OSIAS COLLEGES INC. F. Tañedo St. cor.

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Philippines

CHAPTER 8
LABOR MARKET,INTEREST,RENT AND
PROFIT

MEMBERS:

Dhy jay Longga

Ariel Jan Canlas

Aldryn Cuevas

Princes Marion Mendoza

Mary Grace Puyawan

Cherry Ann Santos

 The Labor Market

Labour Market

Labour markets or job markets function through the interaction of workers and employers.
Labour economics looks at the suppliers of labour services (workers) and the demanders of
labour services (employers), and attempts to understand the resulting pattern of wages,
employment, and income. Labour markets are normally geographically bounded, but the rise of
the internet has brought about a 'planetary labour market' in some sectors.

Macro and micro analysis of labour markets

There are two sides to labour economics. Labour economics can generally be seen as the
application of microeconomic or macroeconomic techniques to the labour market.
Microeconomic techniques study the role of individuals and individual firms in the labour
market. Macroeconomic techniques look at the interrelations between the labour market, the
goods market, the money market, and the foreign trade market. It looks at how these
interactions influence macro variables such as employment levels, participation rates, aggregate
income and gross domestic product.

The macroeconomics of labour markets

The Labour force (LF) is defined as the number of people of working age, who are either
employed or actively looking for work (unemployed). The labour force participation rate (LFPR)
is the number of people in the labour force divided by the size of the adult civilian non-
institutional population (or by the population of working age that is not institutionalized), LFPR =
LF/Population.

The non-labour force includes those who are not looking for work, those who are
institutionalized (such as in prisons or psychiatric wards), stay-at-home spouses, children not of
working age, and those serving in the military. The unemployment level is defined as the labour
force minus the number of people currently employed. The unemployment rate is defined as
the level of unemployment divided by the labour force. The employment rate is defined as the
number of people currently employed divided by the adult population (or by the population of
working age). In these statistics, self-employed people are counted as employed.

Natural Unemployment

Frictional unemployment – This reflects the fact that it takes time for people to find and settle
into new jobs that they feel are appropriate for them and their skill set. Technological
advancement often reduces frictional unemployment; for example, internet search engines have
reduced the cost and time associated with locating employment or personnel selection.
Structural unemployment – the number of jobs available in an industry are not sufficient
enough to provide jobs to all persons who are interested in working or qualified to work in that
 industry. This can be due to the changes in industries prevalent in a country or because wages
for the industry are too high, causing people to want to supply their labour to that industry.
Natural rate of unemployment (also known as full employment) – This is the summation of
frictional and structural unemployment, that excludes cyclical contributions of unemployment
(e.g. recessions) and seasonal unemployment. It is the lowest rate of unemployment that a
stable economy can expect to achieve, given that some frictional and structural unemployment
is inevitable. Economists do not agree on the level of the natural rate, with estimates ranging
from 1% to 5%, or on its meaning – some associate it with "non-accelerating inflation". The
estimated rate varies between countries and across time.

Unnatural Unemployment

Demand deficient unemployment (also known as cyclical unemployment) – In Keynesian

economics, any level of unemployment beyond the natural rate is probably due to insufficient
goods demand in the overall economy. During a recession, aggregate expenditure is deficient
causing the underutilisation of inputs (including labour). Aggregate expenditure (AE) can be
increased, according to Keynes, by increasing consumption spending (C), increasing investment
spending (I), increasing government spending (G), or increasing the net of exports minus imports
(X−M), since AE = C + I + G + (X−M).
Seasonal unemployment - Unemployment due to seasonal fluctuations of demand for workers
across industries, such as in the retail industry after holidays that involve a lot of shopping are
over.

Neoclassical microeconomics of labour markets

Neoclassical microeconomics of labour markets

Neoclassical economists view the labour market as similar to other markets in that the forces of
supply and demand jointly determine the price (in this case the wage rate) and quantity (in this
case the number of people employed).

Neoclassical microeconomic model – Supply

Households are suppliers of labour. In microeconomic theory, people are assumed to be rational
and seeking to maximize their utility function. In the labour market model, their utility function
expresses trade-offs in preference between leisure time and income from time used for labour.
However, they are constrained by the hours available to them.

This is shown in the graph below, which illustrates the trade-off between allocating time to
leisure activities and allocating it to income-generating activities. The linear constraint indicates
that every additional hour of leisure undertaken requires the loss of an hour of labour and thus
of the fixed amount of goods that that labour's income could purchase. Individuals must choose
how much time to allocate to leisure activities and how much to working.
This allocation decision is informed by the indifference curve labelled IC1. The curve indicates
the combinations of leisure and work that will give the individual a specific level of utility. The
point where the highest indifference curve is just tangent to the constraint line (point A),
illustrates the optimum for this supplier of labour services.

If consumption is measured by the value of income obtained, this diagram can be used to show
a variety of interesting effects. This is because the absolute value of the slope of the budget
constraint is the wage rate. The point of optimisation (point A) reflects the equivalency between
the wage rate and the marginal rate of substitution of leisure for income (the absolute value of
the slope of the indifference curve). Because the marginal rate of substitution of leisure for
income is also the ratio of the marginal utility of leisure (MUL) to the marginal utility of income
(MUY), one can conclude: where Y is total income and the right side is the wage rate.

If the wage rate increases, this individual's constraint line pivots up from X,Y1 to X,Y2. He/she
can now purchase more goods and services. His/her utility will increase from point A on IC1 to
point B on IC2. To understand what effect this might have on the decision of how many hours to
work, one must look at the income effect and substitution effect.

The wage increase shown in the previous diagram can be decomposed into two separate effects.
The pure income effect is shown as the movement from point A to point C in the next diagram.
Consumption increases from YA to YC and – since the diagram assumes that leisure is a normal
good – leisure time increases from XA to XC. (Employment time decreases by the same amount
as leisure increases.)
The Income and Substitution effects of a wage increase but that is only part of the picture. As
the wage rate rises, the worker will substitute away from leisure and into the provision of labour
—that is, will work more hours to take advantage of the higher wage rate, or in other words
substitute away from leisure because of its higher opportunity cost.
If the substitution effect is greater than the income effect, an individual's supply of labour
services will increase as the wage rate rises, which is represented by a positive slope in the
labour supply curve (as at point E in the adjacent diagram, which exhibits a positive wage
elasticity). This positive relationship is increasing until point F, beyond which the income effect
dominates the substitution effect and the individual starts to reduce the number of labour hours
he supplies (point G) as wage increases; in other words, the wage elasticity is now negative.
Neoclassical microeconomic model – Demand

See also: Labour demand

A firm's labour demand is based on its marginal physical product of labour (MPPL). This is
defined as the additional output (or physical product) that results from an increase of one unit
of labour (or from an infinitesimal increase in labour). (See also Production theory basics.)

Labour demand is a derived demand; that is, hiring labour is not desired for its own sake but
rather because it aids in producing output, which contributes to an employer's revenue and
hence profits. The demand for an additional amount of labour depends on the Marginal
Revenue Product (MRP) and the marginal cost (MC) of the worker. With a perfectly competitive
goods market, the MRP is calculated by multiplying the price of the end product or service by
the Marginal Physical Product of the worker. If the MRP is greater than a firm's Marginal Cost,
then the firm will employ the worker since doing so will increase profit. The firm only employs
however up to the point where MRP=MC, and not beyond, in neoclassical economic theory.

The MRP of the worker is affected by other inputs to production with which the worker can
work (e.g. machinery), often aggregated under the term "capital". It is typical in economic
models for greater availability of capital for a firm to increase the MRP of the worker, all else
equal. Education and training are counted as "human capital". Since the amount of physical
capital affects MRP, and since financial capital flows can affect the amount of physical capital
available, MRP and thus wages can be affected by financial capital flows within and between
countries, and the degree of capital mobility within and between countries.

According to neoclassical theory, over the relevant range of outputs, the marginal physical
product of labour is declining (law of diminishing returns). That is, as more and more units of
labour are employed, their additional output begins to decline.

Additionally, although the MRP is a good way of expressing an employer's demand, other factors
such as social group formation can the demand, as well as the labour supply. This constantly
restructures exactly what a labour market is, and leads way to cause problems for theories of
inflation.

Neoclassical microeconomic model – Equilibrium

A Firm's Labour Demand in the Short Run

A firm's labour demand in the short run (D) and a horizontal supply curve (S)
The marginal revenue product of labour can be used as the demand for labour curve for this
firm in the short run. In competitive markets, a firm faces a perfectly elastic supply of labour
which corresponds with the wage rate and the marginal resource cost of labour (W = SL =
MFCL). In imperfect markets, the diagram would have to be adjusted because MFCL would then
be equal to the wage rate divided by marginal costs. Because optimum resource allocation
 requires that marginal factor costs equal marginal revenue product, this firm would demand L
units of labour as shown in the diagram.

The demand for labour of this firm can be summed with the demand for labour of all other firms
in the economy to obtain the aggregate demand for labour. Likewise, the supply curves of all the
individual workers (mentioned above) can be summed to obtain the aggregate supply of labour.
These supply and demand curves can be analysed in the same way as any other industry
demand and supply curves to determine equilibrium wage and employment levels.

Wage differences exist, particularly in mixed and fully/partly flexible labour markets. For
example, the wages of a doctor and a port cleaner, both employed by the NHS, differ greatly.
There are various factors concerning this phenomenon. This includes the MRP of the worker. A
doctor's MRP is far greater than that of the port cleaner. In addition, the barriers to becoming a
doctor are far greater than that of becoming a port cleaner. To become a doctor takes a lot of
education and training which is costly, and only those who excel in academia can succeed in
becoming doctors. The port cleaner, however, requires relatively less training. The supply of
doctors is therefore significantly less elastic than that of port cleaners. Demand is also inelastic
as there is a high demand for doctors and medical care is a necessity, so the NHS will pay higher
wage rates to attract the profession.

Monopsony

Some labour markets have a single employer and thus do not satisfy the perfect competition
assumption of the neoclassical model above. The model of a Monopsonistic labour market gives
a lower quantity of employment and a lower equilibrium wage rate than does the competitive
model.
Discrimination and Inequality

Inequality and discrimination in the workplace can have many effects on workers.
In the context of labour economics, inequality is usually referring to the unequal distribution of
earning between households. Inequality is commonly measured by economists using the Gini
coefficient. This coefficient does not have a concrete meaning but is more used as a way to
compare inequality across regions. The higher the Gini coefficient is calculated to be the larger
inequality exists in a region. Over time, inequality has, on average, been increasing. This is due
to numerous factors including labour supply and demand shifts as well as institutional changes
in the labour market. On the shifts in labour supply and demand, factors include demand for
skilled workers going up more than the supply of skilled workers and relative to unskilled
workers as well as technological changes that increase productivity; all of these things cause
wages to go up for skilled labour while unskilled worker wages stay the same or decline. As for
the institutional changes, a decrease in union power and a declining real minimum wage, which
both reduce unskilled workers wages, and tax cuts for the wealthy all increase the inequality gap
between groups of earners.

As for discrimination, it is the difference in pay that can be attributed to the demographic
differences between people, such as gender, race, ethnicity, religion, sexual orientation, etc,
even though these factors do not affect the productivity of the worker. Many regions and
countries have enacted government policies to combat discrimination, including discrimination
in the workplace. Discrimination can be modelled and measured in numerous ways. The oaxaca
decomposition is a common method used to calculate the amount of discrimination that exists
when wages differ between groups of people. This decomposition aims to calculate the
difference in wages that occurs because of differences in skills versus the returns to those skills.
A way of modelling discrimination in the workplace when dealing with wages are Gary Becker's
taste models. Using taste models, employer discrimination can be thought of as the employer
not hiring the minority worker because of their perceived cost of hiring that worker is higher
than that of the cost of hiring a non-minority worker, which causes less hiring of the minority.
Another taste model is for employee discrimination, which does not cause a decline in the hiring
of minorities, but instead causes a more segregated workforce because the prejudiced worker
feels that they should be paid more to work next to the worker they are prejudiced against or
that they are not paid an equal amount as the worker they are prejudiced against. One more
taste model involves customer discrimination, whereby the employers themselves are not
prejudiced but believe that their customers might be, so therefore the employer is less likely to
hire the minority worker if they are going to interact with customers that are prejudiced. There
are many other taste models other than these that Gary Becker has made to explain
discrimination that causes differences in hiring in wages in the labour market.
 Labor supply

Labour supply

In mainstream economic theories, the labour supply is the total hours (adjusted for intensity of
effort) that workers wish to work at a given real wage rate. It is frequently represented
graphically by a labour supply curve, which shows hypothetical wage rates plotted vertically and
the amount of labour that an individual or group of individuals is willing to supply at that wage
rate plotted horizontally.

Neoclassical view

This backward bending supply curve of labour shows how the change in real wage rates affects
the number of hours worked by employees.

Neoclassical microeconomic model of labour supply

Labour supply curves derive from the 'labour-leisure' trade-off. More hours worked earn higher
incomes, but necessitate a cut in the amount of leisure that workers enjoy. Consequently, there
are two effects on the amount of labour supplied due to a change in the real wage rate. As, for
example, the real wage rate rises, the opportunity cost of leisure increases. This tends to make
workers supply more labour (the "substitution effect"). However, also as the real wage rate
rises, workers earn a higher income for a given number of hours. If leisure is a normal good—the
demand for it increases as income increases—this increase in income tends to make workers
supply less labour so they can "spend" the higher income on leisure (the "income effect"). If the
substitution effect is stronger than the income effect then the labour supply slopes upward. If,
beyond a certain wage rate, the income effect is stronger than the substitution effect, then the
labour supply curve bends backward. Individual labor supply curves can be aggregated to derive
the total labour supply of an economy.

Marxist view
Reserve army of labour and Proletarization
From a Marxist perspective, a labour supply is a core requirement in a capitalist society. To
avoid labour shortage and ensure a labour supply, a large portion of the population must not
possess sources of self-provisioning, which would let them be independent—and they must
instead, to survive, be compelled to sell their labour for a subsistence wage. In the pre-industrial
economies wage labour was generally undertaken only by those with little or no land of their
own.
 Market supply of labor services

The supply curve models the tradeoff between supplying labor into the market or using

time in leisure activities at every given price level. The higher the wage, the more labor is
willing to work and forego leisure activities. ... An aging and therefore retiring population will
decrease the supply of labor.

What determines market supply of labor?

The market supply of labor is the number of workers of a particular type and skill level
who are willing to supply their labor to firms at different wage levels. The market supply curve
for a particular type of labor is the horizontal summation of the individuals' labor
supply curves.

Who are the suppliers of labor?

The labor market is an inversion of the goods and services market: in the labor market,

individual buyers from the goods and services market become the suppliers of labor, while the
firms that sold goods in the goods and services market become the buyers.

What factors influence the supply of Labour?

Two factors that influence a workers supply of labour

 Substitution effect of a rise in wages. ...
 Income effect of a rise in wages. ...
 The number of qualified people. ...
 Difficulty of getting qualifications. ...
 The non-wage benefits of a job. ...
 The wages and conditions of other jobs. ...
 Demographic changes and immigration.
The global economy and migration
Before the international economic downturns that began in the 1970s, the composition of
international migration generally held to Ravenstein's hypothesis that the primary motivation for
migration was economic, and that young males predominated long-distance travel. Since the
1970s, the pattern of migration has transformed with global economic changes.
 What is the impact of global migration to global economy?

The economic effects of migration vary widely. Sending countries may experience both

gains and losses in the short term but may stand to gain over the longer term. For receiving
countries temporary worker programs help to address skills shortages but may decrease domestic
wages and add to public welfare burden.

What is the importance of global migration?

Migration is important for the transfer of manpower and skills and provides the needed
knowledge and innovation for global growth. In order to address the issues raised by global
migration, it is necessary to improve international coordination.
What is the purpose of migration?

Reasons to Move

Some animals travel relatively short distances to find food or more favorable living or breeding
conditions. Most animals that migrate do so to find food or more livable conditions. Some
animals migrate to breed. The Atlantic Salmon begins its life in a river and migrates
downstream to the ocean.

What are the impacts of migration?

Positive Impact

Migration helps in improving the quality of life of people. It helps to improve social life of
people as they learn about new culture, customs, and languages which helps to improve
brotherhood among people. Migration of skilled workers leads to a greater economic growth of
the region.

What are two cultural effects of migration?

Individuals who migrate experience multiple stresses that can impact their mental well being,

including the loss of cultural norms, religious customs, and social support systems, adjustment
to a new culture and changes in identity and concept of self.

What are 4 types of migration?

1. Build background about human migration and types of migration.

 internal migration: moving within a state, country, or continent.
 external migration: moving to a different state, country, or continent.
 emigration: leaving one country to move to another.
 immigration: moving into a new country
 “MARKET SUPPLY OF LABOR SERVICE”

Introduction:

- This report will help the students to understand the Market Supply of Labor Services for
the individual workers in our society. This report will include the Total Labor Supply of
the Economy, Population Growth, The History of the worker, and the explanation of the
labor wages for the workers. These topics will be further explained in the report.

Market Supply of Labor Service

- The market supply of labor is the number of workers of a particular type and skill level
who are willing to supply their labor to firms at different wage levels. The market
supply curve for a particular type of labor is the horizontal summation of the
individuals' labor supply curves.

Market Supply Curve

- is an upward sloping curve depicting the positive relationship between price and quantity

supplied. The market supply curve is derived by summing the quantity suppliers are
willing to produce when the product can be sold for a given price.

Key Points

 A supply curve is the graphical representation of the supplier’s

positive correlation between the price and quantity of a good or
service.
 The supply curve can only be attributed to a depiction of a
perfectly competitive market due to the unique attributes of
perfect competition: firms are price takers, no single firm’s
actions can influence the market price, and ease of exit and
entry.
 The market supply curve is derived by summing the quantity
for a given price across all market participants (suppliers). It
depicts the price-to-quantity combinations available to
consumers of the good or service.

Key Terms

Labour supplycurve: A graphical representation of the quantity producers are

 Supply
willing to make when the product can be sold at a given price.
- In mainstream economic theories, the labour supply is the total hours that workers wish
to work at a given real wage rate
 - In summary, labor supply is the total hours that workers or employees are willing to
work at a given wage rate. Changes in income, population, work-leisure preference,
prices of related goods and services, and expectations about the future can all cause
the labor supply to shift to the right or left.

Population Growth

- is the increase in the number of individuals in a population.

- Some theoretical analyses argue that high population growth creates pressures on
limited natural resources, reduces private and public capital formation, and diverts
additions to capital resources to maintaining rather than increasing the stock of capital per
worker.
- Growth in population increases the proportion of younger workers, who are less
experienced. Experience is one of the most important determinants of labor productivity.
A less experienced labor force is a less productive labor force. A decline in the average
age of workers tends to decrease the marginal revenue product of labor, which
contributes to lower average wages.
Marginal Revenue of Product

- Marginal revenue product (MRP), also known as the marginal value product, is

the marginal revenue created due to an addition of one unit of resource. The marginal
revenue product is calculated by multiplying the marginal physical product (MPP) of
the resource by the marginal revenue (MR) generated.

KEY TAKEAWAYS

 Marginal revenue product (MRP) is the

marginal revenue created by using one
additional unit of resource.
 MRP is used to make critical decisions
on business production and determine
the optimal level of a resource.
 The MRP assumes that the
expenditures on other factors remain
unchanged.

Marginal Product of Labor

Key Points

 The marginal product of labor is not always equivalent to the

output directly produced by that added unit of labor.

 When production is discrete, we can define the marginal

product of labor (MPL) as ΔY/ΔL.

 When production is continuous, the MPL is the first derivative

of the production function in terms of L.

 Graphically, the MPL is the slope of the production function.

 The law of diminishing marginal returns ensures that in most

industries, the MPL will eventually be decreasing.
Key Terms

 returns to scale: A term referring to changes in output

resulting from a proportional change in all inputs (where all
inputs increase by a constant factor).
Marginal Product of Labor: This table shows  marginal product: The extra output that can be produced by
hypothetical returns and marginal product of using one more unit of the input.
labor. Note that in reality this firm would never
hire more than seven employees, since a
negative marginal product is bad for the firm
regardless of the wage rate.
Baby Boom/ Baby Boomer

- Baby boomer is a term used to describe a person who was born between 1946 and 1964.
The baby boomer generation makes up a substantial portion of the world's population,
especially in developed nations. It represents nearly 20% of the American public.
- Baby boomers emerged after the end of World War II, when birth rates across the world
spiked. The explosion of new infants became known as the baby boom. During the boom,
almost 77 million babies were born in the United States alone, comprising nearly 40% of
the American population.

- Most historians say the baby boomer phenomenon most likely involved a combination of
factors: people wanting to start the families that they put off during World War II and the
Great Depression, and a sense of confidence that the coming era would be safe and
prosperous. Indeed, the late 1940s and 1950s generally saw increases in wages, thriving
businesses, and an increase in the variety and quantity of products for consumers.

• The "baby boom" generation in the 1950s began entering the labor force 'in the 1970s and
by 1977 the proportion of 20-year-old in the population or force percent higher than it
was in the early 1960s. This large influx of inexperienced workers into the labor force
resulted in a 12 to 15 percent decline in the wages of new workers when compared to
adults.

• The increase in inexperienced workers also serves to sharply reduce the growth of wages
adjusted for changes in the price level.

• A higher proportion of inexperienced workers in the labor force also contribute an

increase in the unemployment rate, because younger workers are more likely to Quit
'their jobs in search of better ones. At any point in time, therefore, there will be younger
workers "between jobs- than older workers
 UNION MEMBERSHIP

• The arrangement most preferred by unions todays is the union shop, in which workers
don’t have to belong to the union to be hired but must agree to become member after
certain period of employment. An Alternative to the union shop is the open shop in
which union membership is voluntary for both new and existing workers.
• The pattern of union membership has been changing in recent years Union Membership
in such traditional strong holds as steel, clothing and textiles, and oil has been declining
in part because of the general decrease in employment in these industries
• On the other hand union membership in service and government jobs has been
increasing for example. between 1971 and 1985 union membership in the hotel and
restaurant industries increased by some 9 percent union membership for teachers ,
firefighters , postal workers, and other government employees has also on the rise.
THE UNION CONTROL ON LABOR SUPPLY

• Union can use power of control over labor supply to establish wages above the
competitive equilibrium wage. Assume a union sells labor services to many independent
firms ,each of which is normally piece taker. Therefore, each firm can normally hire as
great a quality of labor service.
• To achieve the objective of increasing wages above the market equilibrium level, the
union must prevent competition among workers from causing wages to fall. One way
the union can accomplish this is to negotiate a wage agreement with employers.
• Another way the union can achieve its goal of higher wages is by limiting the number of
union members. The union negotiates a contract that requires to use union labor only
through the establishing of a closed shop.
THE COLLECTIVE BARGAINING AGREEMENT

• Collective bargaining sessions between management and unions cover the whole range
of issues relating to employee compensation, including fringe benefits, working hour,
working rules, holidays and retirement age. Fringe benefits include employers provides
insurance for health and other purposes, pensions, child care employee discount and
meals.
• Union are also very sensitive to the issue of seniority a measure of workers length of
service as a union member. Seniority is usually used as a basis for determining
promotion in union work rules. In addition ,priority for laying-off workers is established
by seniority.
• An important fact about contracts that are reached through collective bargaining is that
they often are very detailed and specify wage levels and fringe benefits for a number of
years. Typically, contracts are effect for 2to 3 years.
• When this occurs, there are a number of alternatives. The union and management
officials can submit to process by which an impartial third party settles their disputes.
This process is called arbitration. Arbitration is sometimes required by law. In other
cases unions and management use meditation, a process in which an impartial third
party, often a government official, is sent in try to speed up the process of the reaching
an agreement.
 Interest , Rent And Profit

Interest

• Interest is the charge for the privilege of borrowing money, typically expressed as annual
percentage rate (APR). Interest can also refer to the amount of ownership a stockholder
has in a company, usually expressed as a percentage.
Rent

• Renting, also known as hiring or letting, is an agreement where a payment is made for the
temporary use of a good, service or property owned by another. A gross lease is when the
tenant pays a flat rental amount and the landlord pays for all property charges regularly
incurred by the ownership.
Profit

• Profit, in accounting, is an income distributed to the owner in a profitable market

production process. Profit is a measure of profitability which is the owner's major interest
in the income-formation process of market production
The Stock Capital

• Capital stock is the amount of common and preferred shares that a company is
authorized to issue, according to its corporate charter. ... The amount is listed on the
balance sheet in the company's shareholders' equity section
• Capital stock is the amount of common and preferred shares that a company is authorized
to issue, according to its corporate charter. Capital stock can only be issued by the
company and is the maximum number of shares that can ever be outstanding. The amount
is listed on the balance sheet in the company's shareholders' equity section.
What increases capital stock?

• There are two ways to increase the capital stock of a company: By creating new shares
or issuing new shares. By increasing the nominal value of existing shares.
 THE CREDIT MARKET

What is credit market?

CREDIT MARKET REFERS TO THE MARKET THROUGH WHICH COMPANIES AND

GOVERNMENTS ISSUE DEBT TO INVESTORS, SUCH AS INVESTMENT-GRADE BONDS, JUNK
BONDS, AND SHORT-TERM COMMERCIAL PAPER. SOMETIMES CALLED THE DEBT
MARKET, THE CREDIT MARKET ALSO INCLUDES DEBT OFFERINGS, SUCH AS NOTES AND
SECURITIZED OBLIGATIONS, INCLUDING COLLATERALIZED DEBT OBLIGATIONS (CDOS),
MORTGAGE-BACKED SECURITIES, AND CREDIT DEFAULT SWAPS (CDS).

EXPLANATION; THE CREDIT MARKET THEY ARE THE ONE WHO OFFERING DEBT TO
THE COMPANY OR INVESTORS

4 TYPES OF CREDIT MARKET INTEREST

THERE ARE FOUR BASIC TYPES OF CREDIT MARKET INSTRUMENTS:

1. SIMPLE LOAN—WHICH THE LENDER PROVIDES THE BORROWER WITH

AN AMOUNT OF FUNDS, WHICH MUST BE REPAID TOTHE LENDER AT THE
MATURITY DATE ALONG WITH AN ADDITIONAL PAYMENT FOR THE
INTEREST.
EXPLANATION: SIMPLE EXAMPLE WHEN YOU BORROW A MONEY TO YOUR NEIGHBOR
AND YOU NEED TO PAY IT IN THE DATE YOU TALKED TOGETHER WITH THE INTEREST.

2. FIXED-PAYMENT LOAN(WHICH IS ALSO CALLED A FULLY AMORTIZED

LOAN) IN WHICH THE LENDER PROVIDES THE BORROWER WITH AN
AMOUNT OF FUNDS, WHICH MUST BE REPAID BY MAKING THE SAME
PAYMENT EVERY PERIOD,CONSISTING OF PART OF THE PRINCIPAL AND
INTEREST FOR A SET NUMBER OF YEARS.
EXPLANATION: FROM THE WORD FIXED ALL PAYMENTS HAVE FIXED DATE AND FIXED
A MOUNT PAYMENT AND FIXED INTEREST.

3. COUPON BOND PAYS THE OWNER OF THE BOND A FIXED INTEREST

PAYMENT EVERY YEAR UNTIL THE MATURITY DATE,WHEN A SPECIFIED
FINAL AMOUNT (FACE VALUE OR PAR VALUE)
EXPLANATION: IT IS LIKE A CONTRACT THAT SECURE THE BORROWER TO OBLIGE TO
PAY INTEREST AND PRINCIPAL

4. DISCOUNT BOND(ALSO CALLED A ZERO-COUPON BOND) IS BOUGHT AT A

PRICE BELOW ITS FACE VALUE (AT A DISCOUNT), AND THE FACE VALUE IS
REPAID AT THE MATURITY DATE
EXPLANATION: A BOND WILL TRADE AT A DISCOUNT WHEN IT OFFERS A COUPON RATE
THAT IS LOWER THAN PREVAILING INTEREST RATES. SINCE INVESTORS ALWAYS WANT
A HIGHER YIELD, THEY WILL PAY LESS FOR A BOND WITH A COUPON RATE LOWER THAN
THE PREVAILING RATES. SO THEY ARE BUYING IT AT A DISCOUNT TO MAKE UP FOR THE
LOWER COUPON RATE.

KEY TAKEAWAYS

 THE CREDIT MARKET IS WHERE INVESTORS AND INSTITUTIONS CAN BUY DEBT
SECURITIES SUCH AS BONDS.
 ISSUING DEBT SECURITIES IS HOW GOVERNMENTS AND CORPORATIONS RAISE
CAPITAL, TAKING INVESTORS MONEY NOW WHILE PAYING INTEREST UNTIL THEY
PAY BACK THE DEBT PRINCIPAL AT MATURITY.
 THE CREDIT MARKET IS LARGER THAN THE EQUITY MARKET, SO TRADERS LOOK
FOR STRENGTH OR WEAKNESS IN THE CREDIT MARKET TO SIGNAL STRENGTH OR
WEAKNESS IN THE ECONOMY.
THE RATE OF INTEREST

THE INTEREST RATE IS THE AMOUNT CHARGED ON TOP OF THE PRINCIPAL BY A

LENDER TO A BORROWER FOR THE USE OF ASSETS. MOST MORTGAGES USE SIMPLE
INTEREST. HOWEVER, SOME LOANS USE COMPOUND INTEREST, WHICH IS APPLIED TO
THE PRINCIPAL BUT ALSO TO THE ACCUMULATED INTEREST OF PREVIOUS PERIODS.

EXPLANATION; IN A SITUATION WHEN A LENDER GIVE A MONEY TO BORROWER. THE

RATE OF INTEREST WILL INCREASE DEPENDING ON WHAT THEY TALKED ABOUT.

THE STRUCTURE OF INTEREST RATE

THE TERM STRUCTURE OF INTEREST RATES AT ANY TIME IS THE FUNCTION

RELATING INTEREST RATE TO TERM. THE STUDY OF THE TERM STRUCTURE INQUIRES
WHAT MARKET FORCES ARE RESPONSIBLE FOR THE VARYING SHAPES OF THE TERM
STRUCTURE.

EXPLANATION;THIS TERM STRUCTURE OF INTEREST RATE SHOW HOW AND WHEN

TO PAY, WHEN THE DUE DATE ,AND HOW MUCH INTEREST INCREASES WHEN YOU
EXCEED THE DUE DATE.

THE STRUCTURE OF INTEREST RATE THROUGH; RISK, LIQUIDITY AND MATURITY

RISK - BORROWERS WITH A GOOD CREDIT PAYS LOWER INTEREST RATES THAN
BORROWERS WITH POOR CREDIT RATINGS.

EXPLANATION: WHEN YOU BORROW FROM A BANK TO START OR OPEN A BUSINESS

AND YOUR BUSINESS DOES NOT CLICK OR BANKRUPT. THE MONEY YOU BORROWED
FROM THE BANK WILL CONTINUE TO INCREASE INTEREST IF YOU HAVE NOT ALREADY
PAID FOR IT

LIQUIDITY - A FINANCIAL ASSET THAT CAN BE TURNED INTO CASH QUICKLY OR WITH A
SMALL PENALTY IS SAID TO BE LIQUIDITY.

EXPLANATION: LIQUIDITY IS NOT THE SAME AS MATURITY AND RISK. WHEN YOU
INVEST MONEY YOU CAN GET IT WHENEVER YOU WANT.

MATURITY - GENERALLY, THE LONGER THE TERM TO MATURITY IS, THE HIGHER THE
INTEREST RATE ON THE BOND WILL BE AND THE LESS VOLATILE ITS PRICE WILL BE ON
THE SECONDARY BOND MARKET. ALSO, THE FURTHER A BOND IS FROM ITS MATURITY
DATE, THE LARGER THE DIFFERENCE BETWEEN ITS PURCHASE PRICE AND ITS
REDEMPTION VALUE, WHICH IS ALSO REFERRED TO AS ITS PRINCIPAL, PAR, OR FACE
VALUE.

EXPLANATION: FOR EXAMPLE YOU INVEST AND THEN WHAT IS STATED IN THE
CONTRACT AFTER 2 YEARS YOU CAN GET YOUR MONEY IN SHORT MATURITY HAVE
SPECIFIC DATE OR TIME WHEN WILL YOU GET YOUR MONEY

RENT

RENTING, ALSO KNOWN AS HIRING OR LETTING, IS AN AGREEMENT WHERE A PAYMENT

IS MADE FOR THE TEMPORARY USE OF A GOOD, SERVICE OR PROPERTY OWNED BY
ANOTHER. A GROSS LEASE IS WHEN THE TENANT PAYS A FLAT RENTAL AMOUNT AND
THE LANDLORD PAYS FOR ALL PROPERTY CHARGES REGULARLY INCURRED BY THE
OWNERSHIP. 

EXPLANATION; FOR EXAMPLE YOU HAVE AN APARTMENT AND YOU RENT IT OUT TO
EARN MONEY THE RENT FOR THE APARTMENT DEPENDS ON THE TENANT AND THE
LANDLORD.

TYPES OF RENT

PURE ECONOMIC RENT - PURE ECONOMIC RENT IS THE PRICE USED TO PAY FOR LAND
AND OTHER NATURAL RESOURCES WHICH ARE COMPLETELY FIXED IN SUPPLY. AND AS
WE SHALL SEE, IT IS THE FIXED NATURE OF THE SUPPLY OF LAND THAT MAKES
THE RENTAL PAYMENTS CLEARLY DISTINGUISHABLE FROM THE PRICES PAID TO THE
OTHER FACTORS OF PRODUCTION

EXPLANATION: FOR EXAMPLE, IN A FOREST THERE ARE MANY RAW PRODUCT

MATERIALS AVAILABLE SUCH AS TREES MADE OF PAPER AND PENCIL. THE COMPANY
THAT USES NATURE SUPPLIES PAYS THE GOVERNMENT RENT.

QUASI RENT - THE CONCEPT OF QUASI-RENT WAS GIVEN BY ALFRED MARSHALL. HE

DEFINED QUASI RENT AS SURPLUS EARNINGS GENERATED BY THE FACTORS OF
PRODUCTION, EXCEPT LAND. THE EARNINGS FROM MACHINES AND INSTRUMENTS ARE
TERMED AS QUASI-RENT. THE QUASI-RENT REFERS TO THE INCOME PRODUCED WHEN
THE DEMAND FOR PRODUCTS .

EXPLANATION: QUASI RENT CAN BE COMPARED TO INVESTMENT. THE HIGHER THE

INVESTMENT THE HIGHER THE INCOME THE LESSER INVESTMENT THE LESSER THE
INCOME. EXAMPLE; FOR EXAMPLE YOU HAVE A HOUSE AND LOT BUSINESS AND THE
LAND COST IS EXPENSIVE AND ALSO THE MATERIALS ARE EXPENSIVE SO YOU NEED TO
SELL THE HOUSE AND LOT IN A HIGHER PRICE BUT WHEN THE LAND COST IS CHEAP
AND THE MATERIALS ARE ALSO CHEAP YOU CAN SELL THE HOUSE AND LOT IN A LOW
PRICE TOO.