Transcript Economics and Business What’s the Difference?

Economics and Business
What’s the Difference?

Business: Make Decisions that
Optimize Firm’s Objectives given
Scarce Human and Financial Resources

Is Information about National, State or
Local Economy’s Performance Useful for
Business Decision-making?

Economics: Explains how Goods and
Services are Produced, Distributed and
Consumed
What’s “different” about the Current Recession?
Haven’t we seen this movie before?
“Growth alone will not resolve an increasingly complicated debt
equation. Preserving debt affordability – the ratio of interest
payments to government revenue – at levels consistent with AAA
ratings will invariably require fiscal adjustments [Tax Increases or
Spending Reductions] of a magnitude that, in some cases, will test
social cohesion.”
March 15, 2010. Moody’s
Elastic/inelastic demand
Elastic Demand: Quantity
Demanded is Highly Responsive
to Price Changes (Flatter Curve)
Inelastic Demand: Quantity
Demanded not as Responsive to
Price
Changes
(Steeper
Curve)
Does
this Explain
why
“Sin
Taxes” Pay for Education and
Health Care?
Macroeconomic issues
Four Measures to Follow
Gross Domestic Product (GDP):
National, Regional and Local
Unemployment/Employment Rate:
Job Growth, Wage Levels and Labor
Supply
Inflation: Consumer Price Indexes
Interest Rates: Leading Indicator that
is Principal Tool of Monetary Policy
Notes and Comments
GROSS DOMESTIC PRODUCT
Does Not Include International Output
Difficulty of Measurement raises
Reliability Concerns
Coarse-grained Measure: National
Income Trends may not reflect State
or Local Conditions
UNEMPLOYMENT RATE
What is Causing Changes in
Unemployment Rate: Job Growth
(Numerator) or Labor Force
(Denominator)?
Could High Unemployment Rate be
Politically Undesirable but Favor
Economic Development?
QUESTION: What was Oregon’s Unemployment
Rate when Intel announced it would build its
first plant?
1982: 11.5% Current: 10.5%
National:
9.7%
Notes and Comments
INFLATION RATE
What are the Products or Services
in the “Basket”?
What’s the Geographic Area
covered by the Survey?
Many Types and Forms of
Consumer Price Indices
Theory and applications
INTEREST RATES
 Interest Rate is “Rent” for Using “Other
People’s Money”
 Debt Service: Repayment of Principal
and Interest on Date Certain
Leading Economic Indicator:
(1) Future Economic Conditions
(2) Capital and Operating Costs
Theory and applications
INTEREST RATES
Reflect Risk of Waiting to be Repaid
Business Risk: Likelihood Borrower
will Repay in Full and on Time
“Bird in Hand”: Effects of Inflation
during Loan Term
Opportunity Cost: What happens if
“Better Deal” comes along?
Yield curve: Market dynamics
Upward-sloping Yield Curve
reflects
“Time Value of Money”
Yield Curve on April 1
Source: www,stockcharts.com/charts
Analogous to Supply Curve:
Lenders willing to Supply
Credit for Longer Terms if
Compensated with Higher
Price (Interest Rate) for
bearing Firm-specific and
Systematic Risks
Theory and applications
Compare Rates* in 1971 with Current Rates:
Why wouldn’t you borrow as much as you can?
*FHLMC 30-Yr. Fixed Rate SFR
Theory and applications
REGULATING THE NATIONAL ECONOMY
Why do it?
Promote Employment and Price Stability
_______________________________________________
How to do it and Who should do it?
Fiscal Policy - Government Actions
(Taxes/Spending): “Direct” Effect
Monetary Policy – Federal Reserve System
(Interest Rates/Money Supply): “Indirect” Effect
The Case of Hurd v. Rock Island Railroad
“This current of
travel [east and
west] has its
rights as well as
those of north and
south.”
May 6, 1856
A National economy
Promontory Summit, Utah
May 10, 1869
FISCAL POLICY
ISSUES
MULTIPLIERS
Benefit/Cost Ratios
Government
Spending
Personal and Business
Tax Decreases
Obama Assumptions
$1.57 to 1
$0.99 to 1
Economic Studies
and Models
$1.40 to 1
$3.00 to 1*
Why did Policy Choice favor
Government Spending?
* Romer and Romer
(2009) American
Economic Review
Theory and applications
Federal Reserve
System’s Duties
Conduct Nation’s Monetary Policy
Pursue Maximum Employment and
Stable Prices
Supervise and Regulate Banks
Ensure Safety and Soundness of
Financial System
Theory and applications
Federal Reserve System
Structure
Twelve Member Banks
 Board of Governors:
7 members
appointed by President and Confirmed by
Senate for staggered, 14-year Terms
Current Chair: Ben Bernanke
Federal Open Market Committee
Theory and applications
Conducting
Monetary Policy
Monitor Availability of Credit by
“Influencing Federal Funds Rate”
Regulate Money Supply with Bank
Reserve Requirements
Federal Reserve’s Independence
Theory and applications
Conducting Monetary Policy
The Fed’s Three Tools
 Discount Rate: “Lender of Last Resort”
 Regulate Money Supply with Bank
Reserve Requirements
 Open Market Operations: Regulate
Credit Availability by setting Target for
and “Influencing” Federal Funds Rate
Theory and applications
Conducting
Monetary Policy:
Reserve Requirements
LIABILITY TYPE
RESERVE REQUIREMENT
(Percentage of Liability)
Net Transaction Accounts
$0 to $9.3 Million
0%
More than $9.3M to $43.9M
3%
More than $43.9 Million
10%
Non-personal Time Deposits
0%
Eurocurrency Liabilities
0%
Net Transaction Accounts: Demand Deposits and Other
Transactions maturing in Seven (7) days or less
What is the “Federal Funds Rate” and does
“Influencing” it Influence other Interest Rates?
“Federal Funds” are Loans of Excess Reserve
Balances that Member Banks make to one another
By trading Government
Securities, “The Fed”
influences the Federal
Funds Rate, which is the
Interest Rate that Member
Banks charge one another
for Overnight Loans of
Excess Reserve Balances
What is the “Federal Funds Rate” and does
“Influencing” it Influence otherFed
Interest
Rates? Rate”
raises “Target
to Slow-down Economy 30-Year Mortgage Rate
Balances
maintained
Doesn’t Change
“Federal Funds” are the Reserve
by Banks with the FederalThis
Reserve
is NOT how Things
By trading Government
Securities,
“The
Fed”
Fed lowers
“Target
influences
the Federal
Rate” to Stimulate
Economy
30-Year
Funds
Rate – -the
Interest
Mortgage
RateBanks
also
Rate
Member
charge Decreases
one another for
This IS how
Things
are
Overnight
Loans
of Excess
Supposed to work
Reserve
Balances
are Supposed to work
Open Market Operations
Trading Range of Federal
Funds Rate compared to
Target Rate (0% to 0.25%)
If Federal Funds Rate
trades above Target Rate
Range, Open Market
Operations buy
Securities and Increase
Supply of Reserves.
If Demand is unchanged,
Federal Funds Rate
should decrease to be
within Target Range
Open Market Operations: How they work
GOAL: Lower Interest
Rates to Stimulate Credit
Demand and Economic
Activity
ACTION: Federal Reserve
Buys Government
Securities
EFFECT: Dealer/Sellers
deposit Cash received
from Federal Reserve in
Bank. Deposits increase
Bank’s Supply of both
Loanable Funds and
Reserves
PA
QA
Increased supply of Federal Funds (QA>QE)
decreases Federal Funds Rate and other
Interest Rates (PA<PE)
Monetary Policy Action Increased Supply of
Credit and Lowered Price of Credit
Yield curve: Market dynamics
Was a “FLAT” YIELD CURVE to blame?
• Should Long-Term Risk (30
years) and Short-Term Risk
(3 months) be Equally
Compensated?
• Wasn’t that what Financial
Markets were trying to do?
• What happens When (Not If)
Inflation comes back?
Source: www,stockcharts.com/charts
Theory and applications
What about the Safety
and Soundness Duty?
What explains the “Sub-prime Mortgage
Mess?”
What happens when Bankers lose
Depositor’s Funds by making Bad Loans?
Does Deposit Insurance encourage Risky
Behavior (Moral Hazard)?
DECISION-MAKING PERSPECTIVES
PURPOSE
Strategic or Tactical?
SCALE
SCALE
Large versus
Large or Small?
Small
APPROACH
Entrepreneurial or
Managerial?
PURPOSE
Strategy: Deciding What to Do
(Make Policy)
Tactics: Deciding How to Do
what has been decided to be
done (Take Action)
SCALE
Small Firms: 500 or fewer Employees
and Privately Held (Stock not traded in
Publicly-accessible Market)
Large Firms: More than $10 Million in
Assets and more than 500 Stockholders
APPROACHES
Managerial
versus
Entrepreneurial
APPROACHES
Entrepreneurial versus Managerial
Competitive
Advantage
Entrepreneur
Manager
Obtain
Protect
Income
Context
Long-term
Resolve
Uncertainty
Short-term
Minimize
Risk