Chapter5: Economics and Banking

Learning Outcomes for Economics and Banking

• Global Economic Systems: Describe different types of global economic systems based on their control of the factors of production through input and output markets.

• Law of Supply and Demand: Understand the law of supply and demand and how the equilibrium price is determined.

• Degrees of Competition: Identify the various degrees of competition within the Canadian economic system.

• Business Cycle: Describe the characteristics of each of the four stages of the business cycle.

• Unemployment Measurement: Explain how the unemployment rate in Canada is measured and identify the four different types of unemployment: frictional, structural, cyclical, and seasonal.

• Consumer Price Index (CPI): Explain how the CPI measures inflation.

• Stabilization Policies: Summarize how the government utilizes monetary and fiscal policies to stabilize the economy in response to business cycle fluctuations.

• Properties of Money: List the four crucial properties of money required for it to serve as a medium of exchange.

• International Trade Assistance: Explain the roles of the World Bank and the International Monetary Fund (IMF) in assisting international trade.

Fundamental Concepts of Business and Economics

• Definition of Economics: Economics is the study of how individuals, businesses, governments, and nations allocate their limited resources to satisfy their unlimited wants and needs. It focuses on how a society uses scarce resources to produce and distribute goods and services.

• Concept of Scarcity: Scarcity refers to the limitation of resources for a person, firm, or nation. A quintessential example of scarcity is a food shortage in a geographic region caused by a drought or harsh winter. Because demand exceeds availability, economics is inherently the study of choices among available resources.

• Core Economic Questions: Every economy must address three primary questions:

  • What types and amounts of goods and services should be produced? (Quantity and timing included).

  • How should they be produced? (Who produces them, and what technology/resources are used).

  • For whom should they be produced? (How products are allocated among consumers).

• Microeconomics vs. Macroeconomics:

  • Microeconomics: The study of individual and business-level decisions.

  • Macroeconomics: The study of decisions made by countries and governments.

  • These two branches are interdependent and complement each other.

• The Canadian Context: In Canada, the government and the free-market system guide the economy together.

Factors of Production: Inputs and Outputs

• Resources (Inputs): The allocation of resources involves the production, distribution, and consumption of goods and services. The five primary factors of production include:

  • Land and Natural Resources: Provides the necessary raw materials.

  • Labour: Includes both physical and mental effort used to transform raw materials into products.

  • Capital: Includes buildings, equipment, vehicles, and the financial resources (cash) required to operate a business.

  • Entrepreneurship: The skill, drive, and creativity needed to combine other resources to produce a marketable good or service.

  • Knowledge: An additional resource contributing to production efficiency.

• Example: Factors of Production for a Shirt:

  • Land: The physical factory space, electricity used for power, and the raw cotton.

  • Labour: The workers manufacturing the shirts.

  • Capital: The machinery, the factory building, and the operational funding.

  • Entrepreneurship: The knowledge and management skills required to organize resources and bring the shirt to market.

The Circular Flow Model of Inputs and Outputs

• The Model Defined: The circular flow model depicts how money circulates through the economy between individuals (households) and firms.

• Dual Roles of Households:

  • Providers of Inputs: Households provide businesses with labour (as workers), land/buildings (as landlords), and capital (as investors).

  • Consumers of Outputs: Households purchase goods and services from businesses.

• Dual Roles of Businesses:

  • Buyers of Inputs: Businesses pay households income in the form of wages, rent, and interest for used resources.

  • Producers/Sellers of Outputs: Businesses use resources to produce goods and services, which they sell to households to generate revenue.

Measures of Productivity

• Definition of Productivity: The efficiency with which goods and services are produced. Theoretically, higher labor productivity leads to higher economic output and lower inflation.

• Growth Mechanics: Productivity increases when more output is produced with the same inputs, or the same output is produced with fewer inputs.

• Calculations:

  • General Ratio: $\text{Productivity} = \frac{\text{Aggregate Output}}{\text{Aggregate Input}}$

  • Labour Productivity: Calculated as economic output (Gross Domestic Product, or GDP) per hour worked. This is the primary determinant of long-term economic and wage growth.

  • National Example: If a country has a GDP of $\$1,000,000,000,000$ ($1\,\text{trillion}$) and residents work $20,000,000,000$ hours, the labour productivity is $\$50$ per hour.

• Alternative Productivity Measures:

  • Capital Productivity: Measures how effectively physical capital (real estate, equipment, inventory) generates output.

  • Total Factor Productivity: The portion of output growth not explained by labour or capital; often termed "innovation-led growth."

Economic Systems and Philosophies

• Free Market Economy: Production and distribution are determined by supply and demand with minimal government intervention. Private individuals and businesses own the means of production.

• Mixed Economy: A system where some resources are planned by the government while citizens control others. This is the world's dominant economic organization.

• Planned Economy: The state determines production levels and regulates prices using advanced planning mechanisms rather than supply and demand.

• Capitalism: Promotes the creation and ownership of capital and wealth. A pure free-market system is a capitalist system with zero government interference.

• Socialism: Means of production are owned by the public or state to foster an equal society. This is generally a planned economy where the government manages production and services.

• Communism: A political and economic system aiming to eliminate class struggles through public ownership of all means of production. In theory, there is no private property or currency, and wealth is shared based on need.

Comparative Systems in Practice

• Planned Systems (High Control):

  • Communism: Government owns all/most enterprises. Examples include North Korea and Cuba.

  • Socialism: Basic services (utilities, banking, healthcare) are state-owned, while other businesses may be private. Taxes are generally steep to fund public services. Examples include Venezuela, Sweden, and France.

• Free Market Systems (Low Control): Businesses are owned by individuals (Capitalism). Interaction is dictated by competition and private property rights. Examples include the United States and Japan.

• Mixed Market Systems: Relies on both market forces and government allocation.

  • Privatization: The process of converting government-owned businesses to private ownership (e.g., Eastern Europe and China).

  • Nationalization: The government taking control of private industries (e.g., oil and media in Venezuela).

The Canadian Economic System

• Classification: Canada is a mixed market system.

• Market Features: Primarily a free market but with federal control over basic services such as the postal service and air traffic control.

• Socialist Features: Provision of social security retirement benefits and free healthcare.

• Influence of Adam Smith: His book, The Wealth of Nations ($1776$), argued that the "invisible hand" of competition ensures consumers receive the best products at the best prices without government regulation of wages or prices.

• Regulatory Balance: Canada balances laissez-faire principles with intervention, such as the Food and Drug Act and Regulations, to protect consumers from unsafe products.

Degrees of Market Competition

• Porter's Five Forces Model: Used to analyze industry competition through: 1) Threat of new entrants, 2) Threat of substitutes, 3) Bargaining power of buyers, 4) Bargaining power of suppliers, and 5) Rivalry among existing competitors.

• Types of Competition:

  • Perfect Competition: Many small buyers and sellers of homogeneous (identical) products. No single participant has market power. Price is determined solely by supply and demand. Example: Agriculture.

  • Monopolistic Competition: Many sellers offering differentiated products (style, quality, brand). Companies have limited control over price because consumers may switch if prices rise too high. Example: Retail trade (e.g., Pepsi vs. Coke).

  • Oligopoly: A few sellers supplying a large portion of the market. High entry costs (barriers to entry). If one firm lowers prices, others typically follow. Examples: Banking, automobiles, airlines.

  • Monopoly: Only one seller in a specific market.

    • Natural Monopoly: Legal because they are important to society but regulated (e.g., public utilities like gas and electricity). They require massive investment.

    • Legal Monopoly: Arises from patents (usually for $20$ years) giving exclusive use of an invention. Example: Polaroid's instant film.

The Law of Supply and Demand

• Definitions:

  • Demand: The quantity of a product buyers are willing to purchase at various prices. People buy more when prices fall and less when prices rise.

  • Supply: The quantity of a product sellers are willing to sell at various prices. Businesses sell more at higher prices to maximize profit.

• Equilibrium Price: The point where the supply and demand curves intersect ($\text{Quantity Demanded} = \text{Quantity Supplied}$).

  • Case Study (Apples): At a price of $\$0.60$, demand equals supply at $2,000$ pounds per day ($\text{Equilibrium Price} = \$0.60$).

• Market Fluctuations:

  • Surplus: Sellers supply more than buyers want.

  • Shortage: Sellers do not produce enough to meet demand.

• Determinants of Demand: Income levels, population changes, consumer preferences, complementary goods, and substitute goods.

• Determinants of Supply: Technological changes, resource prices, price expectations, number of suppliers, and substitute goods.

Measuring Economic Health

• Three Main Goals: Growth, High Employment, and Price Stability.

• Gross Domestic Product (GDP): The market value of all final goods and services produced domestically in a given year. Intermediate products (e.g., individual silicon chips) are excluded.

• Gross National Product (GNP): The value of all products and services produced by a country's citizens domestic and international, minus income earned by foreign residents.

• Global Comparisons ($2017$ Data):

  • Total GDP (Rank): India ranked $7^{\text{th}}$ ($\$2.439\,\text{trillion USD}$); Canada ranked $10^{\text{th}}$ ($\$1.640\,\text{trillion USD}$).

  • GDP per Household (Rank): Canada ranked $18^{\text{th}}$ ($\$44,773$); India ranked $142^{\text{nd}}$ ($\$1,852$).

The Business Cycle

• Phases of the Business Cycle:

  1. Prosperity: Expansion, low unemployment, rising incomes, increased consumer buying.

  2. Recession: Slowdown in economic activity. Defined technically as two consecutive quarters of decreasing GDP. Unemployment rises and revenues decline.

  3. Recovery (Expansion): The economy starts growing again following a recession.

  4. Depression: A long-term recession (possibly a decade) characterized by very high unemployment and severely curtailed production. Canada has not seen a severe depression since the $1930\text{s}$.

Employment and Unemployment

• Unemployment Rate: The percentage of the labour force ($15$ years or older) that is unemployed and actively seeking work.

• Full Employment: Philosophically occurs when everyone who wants a job has one; in practice, it is defined as roughly $95\%$ employment.

• Types of Unemployment:

  • Frictional: Workers moving between jobs or locations.

  • Structural: Due to job termination or permanent changes in the economy.

  • Cyclical: Caused by downturns in the business cycle and lack of demand for labour.

  • Seasonal: Jobs that exist only during certain parts of the year (e.g., snow plowing).

• Provincial Statistics (September $2024$): The Canadian national unemployment rate was $6.5\%$. Variations: Newfoundland and Labrador ($9.7\%$), Ontario ($7.1\%$), Alberta ($7.5\%$), Quebec ($5.5\%$), and British Columbia ($6.0\%$).

Price Stability and Inflation

• Inflation: A rise in the overall price level, often caused by lax monetary policy or the money supply growing too large relative to the economy, leading to lower purchasing power.

• Deflation: A decrease in the price level. This can cause consumers to defer purchases, leading to economic stagnation (e.g., Japan's historical stagnation).

• Consumer Price Index (CPI): Measures the rate of inflation based on a monthly report from Statistics Canada tracking a "basket of goods" (food, housing, clothing, etc.).

  • Calculation: Uses a base year of $2002 = 100$. In $2012$, CPI was $121.70$, indicating that goods costing $\$100$ in $2002$ cost $\$121.70$ ten years later.

• Producer Price Index (PPI): Tracks average price changes at the wholesale level for raw materials and product components.

Economic Indicators

• Leading Indicators: Signal future activity and predict changes before they occur. Examples: Stock prices, building permits, consumer confidence index, new manufacturing orders, and new unemployment claims.

• Lagging Indicators: Reflect changes that have already occurred. Examples: Unemployment rate, length of unemployment, consumer debt levels, and the inflation rate.

• Coincident Indicators: Move in real-time with the economy. Examples: GDP, current employment levels, retail sales, and industrial production.

Government Management of the Economy

• Roles of Government: Customer (buying infrastructure), Competitor (Crown corporations like Canada Post), Regulator (competition and safety laws), Taxation Agent, Provider of Incentives (subsidies), and Provider of Essential Services (healthcare).

• Monetary Policy (Bank of Canada):

  • Governing Council: Comprised of the Governor, Senior Deputy Governor, and Deputy Governors.

  • Bank Rate: The interest rate charged to commercial banks. Lowering it encourages spending; raising it reduces inflation.

  • Open Market Operations (OMO): Buying government bonds increases money supply (Expansionary); selling bonds decreases money supply (Contractionary).

• Fiscal Policy: Reliance on spending and taxation.

  • Expansionary Fiscal Policy: Decreasing taxes and increasing government spending during recessions to increase the budget deficit.

  • Contractionary Fiscal Policy: Increasing taxes and decreasing spending during inflation to decrease the budget deficit.

National Debt and Budget Management

• Surplus vs. Deficit:

  • Budget Surplus: Revenue exceeds spending.

  • Budget Deficit: Spending exceeds revenue (paid for by issuing Treasury bonds).

• National Debt Statistics:

  • Canada's federal debt increased from $\$1,048.75\,\text{billion CAD}$ in $2021$ to $\$1,134.49\,\text{billion CAD}$ in $2022$ due to COVID-19 responses.

  • Total combined federal-provincial net debt reached approximately $\$2.18\,\text{trillion CAD}$ in $2023/24$.

  • Federal debt per capita is approximately $\$33,682$ per Canadian.

The Role and Functions of Money

• Three Basic Functions: 1) Medium of exchange, 2) Measure of value, and 3) Store of value.

• Properties of Money: To be a medium of exchange, it must be:

  • Divisible: Easily divided into fractions (e.g., five $\$1$ bills = one $\$5$ bill).

  • Portable: Easy to carry.

  • Durable: Resists wear and tear.

  • Difficult to Counterfeit.

• Money Supply Measures:

  • M-1: Narrowest measure (cash and chequing account funds).

  • M-2: M-1 plus savings accounts, time deposits, and money market mutual funds.

  • M-3: "Broad money," including M-2 plus long-term time deposits, institutional money market funds, and short-term repurchase agreements.

  • $2023$ Supply Figures (CAD): M-1 = $\$1,510,782\,\text{million}$; M-2 = $\$2,423,488\,\text{million}$; M-3 = $\$3,493,917\,\text{million}$.

• Note on Credit Cards: Known as "plastic money" but are not actually money; they are promises of repayment (loans) and are excluded from M-1 and M-2 calculations.

International Banking and Trade agencies

• World Bank: Provides economic assistance (loans, grants, guarantees) to poor and developing nations to improve health, education, and infrastructure.

• International Monetary Fund (IMF): Governed by $191$ member countries. Its mission includes furthering monetary cooperation, expanding trade, and providing short-term loans to countries in financial crises (e.g., Mexico, Russia, Argentina).

• Exchange Rates: The price of one currency in terms of another.

  • Appreciation: A currency's value increases.

  • Depreciation: A currency's value decreases.

Future of Money: Digital Currencies

• Centralized Digital Currencies: Regulated by a central location like a bank.

• Decentralized Cryptocurrencies: Governed by the community (e.g., Bitcoin).

• CAD-coin: The Bank of Canada has been developing this digital version of the Canadian dollar since $2016$ in collaboration with Royal Bank of Canada, CIBC, and TD Bank Group.

• Digital Currency Forms: 1) Value-based (phone app/card transfers) or 2) Account-based (accounts held directly at the central bank).

Explore the Concept: Indigenous Entrepreneurship and Discussion

• Economic Leakage: Occurs when resource extraction agreements with multi-national corporations do not stay in the community, leaving them in the same socio-economic state. Business development within Indigenous communities aims to recapture this leakage.

• Interactive Exercises:

  • Unemployment Rate: Identification of employment rates by industry and which industry has the most employment.

  • Inflation Rate: Locating the province with the fastest-rising inflation and assessing government intervention measures.