CHAPTER2.

EXPLORING THE WORLD OF BUSINESS AND ECONOMICS

Prof by Cynthia LEE

ECONOMIC

The definition
 Economics: the study of the choices that people, companies, and government make in allocating
society’s resources.
 Economy: the financial and social system of how resources flow through society, from production
to distribution, to consumption
 Microeconomics: the study of smaller economic units such as individual consumers, families and
individual businesses
 Macroeconomics: the study of a country’s overall economic dynamic, such as the employment
rate, gross domestic product, and taxation policies
 RECALL: Gross domestic product (GDP) is: the monetary value of all the finished goods and
services produced within a country’s borders in a specific time period (usually annually)
Put simply, GDP is a broad measurement of a nation’s overall economic activity

Global Economic Crisis

 Began when the dot-com bubble burst in 2000, followed by the 9/11 terrorist attacks in 2001
• Stock market dropped
• Unemployment rate increased
• Economy was on the brink of recession
 Subprime mortgage loans - Granted to borrowers with low credit scores
• Provided lenders higher return than many other investments

THE GREAT DEPRESSION

 The financial crisis of The Great Recession is considered by many economists to have been
the worst financial crisis since the Great Depression of the 1930s
 A combination of subprime lending, the property bubble, fraudulent underwriting practices,
deregulation and poor economic forecasting, among others, all contributed to the crisis
 In 2007, there was a crisis in the subprime mortgage market in the USA (loans granted to
borrowers with low credit scores, should never have been issued)

Subprime Mortgage Prime Mortgage
 Low income  High income
 Insecure job  Secure job
 History of default, bad credit  History of prompt payments,
 rating good credit rating
 Loan close to value of borrower’s  Loan much less than value of
home borrower’s home

The great recession

 This caused banks in the U.S. to fail, setting off a domino effect of bank failures locally and
around the world, and developed into a full-blown international banking crisis in 2008
 Massive bail-outs of financial institutions and businesses followed worldwide; in South Korea,
the foreign exchange reserves
of South Korea's central bank contained many devalued bonds, threatening a currency crisis
and leading to depreciation of the South Korean won
 The crisis was followed by a global economic downturn, the
“Great Recession”
 Economic recovery in the U.S. started after the low point was hit in 2009, with the economy
growing steadily

GLOBAL ECONOMIC CRISIS: ECONOMIC RELIEF

 Troubled Assets Relief Program (TARP)

• Introduced as an economic bailout plan
 Government passed the American Recovery and Reinvestment Act to help the nation
recover from a financial disaster
• Included cutting taxes, building infrastructure, and investing in green energy

Fiscal and monetary policy

• These policies are developed to help achieve the goal of controlled, sustained economic
growth
• Fiscal policy: government efforts to influence the economy through taxation and spending
• Monetary policy: Federal Reserve (the U.S. central bank)and the Korean Central Bank make
decisions that shape the economy by influencing interest rates and supply of money
 Fiscal Policy
• Government efforts to influence the economy through taxation and spending
o Designed to encourage growth, boost employment, and curb inflation
o Increasing the debt ceiling created the fiscal cliff
 Debt ceiling - Maximum amount Congress lets the government borrow
 Fiscal cliff - Across-the-board spending cuts and sharp tax hikes to
decrease the U.S budget deficit

 Monetary Policy
• Federal Reserve decisions that shape the economy by influencing interest rates
and the supply of money
• Functions of the Fed
• Bailing out shaky firms during a financial crisis
• Providing banking services for member banks and the federal government

 The FEDERAL reserve & bank of Korea

• The Central Banks of the U.S. and Korea

 • Core Purpose: To regulate (speed up or slow down) the US economy to maintain a
healthy balance
• The world’s leading economists have been chairs of the Central Federal Reserve

 Monetary Policy
• Federal Reserve decisions that shape the economy by influencing interest rates and the
supply of money
• Functions of the Fed
• Bailing out shaky firms during a financial crisis
• Providing banking services for member banks and the federal government

 THE PURPOE OF THE FEDERAL RESERVE

• To influence the size of the money supply
• M1: money supply: Includes all currency plus checking accounts and traveler’s checks
• M2: money supply: Includes all M1 money supply plus most saving accounts, money
market accounts, and certificates of deposit

• HELICOPTER MONEY: the term used for a large sum of new money that is printed and
distributed among the public, to stimulate the economy during a recession or when interest
rates fall to zero

 FISCAL POLICY vs MONETARY POLICY

Fiscal policy Monetary policy
Change in government spending and tax rates Change in interest rates/ money supply
Set by the Government Set by a Central bank
No specific target Target inflation
Side effect on government budget/ borrowing Side effect on exchange rat and housing
market
Strong political dimension to changing tax Mostly independent fro the political process
rates

FEDERAL BUDGET

 Every year, the government must create a budget, or a financial plan, that outlines expected
revenue from taxes and fees and expected spending
 Outcomes of Budget
• Budget surplus: Overage that occurs when revenue is higher than expenses over a
given period of time
• Budget deficit: Shortfall that occurs when expenses are higher than revenue over a
given period of time
 • Federal debt: Sum of all the money that the federal government has borrowed over the
years and not yet repaid

MONEY: DEFINITIONS
 Money: the medium of exchange, a measure of value, or a means of payment
 Money Supply: the total amount of money circulating within the overall economy
 Inflation: a general increase in prices and fall in the purchasing value of money

COMMERCIAL BANKS
 Commercial banks are privately owned financial institutions that:
 Accept demand deposits
 Make loans
 Provide other services for the public
 Reserve requirement: The minimum amount of funds a bank must actually hold (a percentage
of their deposits), specified by the Central Bank

FEDERAL RESERVE BANKS

 Federal Reserve banks perform banking services for commercial banks in their districts
 Execute “Central Bank” policies
 Discount rate: the interest rate the Fed charges on its loans to commercial banks

CONTROLLING THE MONEY SUPPLY

 The BOK (Bank of Korea) that is “Central Bank” is responsible for controlling the money
supply
 They influence the economy by changing the size of the money supply

REMEMBER Goals of Monetary policy

 Monetary policy: The Central Bank makes decisions that shape the economy by influencing
interest rates and supply of money
 These policies are developed to help achieve the goal of: “Controlled, sustained economic
growth.”
 When the economy is growing too fast, it is not sustainable and could crash – high inflation is
bad for an economy!
 When the economy is struggling, it needs stimulation

HOW TO ACHIEVE MONETARY POLICY?

• Open market operations: Central bank function of buying and selling government securities
• Discount rate: Rate of interest that the Central bank charges when it loans funds to banks
• Reserve requirement: Rule set by the Central bank, which specifies the minimum amount of
reserves a bank is required to hold

 WHEN THE EONOMY IS GROWING

• When the economy is doing well, we all have jobs and want to shop - more demand means
prices go up!
• When prices begin to rise (Inflation), the Central bank increases the discount rate
• The Central bank might also increase the reserve requirement
• This increases the interest rate at commercial banks
• Higher interest rates means loans are more expensive businesses and people tend to
borrow less
• Combine this with higher reserve requirements, there is less money in circulation
 • When there is less money in circulation, it reduces spending (imagine a higher interest rate
on your credit card – you will spend less!)
• Reduced spending brings prices back down (remember supply and demand), and therefore
reduces inflation

 WHEN THE ECONOMY IS SLOWING

• When the economy contracts, the Central bank reduces the discount rate
• They might also decrease the reserve requirement
• When the economy contracts, the Central bank reduces the discount rate
• They might also decrease the reserve requirement
• This decreases the interest rate at commercial banks
• Lower interest rates means loans are less expensive –businesses and people tend to borrow
more
• Combine this with lower reserve requirements, there is more money in circulation
• When there is more money in circulation, at lower interest rates, it increases
spending
• Businesses are encouraged to expand, consumers to spend
• This puts money back in the system, encourages economic growth (growing businesses
means more jobs, more spending!)

ECONOMIC SYSTEM

ECONOMIC STYLE
 Different countries employ different economic systems which allocate society’s resources
differently
 The four type of Economic System
 Capitalism
 Socialism
 Communism
 Mixed Economies
 Many first world countries in Europe for example, have mixed economies or operate as
socialist democracies
 CAPITALISM
• Capitalism: an economic system in which individuals own and operate the majority of
businesses that provide goods and services
• Capitalism (free-market economy) : an economic system in which businesses and
individuals decide what to produce and buy, and the market determines prices and
quantities sold.

• FUNDAMENTAL RIGHTS OF CAPITALISM

o Right to own a business and keep after-tax profits
o Right to private property
o Right to free choice
o Right to fair competition

• CAPITALISM, THE DOWNSIDE

o Has survived for 225 years and produced highest standard of living in human
history
o People ‘vote’ by buying; they are the best judges of what to make
o Drives higher quality and lower prices for consumers
o BUT Has produced the greatest volume of waste in human history
o ‘People acting separately’ does not allow for planning of scarce resources
o Growing inequality within individuals is a product of modern capitalism
o Does not really exist; large corporations, government intervention

 COMMAND ECONOMY
• Command Economy: an economic system in which the government decides what
goods and services will be produced, how they will be produced, for whom available
goods and services will be produced, and who owns and controls the major factors
of production.
• Socialism: the key industries are owned and controlled by the government.
• Communism: mid-1800s, Karl Marx advocated a classless society whose citizens
together owned all economic resources.

• PLANNED ECONOMIES: SOCIALISM

o Economic system based on the principle that the government owns and operates
key enterprises that directly affect public welfare
 o Has higher taxes, designed to distribute wealth more evenly through
society
o Operates key enterprises (utilities, education, banking) in the best interest of the
general public.
o Socialist economies
o Caused by high taxes and lavish social programs

• PLANNED ECONOMIES: COMMUNISM

• An extremist form of socialism
• Introduced by Karl Marx
• An economic system that calls for public ownership of all enterprises, under a
strong central government
• Did not thrive due to following reasons:
o Authoritarian governments suspended individual rights and choices
o Developed crippling shortages and surpluses
o Businesses run inefficiently
o Corruption at every level of government

• MIXED ECONOMY
o Embody elements of both planned and market-based economic systems
o Federal government partly owns number of financial institutions
o Government intervenes in the free market by creating regulations
o Privatization: the conversion of government-owned businesses to private
ownership

 ECONOMIC SYSTEMS Example

BASIC KNOWLEDGE FOR ECONOMY

TYPE OF COMPETITION
• Pure (or perfect) competition: the market situation in which there are many buyers and sellers
of a product, and no single buyer or seller is powerful enough to affect the price of that product

Type of Competition Number of Business Firms or Suppliers Real-World Examples

Perfect Many Corn, Wheat, peanuts, many
agricultural products
Monopolistic Many Clothing, Shoes
Oligopoly Few Automobiles, cereals
Monopoly One Software protected by copyright, many
local public unities
 • PERFECT (PURE) COMPETITION CONTIONS
o We are discussing the market for a single product, such as bushels of wheat.
o There is no barrier on firms entering the industry.
o All sellers offer essentially the same product for sale.
o All buyers and sellers know everything there is to know about the market (including, in our
example, the prices that all sellers are asking for their wheat).
o The overall market is not affected by the actions of any one buyer or seller.

• Oligopoly: a market (or industry) situation in which there are few sellers

o <Ex>the automobile, airline, car rental, cereal, and farm implement industries. And farm
implement industries.
• Monopoly: a market (or industry) with only one seller, and there are barriers to keep other
firms from entering the industry.

o <Ex> United States - public utilities, including companies that provide local gas, water, or
electricity as natural monopoly.
o < E x > Legal monopoly as franchise, license, copyright, patent, or trademark)

SUPPLY AND DEMAND

Explains the dynamic interaction between buyers and sellers that directly affects:
o Range of products
o Prices

 SUPPLY: the quantity of products that producers are willing to offer for sale at different market
price
 DEMAND: the quantity of products that consumers are willing to buy at different market prices.
 Market price: the price at which the quantity demanded is exactly equal to the quantity supplied.
Supply Curve & Demand Curve

EQUILIBRIUM AND MARKET PRICE

• Equalibrim : price: Quantity demanded of a
product equals the quantity supplied
• Associated with the point at which the quantity
demanded equals the quantity supplied
• Constant interaction between supply and
demand determines the equilibrium price,the
market price
• Thus, the price of goods and services that
consumers buy is set by the laws of supply
and demand

MEASUTING THE ECONOMIC INDICATOR

 Governments and governing bodies work hard to improve economies – but how do we know if it is
working?
 We evaluate the economic performance of a country by examining the following:

 Gross domestic product (GDP)

 Employment level
 Business cycle
 Inflation rate/price levels
 Productivity
 BUSIESS AND ECONOMY

• Consumers: people who purchases goods and services for personal use
• Gross domestic product (GDP): the monetary value of all the finished goods and services
produced within a country's borders in a specific time period
• In the U.S. 70% country’s GDP comes from consumer spending
• Therefore businesses selling products and services to consumers are vital to the economy

 EMPLOYMET LEVEL
• Unemployment rates refer to the percentage of a people in the labor force (over the age of
15) who do not have jobs and are actively seeking employment
• People who are not employed do not pay taxes (less government revenue)
• They are usually have limited spending, which means lower consumer spending
o Frictional unemployment - When it is possible to find better jobs
o Structural unemployment - Unemployment for a longer term as skills are no longer relevant
o Cyclical unemployment - Layoffs during recessions
o Seasonal unemployment - Job loss related to the time of year
• A “normal” unemployment rate in a healthy economy is between 4% - 6%
• In the US, unemployment returned to pre-2008 rates in 2014

 THE BUSINESS CYCLE

: Periodic contraction and expansion of the economy

 INFLAITON RATE/PRICE LEEVELS

• Inflation: a general rise in the level of prices (Opposite: Deflation)
o Hyperinflation: Average monthly inflation rate of more than 50 percent
o Disinflation: Period of slowing average price increases
• Price indexes to evaluate inflation
o Consumer price index (CPI): Evaluates the change in the weighted-average price of
goods and services that an average consumer buys each month
o Producer price index (PPI): Evaluates the change over time in the weighted-average
wholesale prices

• With inflation, prices creep upward - an item that cost $100 in 1982 cost $215 in 2008
• Inflation that outpaces the growth of an economy or increases in salaries can harm an
economy
 PRODUCTIVITY
• Relationship between:
o Output - Production of goods or services
o Input -Resources required to produce goods or services
• Productivity can grow due increased technology or other innovations that reduced the
resources required to produce a good or service

KEY TERMS