads to lower business investment. • Discourages consumer spending on durable goods and other commodities. • May lead to a general economic slowdown. CSI Global Education Inc. 24
  25. 25. Determinants of Interest Rates • Demand and Supply of Capital • Default Risk • Central Bank Activities/Credibility • Foreign Developments – Interest Rates/Exchange Rate • Inflation CSI Global Education Inc. 25
  26. 26. Inflation A generalized, sustained trend of rising prices. - usually an indication of growth in the money supply - economic expansion - increase in demand without corresponding change in supply Can lead to: - investors demand a rate of return that protects them from the erosion of their purchasing power - pressure on wages and other variables …Why are rising prices considered ‘bad’ for the economy? CSI Global Education Inc. 26
  27. 27. Inflation & the Consumer Price Index Using the CPI to measure inflation: • Tracks the retail price of a basket of goods to reflect typical consumer spending • Measures the ‘average’ price level for a consumption bundle • Compares the CPI in the current period relative to a base year to arrive at the inflation rate for the year • If CPI is currently 130 and the base year was 120, what does this imply? CSI Global Education Inc. 27
  28. 28. Inflation Costs of Inflation • Erodes standard of living for those on a fixed income • Erodes purchasing power or forces investors to demand higher returns • Higher interest rates slows growth • Increases the cost of debt servicing to individuals, corporations and governments CSI Global Education Inc. 28
  29. 29. Growth in the Money Supply • In the short-run, higher money growth lowers interest rates, and increases economic activity • In the long-run, money growth is fully reflected in changes in inflation • If money grows 10% and the supply of goods and services grows 5%, inflation will be 5%. • There is evidence that unemployment can be reduced in the short-run by increasing inflation at a faster rate (Phillips curve). CSI Global Education Inc. 29
  30. 30. Growth in the Money Supply The Output Gap • The difference between real GDP and potential GDP • Potential GDP = what the economy is capable of producing when its existing inputs of labour, capital, and technology are fully employed at their normal levels of use. - (the BoC does estimate potential output levels) Negative Output Gap: • When actual output is below potential output - spare or excess capacity. • Increased demand does not result in inflation. CSI Global Education Inc. 30
  31. 31. Growth in the Money Supply Positive Output Gap: • Economy is operating above its potential: - actual output (GDP) > potential output • Strong consumer demand for goods and services. • When companies continue to operate above capacity, they can raise prices in response to this demand. • leads to demand-pull inflation. • A scarcity of resources can lead to cost-push inflation. CSI Global Education Inc. 31
  32. 32. Disinflation vs. Deflation Disinflation Deflation A decline in the rate at which A sustained fall in prices - the prices rise – is a decrease in the annual change in the CPI is rate of inflation. negative year after year. Prices are still rising, but at a Deflation is just the opposite of slower rate. inflation. Captured through the Phillips Problem: sustained falling prices Curve and the sacrifice ratio. could lead to a decline in corporate profits. CSI Global Education Inc. 32
  33. 33. Labour Markets Economic performance directly affects the labour market. Indicators: • Labour Force: sum of the working age population who are employed or unemployed. • Participation rate: the % of the working age population in the labour force. • Unemployment rate: the % of the labour force unemployed but looking. CSI Global Education Inc. 33
  34. 34. Types of Unemployment Cyclical • fluctuates with the business cycle Frictional • result of normal labour turnover • have the proper skills to find a new job Structural • when individuals can’t find jobs due to outdated skills CSI Global Education Inc. 34
  35. 35. Labour Markets • Is an unemployment rate of 0% possible? Why or why not? • What stops the economy from moving to such a position? CSI Global Education Inc. 35
  36. 36. The External Sector • Exports accounted for just over 44% of GDP in 2006. • Interestingly: – Canada exported about 80% of its goods to the U.S. and imported about 70% of its goods from the U.S. • What this means: the performance of the Canadian economy is strongly tied to the performance of the U.S. economy. • The balance of payments is used to track the economic transactions with the rest of the world over a given time period. CSI Global Education Inc. 36
  37. 37. Current Account • Records the exchanges of goods and services between Canadians and foreigners, the earnings from investment income, interest, and dividends and net transfers such as for foreign aid. • Deficit implies Canadians are spending more on foreign goods than they are selling – imports are higher than exports. • Surplus implies Canadians are selling more to foreigners than buying abroad – exports are higher than imports. • There is a link with the capital account. CSI Global Education Inc. 37
  38. 38. Capital Account • Records the financial flows between Canadians and foreigners related to investments by foreigners in Canada and investments by Canadians abroad. When a country runs a current account deficit, the shortfall financed from foreign sources by: • Selling assets • Borrowing funds Both of these activities are captured through the capital account. CSI Global Education Inc. 38
  39. 39. The Exchange Rate Why it’s important: • The external value of a nation’s currency impacts the volume of trade. • As the C$ rises in value against a trading partner the volume of exports falls and the volume of imports rises. • As the C$ falls in value against a trading partner, the volume of exports rises and the volume of imports falls. – Can we explain these relationships using the current behaviour of the C$ vs. the US$? CSI Global Education Inc. 39
  40. 40. The Exchange Rate Determinants of the Exchange Rate: • Inflation differentials • Interest rate differentials • Current account • Economic performance • Public debt and deficits • Political stability CSI Global Education Inc. 40
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