Untitled Flashcards Set

money and banking

Trade: the exchange of goods and services between different parties. People/countries trade because it is impossible to reach self-sufficiency. 

Hence there is a need to trade to get the goods and services you use to satisfy your needs/wants.

Specialization: each worker of a firm specializes in different goods/services.

International specialization: each country specializes in different goods/services.

Advantages:

• Faster production

• Better quality

• Cheaper production

Result: people/countries have to trade to get goods/services they don't produce. 

Exchange rates depend on scarcity. 

The problem of the double coincidence of wants:

Most of the time it isn't: they want what I have, I want what they have. 

5 characteristics of money:

• Money must be divisible (no eggs)

  • You can pay smaller amounts

• Money must be portable (not cars)

  • For convenience reasons

• Money must be durable (not grapes)

  • Have to be used repeatedly

• Money must be recognisable (this is done through the water mark) (not a rock)

  • Accepted everywhere

• Money must be scarce (otherwise it will have no value) (not sand)

  • To keep value

5 functions of money:

• Medium of exchange

• Unit of account

• Store of value

• Standard for deferred payment

Medium of exchange: 

• Used to swap goods/services in exchange for money

• Before there was money there was barter trade, swap goods/services in exchange for other goods/services

Unit of account

• Money is used to account for the value goods/services

• Makes it possible to compare values of goods/services

• Ex: prices for different car types

Store of value

• Money is used to save/store your wealth

• wealth=your possessions

• Wealth can be stored in valuables like gold, jewelry, property and money

• Banks offer services to store your wealth safely with them (and can even reward you with paying interest)

Standard for deferred payment

• Allows you to borrow money. Money can be used to pay off debts

• Ex: you want a new car, how to pay for this?

• You can borrow money/take a loan and use it to buy a new car.

• Deferred payment: payment postponed

Commercial and central banks

• Want to make profit

• Provides commercial services to individuals, firms and governments

• Makes profit from insurance and interest

They:

• Keep money safe

• Pay interest for saving deposits

• Charge interest interest on loans

• Enable payments between people, firms and governments

• Charge fees for the provision of other financial services: private banking/wealth management (only for high-income households)

  • Insurance

  • Credit card

  • Foreign currency/money changer

• Make investments in new firms

Interest rate 

For customers -> reward for putting their money in the bank

For borrowers -> cost of borrowing money

Banks also make money from insurance and currency exchange. The difference in interest rate is profit for the bank.

Type of lending by commercial banks

• Overdraft: taking out more from your bank account than you have. Short-term, ex. To pay bills

• Loans: borrowing a fixed amount of money to buy expensive things, ex. A car or new household appliances

• Mortgage: borrowing a fixed of money to buy a house, if it cannot be repaid, the bank will take the house

Central bank: bank organisation entrusted by the government to supervise all commercial banks and carry out monetary policies.

Roles of central banks: 

• Issue money - notes and coins

• Supervise banking sector in the country

• Supervising monetary policy of the government

• Governments and commercial banks banker

• Lender of last resort

• Coordinating with other central banks and international financial institutes (like in the 2008 market collapse)

If there is too much money in circulation it would lose its value, so only the central bank is allowed to issue money.

Commercial banks may only operate in a country after approval from its central bank.

Central banks can revoke the licence of commercial banks if they break the law.

Central banks also determine how much money can be lent out to the public. 

Central banks hold the government's main account.

It keeps the country’s gold and foreign currency reserves. 

All commercial banks hold bank accounts with the central bank, they can lend money to commercial banks.

If commercial banks run out of money they will borrow first from other commercial banks. If that doesn't work central banks will step in and lend money to them. 

In the financial crisis of 2008 central banks had to ‘pump’ money in commercial banks to prevent bankruptcy. 

Questions: why is a good banking system important for trade?

What is the function of the gold and foreign currency reserve?

Explain how the central bank can influence the rate of the economy?

Who benefits from a higher interest rate?

Who benefits from a lower interest rate?
If there is high unemployment would it be better to raise or lower the interest rate? Why?

If prices rise too fast should the interest rates rise or fall? Why? 

Question 6. Central banks lower interest rates → commercial banks lower interest rates → more borrowing because it's cheaper → more spending → forms produce more output →  firms hire more labour

Question 7. central banks raise interest rates → commercial banks raise interest rates → less borrowing because it's expensive → less spending → lower prices

Households/income

Gross income: income before tax.

Disposable income: income available for consumption after all tax is deducted.

Nominal income: income absolute numbers.

Real income: income adjusted for inflation. 

Factors that influence choice of occupation

• wages/salary (wages are paid by the hour, salary by the year)

  • Basic pay

  • Overtime

  • Bonus

  • Commission (salesmen)

• Non-wage factors

  • Job satisfaction (voluntary)

    • Make new contacts

    • Learn new skills

  • Career prospects

    • Possibility of getting a promotion to a desired higher position

  • Fringe benefits

Questions: compare the salaries of a pilot and cashier, explain the differences.

Find 2 other occupations and compare them as well, explain the differences.

What are the benefits and the disadvantages of a piece rate wage?

Why may some people choose a low paying job?

Define specialization of labour.

Explain one benefit and one disadvantage of the above.

Demand for labour

Derived demand: demand for labour depends on the demand for the output they produce. Ex: demand for the steelworkers increases if there is more demand for cars.

Supply of labour

Higher wage rates lead to workers willing to work more hours (normal supply curve)

However at a certain point wages have reached a point that workers are satisfied and choose to relax, even though, the wage rises (backwards bending supply curve)

Market wage: the equilibrium price of labour

• Where supply of labour = demand for labour#

Demand and supply for labour

Factors affecting the wage rate: 

• Relative bargaining power

If the trade union is more powerful they can ask for higher wages

• Age/experience: older workers are more experienced and hence can ask for higher wages.

• Level of education: higher education can give more power to starting workers to ask higher wages.

Minimum wage

Governments can set a minimum wage to support low-income households and to prevent exploitation by large firms who want to keep production costs low.

Benefits: workers now receive a fair income in order to survive and afford basic necessities. Workers are not looking for a job because the wage is too low and are now encouraged to look for a job. Low income households now have more money to spend which is good for economic growth. 

Disadvantages: higher production costs for firms. Firms may have to increase prices, which could cause inflation. Oversupply of workers: firms may be reluctant to hire more workers at higher wages and may even fire workers to lower production costs hence creating more unemployment. 

Wage differentials

Skilled vs. unskilled workers: skilled workers have higher productivity and their output has more value. Supply of skilled workers is also lower. 

Public vs. private sector: basic pay in the public sector is higher but total earnings in the private sector are often higher because of bonuses and overtime.

gender/race wage differentials:

• Women work a shorter period of their life compared to men

• Women work more often part-time jobs

• discrimination/racism

Agriculture vs. manufacturing vs. service jobs

Derived demand influences heavily the wage rate for workers

Demand for skilled manufacturing jobs or service jobs is higher than agricultural jobs, hence the wages in these industries is higher.

Age: older workers are paid more that younger workers due to:

• More experience and better skills

• Hierarchy: older workers are often higher ranked than younger workers

• Need for higher earning due to hiring costs

Reasons to choose low-paying jobs

• Job satisfaction

• Comfortable working conditions

  • Nice colleagues/manager

  • Short home-work travel distance

  • Easy working hours

  • Simplicity of the job

• No choice/necessity

trade/labour union

A trade union is an association of employees with the objective to protect the rights of workers.

Members pay fees and can turn to unions in case of problems or questions regarding work.

Advantages:

• Trade union can:

  • Negotiate better wages and/or working conditions for its members

  • Give legal advice to its members in case of problems (dismissal, working conditions)

  • Organise protest against firms in case of a problem

  • Provide (free/cheaper) training to upgrade skills of members

• Power in numbers

  • Increase in salary

  • If it doesn't work they go on collective action/strike

  • If employees stop working firms lose money and profit

  • Might not work if: 

    • They can be replaced by machines

    • No freedom of speech

    • Not enough strikers

Questions: can the labour union negotiate higher wages if:

• There is huge unemployment? Why?

• There is a shortage of workers? Why?

• They have few members? Why?

• Workers can be replaced by robots? Why?

Spending, saving, and borrowing

Reasons to buy things

• Satisfy needs

• Satisfy wants

Conspicuous consumption:

People buying goods, services that give them the feeling of a higher social status (veblen goods).

In order to consume, people need money from income or they can borrow or use their savings.

Factors that affect consumption

• Income

  • Disposable income: income after taxes paid

  • Gross salary: before tax

  • Net salary: after tax

• Wealth

  • Income+wealth=all valuable possessions

    • Income, savings, real estate, stock instruments, jewellery/gold, collector items

• Consumer confidence about future

• Interest rates

Low income families spend most of their money on basic needs: food, water, housing

High income families spend relatively less on basic needs but more on luxurious goods like electronic gadgets and leisure goods.

Reasons for saving:

• Saving for suture consumption

• Gain interest over their savings

• Precaution (for future emergencies)

Reasons for borrowing:

• Survival/unable to buy goods/services

• Price of desired goods service is too high to pay at once (car)

Factors affecting borrowing

• Interest rate

• Wealth

• Consider confidence about the future

• availability to borrow

If the borrower is unable to repay the loan: bankrupt or insolvent.

Individuals go bankrupt.

Companies go insolvent.

Financial crisis: too many us borrowers unable to repay loans

Loan to buy a house: mortgage

If you are unable to repay a mortgage, the bank will take the house

Interest rates

Cost of borrowing money; borrowing money is actually buying money from a financial lender like banks

Reward for saving money; where households put their money in the bank and they lend the commercial banks their money.

Interest rates determine the level of trade in the economy. When commercial banks borrow from the central bank they pay the discount rate.

The more borrowing the more consumption and investment.

Consumption: households spend

Investment: firms spend (capital+labour)

Questions: what will happen to spending, saving and borrowing? Why?

• Income rises 

• Consumers are pessimistic about about the future

• Banks raise interest rates

• Governments limit the use of credit card

Types of business organisation

Public sector

Involves firms owned/controlled by the government/city councils.

Ex: public transport, public schools, public hospitals, public libraries

Firms that are financed/subsidised by the government and serve the public interest instead of making profit. Usually offer for free or low price.

Private sector

Involves firms that are privately owned by individuals, a group of individuals, or shareholders.

Their main objective is often to make profit or manage private money (charities/donations)

This can be small firms like sole trader (1 owner); partnership (2 owners); to private/public limited companies

Multinationals

Firms that produce and sell in different countries

headquarters/head office in 1 country but side offices/factories worldwide. Ex: mcdonalds

Public corporations/public sector organizations

Organisation owned by the government

Objective: provide goods/services necessary for society.

Ex: utility companies (gas, water, electricity, public transport)

Disadvantages:

• Require tax money to be financed

• May become very large and difficult to manage - inefficient

Privatization: public corporations become private firms.

Have to compete to make more profit hence it becomes more efficient.

Growth of firms

Firms may grow in size. This may require changing the type of organisation. Ex: mcdonalds grew from partnership to public limited company.

Changing type of organisation is due to:

• Acquiring more financial funds through stocks/shares

• Protecting owners from huge debt

  • If the company goes insolvent consumers lose the value of their shares

Advantages of growing as a firm

• Able to raise more money

• Attract talented and better skilled employees

• More famous as a brand

• Conduct more research to develop new products/improve quality

• Able to expand to other countries

Demand for factors of production (FOP)

Derived demand: need one good to produce another.

Demand for labour is derived from the demand for the output they produce.

Demand for the FOP is also derived. Ex: more demand for coffee means more demand for

• Land to produce coffee beans 

• Coffee shop staff/baristas

• Coffee makers

• Owner of the cafe

If people pay the franchise for the anime that is already popular it is called a franchise fee. 

Labour-intensive vs. capital-intensive production

Labour intensive production

High proportion of labour used in the production process compared to capital. Ex: restaurants and textile industry.

Capital intensive production

High proportion of capital used in the production process compared to labour. Ex: car and food-processing industry

Production vs. productivity

Production: process of making goods/services (output). 

Productivity: output produced per worker per time period.

The value of output being higher does not mean they are working much harder.

Higher productivity could be achieved through

• Education and training

• Better technology (like the computer)

• Use of capital (robot)

• Use of fertilizers (agriculture)

Sectors in the economy

• Primary sector (extraction of raw materials)

  • Renewable or non-renewable energy (fishing, oil agriculture, mining, forestry)

  • More dominant in less developed countries

• Manufacturing sector (secondary sector)

  • Manufacturing (factories and construction companies)

  • Utilities

  • Combines raw materials into goods

• tertiary sector (production stages)

  • Retail, communications, healthcare, IT, entertainment, shops, hotels, sales, transport services

  • Services to customers

  • +insurance and banking

  • Increased a lot in the last century

revenue-production costs=profit

Costs: the payment that the firm has to make to produce goods and services.

Raw materials depend.

Rent is fixed. 

Cost types

• Total cost (TC): the total sum of all costs

• Total fixed costs (TFC): costs that do not change when output changes in the short run. They exist even at zero output. Ex: rent or interest on a bank loan. The firm still has to pay rent or interest even though it is not producing.

• Total variable cost (TVC): costs that change when output changes. Ex: electricity; the more production, the more electricity needed. The TVC curve is upward sloping starting at the origin. 

• TC=TFC+TVC

• Total revenue=price x quantity

  • TR=P x Q

• Total cost=total fixed costs+total variable costs

  • TC=TFC+TVC

• Total profit=total revenue-total costs

  • TR-TC

• Average fixed costs=total fixed costs/output

• Average variable costs=total variable costs/output

• Average total cost=total cost/output

• When TR=TC it's called Break Even. 

• ATC>TR otherwise there is no profit

Fixed costs: independent from output

• Interest over bank loan

• Rent

• Administrative staff

• Investment for office computer

• Advertisement cost

Variable cost: dependent on output

• Electricity

• Overtime payment

• Raw materials

• Fuel for company car

Business goals

• Maximize profits

• Maximize sales/increase market share (want to become more famous)

• Expand into other countries 

• Creating a good reputation (ex: Gucci)

• Survive against competition

Market structures

• Where buyers and sellers interact

  • Not necessarily a place, could be online, in a city/country or even the whole world. Ex: pizza restaurants and sushi restaurants, the market for pizza is bigger

Characteristics of market structure

• Number of big sellers

• Type of good/service

• Entry to market (easy or difficult to start a business?)

Number of sellers, many? Few?

If there are many sellers, can each seller charge a high price?

Price taker: firms that follow the price of other competitors. The firm is too small to charge a higher price than other competitors.

Price setter: firms that are able to set higher prices than other competitors because they all sell something unique. Ex: apple and IOS.

Type of good

Homogenous: the good/service is identical for the buyer (kind of metaphorical). Ex: electricity

Differentiated: identical but slightly different. Ex: pizza from Dominos or New York Pizza

Unique: only one type available. No close substitutes available. 

Access to market: is it easy or difficult to start a business?

• Barriers to entry: obstacles that prevent a business from starting. Ex: start-up costs; technology, patents/copyrights, regulations (licence/permission required from the government)

perfect competition

Market structure/situation with many sellers who sell the same good/service. 

Many sellers price takers. Most sellers change roughly the same prices.

Monopoly

Market structure/situation where only one firm sells a unique good or differentiated good with almost no substitutes. 

The firm has a lot of power to change their own price without fear of losing customers: price setter.

So the government sets a price ceiling.

Pure monopoly rarely exists. Most monopolies are government owned. Ex: public transport/utility companies.

Monopolies can be created through

• Government. Ex: public transportation

• Regulation

• patents/copyrights

• Contracts between firms (coca cola and mcdonalds)

• Brand loyalty through advertising

Size of firms:

• Number of employees

  • Generally less than 50 means small, unless there is a lot of capital involved in the production process.

• Organization (number of departments/branches)

• Capital employed

• Market share

  • Firms revenue/total market revenue

  • Total market revenue=revenue made by all firms in the industry

Diversification

Some firms have grown large because they produce a diverse range of goods/services. This is called diversification: producing different types of goods and services by one firm. Ex: apples: smartphones, earphones, tvs, music devices

How firms grow in size

Internal (organic growth)

Firms grow by increasing output produced. Ex: mcdonalds started with two restaurants opening and then worldwide

External growth: firms joining together to form a larger firm: integration

• Merger. Ex: disney and marvel

• Takeover and acquisition

horizontal integration

merger/takeover of firms of the same type of good/service. Ex: Adidas and reebok. Meta acquiring Instagram and facebook. Also competition is reduced. 

vertical integration

Merger takeover of firms at different stages of production. Ex: Toyota taking over a tyre factory. This ensures enough supply of tires and means they can esure production costs themselves.

Forward integration

Firms taking over other other firms in the next stage of production/its consumer. Ex: factory takes over shop (milk factory takes over cheese factory)

Backward integration

Firm taking over other firms in the previous stage of production/its supplier. Ex: factory takes over supplier of raw materials ex: milk factory takes over dairy firms

Ex: Shell, oil fields->oil refinery->gas/fuel stations

Reasons for integration with other firms

• Increase market share (take over customers)

• Eliminating competition (competitor does not exist anymore because it's taken over)

• Taking over assets and technology from other companies. Ex: marvel copyrights on superheroes taken over by Disney. Nokia technologies taken over by microsoft (2014)

• Ensuring stable supply of raw materials (backward vertical integration 0 ensuring places to sell their own products. Ex: Apple and Apple stores

• Economies of scale. Reducing average total costs by becoming bigger. 

Economies of scale: a decrease in average costs due to an increase in output produced.

The larger the firm, the lower the costs.

Internal economies of scale: decreasing unit costs due to firms growing internally.

External economics: decreasing unit costs due to the whole industry/market growing. 

Internal EOS

• Purchasing economies: lower costs because firms buy in bulk quantities and receive discounts

• Marketing economies: ad costs are lower because it spreads over a large output. Ex: coca cola produces thousands of bottles each day, so their market cost is low. 

• Financial economies: large firms can borrow more at lower interest rates because the bank trusts them more.

• Technical economies: large firms have more money to buy better equipment and hire researchers. This better equipment lowers costs. The researcher can develop new technology which lowers costs as well.

• Risk-bearing economies: large firms produce a large amount of different goods/services. The loss of one good can be compensated by profits on other goods.