General Economic definations and inforation

ECONOMICS: A social science that studies the allocation of limited resources to the production of goods and services used to satisfy consumer's unlimited wants and needs. Two of the major approaches in economics are named the classical and Keynesian approaches. Classical economists believe that markets function very well, will quickly react to any changes in equilibrium and that a "laissez faire" government policy works best. On the other hand, Keynesian economists believe that markets react very slowly to changes in equilibrium (especial to changes in prices) and that active government intervention is sometimes the best method to get the economy back into equilibrium.

1. Microeconomics Those who have studied Latin know that the prefix “micro-“ means “small,” so it shouldn’t be surprising that microeconomics is the study of small economic units. The field of microeconomics is concerned with things like:

Consumer decision making and utility maximizationFirm production and profit maximizationIndividual market equilibriumEffects of government regulation on individual marketsExternalities and other market side effects

2. Macroeconomics Macroeconomics can be thought of as the “big picture” version of economics. Rather than analyzing individual markets, macroeconomics focuses on aggregate production and consumption in an economy. Some topics that macroeconomists study are:

The effects of general taxes such as income and sales taxes on output and pricesThe causes of economic upswings and downturnsThe effects of monetary and fiscal policy on economic healthHow interest rates are determinedWhy some economies grow faster than others The Relationship Between Microeconomics and Macroeconomics There is an obvious relationship between microeconomics and macroeconomics in that aggregate production and consumption levels are the result of choices made by individual households and firms, and some macroeconomic models explicitly make this coection. Most of the economic topics covered on television and in newspapers are of the macroeconomic variety, but it’s important to remember that economics is about more than just trying to figure out when the economy is going to improve and what the Fed is doing with interest rates.

Definition of Gross Domestic Product - GDP

Background:

GDP is a gross measure of market activity. It represents the monetary value of all the goods and services produced by an economy over a specified period. This includes consumption, government purchases, investments, and the trade balance (exports minus imports). The GDP is perhaps the greatest indicator of the economic health of a country. It is usually measured on a yearly basis, but quarterly stats are also released. The Commerce Department releases an "advance report" on the last day of each quarter. Within a month it follows up with the "preliminary report" and then the "final report" is released another month later.

The GDP is presented in two ways:
- "current dollars" which represent actual prices in every period.
- "constant dollars" which abstract from changing prices over time.

The "current dollar GDP" equals the market value of goods and services produced. Meanwhile the "constant dollar GDP", also known the real GDP, represents the quantity of economic output, which is used in measuring the overall rate of economic growth.

What it means for Investors:
The most recent GDP figures have a relatively high importance to the markets. GDP indicates the pace at which a country's economy is growing (or shrinking). If GDP growth fails to meet or beat the market expectations stocks can temporarily pay the price.

Traditionally, the U.S. Economy's average growth rate has been between 2.5 - 3%. Economists believe that this range represents the sustainable long-run growth rate of output.

Strengths:
· GDP is considered the broadest indicator of the economic output and growth. · pay close attention to increasing inventories as it can indicate that growth is slowing, or consumer demand is changing.

Weaknesses:
· The data is not very timely because it is released quarterly unlike many economic indicators which are released monthly.
A region's gross domestic product, or GDP, is one of several measures of the size of its economy. The GDP of a country is defined as the market value of all final goods and services produced within a country in a given period of time. It is also considered the sum of value added at every stage of production of all final goods and services produced within a country in a given period of time. Until the 1980s the term GNP or gross national product was used in the United States. The two terms GDP and GNP are almost identical. The most common approach to measuring and understanding GDP is the expenditure method:
GDP = consumption + investment + government spending + (exports - imports)

"Gross" means depreciation of capital stock is not included. With depreciation, with net investment instead of gross investment, it is the net domestic product. Consumption and investment in this equation are the expenditure on final goods and services. The exports minus imports part of the equation (often called cumulative exports) then adjusts this by subtracting the part of this expenditure not produced domestically (the imports), and adding back in domestic production not consumed at home (the exports).
Economists (since Keynes) have preferred to split the general consumption term into two parts; private consumption, and public sector (or government) spending. Two advantages of dividing total consumption this way in theoretical macroeconomics are:

•Private consumption is a central concern of welfare economics. The private investment and trade portions of the economy are ultimately directed (in mainstream economic models) to increases in long-term private consumption.
If separated from endogenous private consumption, government consumption can be treated as exogenous, so that different government spending levels can be considered within a meaningful macroeconomic framework
The components of GDP
Each of the variables C, I, G and NX (where GDP = C + I + G + NX as above):
•C is private consumption in the economy. This includes most personal expenditures of households such as food, rent, medical expenses and so on but does not include new housing.
•I is defined as business investments in capital. Examples of investment by a business include construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory. Spending by households on new houses is also included in Investment. 'Investment' in GDP is meant very specifically as non-financial product purchases. Buying financial products is classed as saving in macroeconomics, as opposed to investment (which, in the GDP formula is a form of spending). The distinction is (in theory) clear: if money is converted into goods or services, without a repayment liability it is investment. For example, if you buy a bond or a share, the ownership of the money has only nominally changed hands, and this transfer payment is excluded from the GDP sum. Although such purchases would be called investments in normal speech, from the total-economy point of view, this is simply swapping of deeds, and not part of the real economy or the GDP formula.
•G is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits. The relative size of government expenditure compared to GDP as a whole is critical in the theory of crowding out, and the Keynesian cross.
•X is gross export. GDP captures the amount a country produces, including goods and services produced for overseas consumption, therefore exports are added.
•M is gross import. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic.
•NX are "net exports" in the economy: gross exports - gross imports. There is a fixed relation: NX = X - M.
It is important to understand the meaning of each variable precisely in order to:
•Read national accounts.
•Understand Keynesian or neo-classical macroeconomics

Examples of GDP component variables
Examples of C, I, G, & NX: If you spend money to renovate your hotel so that occupancy rates increase, that is private investment, but if you buy shares in a consortium to do the same thing it is saving. The former is included when measuring GDP (in I), the latter is not. However, when the consortium conducted its own expenditure on renovation, that expenditure would be included in GDP.
If the hotel is your private home your renovation spending would be measured as Consumption, but if a government agency is converting the hotel into an office for civil servants the renovation spending would be measured as part of public sector spending (G).

If the renovation involves the purchase of a chandelier from abroad, that spending would also be counted as an increase in imports, so that NX would fall and the total GDP is unaffected by the purchase. (This highlights the fact that GDP is intended to measure domestic production rather than total consumption or spending. Spending is really a convenient means of estimating production.)

If you are paid to manufacture the chandelier to hang in a foreign hotel the situation would be reversed, and the payment you receive would be counted in NX (positively, as an export). Again, we see that GDP is attempting to measure production through the means of expenditure; if the chandelier you produced had been bought domestically it would have been included in the GDP figures (in C or I) when purchased by a consumer or a business, but because it was exported it is necessary to 'correct' the amount consumed domestically to give the amount produced domestically. (As in Gross Domestic Product.).

What Does Real Gross Domestic Product (GDP) Mean?
An inflation-adjusted measure that reflects the value of all goods and services produced in a given year, expressed in base-year prices. Often referred to as "constant-price", "inflation-corrected" GDP or "constant dollar GDP". Unlike nominal GDP, real GDP can account for changes in the price level, and provide a more accurate figure.
Let's consider an example. Say in 2004, nominal GDP is $200 billion. However, due to an increase in the level of prices from 2000 (the base year) to 2004, real GDP is actually $170 billion. The lower real GDP reflects the price changes while nominal does not

What Does Nominal GDP Mean?
A gross domestic product (GDP) figure that has not been adjusted for inflation.
Also known as "current dollar GDP" or "chained dollar GDP".
t can be misleading when inflation is not accounted for in the GDP figure because the GDP will appear higher than it actually is. The same concept that applies to return on investment (ROI) applies here. If you have a 10% ROI and inflation for the year has been 3%, your real rate of return would be 7%. Similarly, if the nominal GDP figure has shot up 8% but inflation has been 4%, the real GDP has only increased 4%.

The GDP income account
another way of measuring GDP is to measure the total income payable in the GDP income accounts. This should provide the same figure as the expenditure method described above.
The formula for GDP measured using the income approach, called GDP(I), is:
GDP = Compensation of employees + Gross operating surplus + Gross mixed income + Taxes less subsidies on production and imports
•Compensation of employees (COE) measures the total remunerations to employees for work done. It includes wages and salaries, as well as employer contributions to social security and other such programs.

•Gross operating surplus (GOS) is the surplus due to owners of incorporated businesses. Often called profits, although only a subset of total costs is subtracted from gross output to calculate GOS.

•Gross mixed income (GMI) is the same measure as GOS, but for unincorporated businesses. This often includes most small businesses.

The sum of COE, GOS and GMI is called total factor income, and measures the value of GDP at factor (basic) prices. The difference between basic prices and final prices (those used in the expenditure calculation) is the total taxes and subsidies that the Government has levied or paid on that production. So adding taxes less subsidies on production and imports converts GDP at factor cost to GDP(I).
Another formula can be written as this:
GDP = R + I + P + SA + W
R = rents
I = interests
P = profits
SA = statistical adjustments (corporate income taxes, dividends, undistributed corporate profits)
W = wages

Cross-border comparison
The level of GDP in different countries may be compared by converting their value in national currency according to either
•current currency exchange rate: GDP calculated by exchange rates prevailing on international currency markets
•purchasing power parity exchange rate: GDP calculated by purchasing power parity (PPP) of each currency relative to a selected standard (usually the United States dollar).
The relative ranking of countries may differ dramatically between the two approaches.

•The current exchange rate method converts the value of goods and services using global currency exchange rates. This can offer better indications of a country's international purchasing power and relative economic strength. For instance, if 10% of GDP is being spent on buying hi-tech foreign arms, the number of weapons purchased is entirely governed by current exchange rates, since arms are a traded product bought on the international market (there is no meaningful 'local' price distinct from the international price for high technology goods).

•The purchasing power parity method accounts for the relative effective domestic purchasing power of the average producer or consumer within an economy. This can be a better indicator of the living standards of less-developed countries because it compensates for the weakness of local currencies in world markets. The PPP method of GDP conversion is most relevant to non-traded goods and services.
There is a clear pattern of the purchasing power parity method decreasing the disparity in GDP between high and low income (GDP) countries, as compared to the current exchange rate method. This finding is called the Pe effect

Criticisms and limitations
GDP is widely used by economists to follow how the economy is moving, as its variations are relative quickly identified. However, its value as an indicator for the standard of living is considered to be limited. An alternative for this purpose is the United Nations' Human Development Index in which the GDP is a contributing factor in its calculation. Criticisms of how the GDP is used include:

What Does Consumer Price Index - CPI Mean? A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living.

What Does Inflation Mean?
The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.
Most countries' central banks will try to sustain an inflation rate of 2-3%. What Does Deflation Mean?
A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression. Central banks attempt to stop severe deflation, along with severe inflation, in an attempt to keep the excessive drop in prices to a minimum. What Does Stagflation Mean?
A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation.

What Does Economic Cycle Mean?
The natural fluctuation of the economy between periods of expansion (growth) and contraction (recession). Factors such as gross domestic product (GDP), interest rates, levels of employment and consumer spending can help to determine the current stage of the economic cycle.

What Does Monetary Policy Mean?
The actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as increasing the interest rate, or changing the amount of money banks need to keep in the vault (bank reserves).

What Does Fiscal Policy Mean?
Government spending policies that influence macroeconomic conditions. These policies affect tax rates, interest rates and government spending, in an effort to control the economy.
What does Interest Rate mean?

The amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of assets. Interest rates are typically noted on an aual basis, known as the aual percentage rate (APR). The assets borrowed could include, cash, consumer goods, large assets, such as a vehicle or building. Interest is essentially a rental, or leasing charge to the borrower, for the asset's use. In the case of a large asset, like a vehicle or building, the interest rate is sometimes known as the “lease rate”. When the borrower is a low risk party, they will usually be charged a low interest rate; if the borrower is considered high risk, the interest rate that they are charged will be higher.

Interest is charged by lenders as compensation for the loss of the asset's use. In the case of lending money, the lender could have invested the funds instead of lending them out. With lending a large asset, the lender may have been able to generate income from the asset should they have decided to use it themselves.
Using the simple interest formula:
Simple Interest = P (principal) x I (aual interest rate) x N (years)
Borrowing $1,000 at a 6% aual interest rate for 8 months means that you would owe $40 in interest (1000 x 6% x 8/12).
Using the compound interest formula:
Compound Interest = P (principal) x [ ( 1 + I(interest rate) N (months) - 1 ]
Borrowing $1,000 at a 6% aual interest rate for 8 months means that you would owe $40.70.
The interest owed when compounding is taken into consideration is higher, because interest has been charged monthly on the principal + accrued interest from the previous months. For shorter time frames, the calculation of interest will be similar for both methods. As the lending time increases, though, the disparity between the two types of interest calculations grows.

What Does Money Mean?
1. A commodity or asset, such as gold, an officially issued currency, coin or paper note, that can be legally exchanged for something equivalent, such as goods or services.
2. As defined by common law: a medium of exchange that is authorized or adopted by a domestic or foreign government and includes a monetary unit of account established by an intergovernmental organization or by agreement between two or more nations

what Does Finance Mean?
The science that describes the management of money, banking, credit, investments, and assets.
What Does Bank Mean?
A financial institution licensed as a receiver of deposits. There are two types of banks: commercial/retail banks and investment banks. In most countries, banks are regulated by the national government or central bank.
Commercial banks are mainly concerned with managing withdrawals and deposits as well as supplying short-term loans to individuals and small businesses. Consumers primarily use these banks for basic checking and savings accounts, certificates of deposit and sometimes for home mortgages. Investment banks focus on providing services such as underwriting and corporate reorganization to institutional clients. While many banks have both a brick-and-mortar and online presence, some banks have only an online presence. Online-only banks often offer consumers higher interest rates and lower fees. Convenience, interest rates and fees are the driving factors in consumers’ decisions of which bank to do business with. As an alternative to banks, consumers can opt to use a credit union.

What Does Risk Mean?
The chance that an investment's actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment. A high standard deviations indicates a high degree of risk.
Many companies now allocate large amounts of money and time in developing risk management strategies to help manage risks associated with their business and investment dealings. A key component of the risk management process is risk assessment, which involves the determination of the risks surrounding a business or investment.
What Does Producer Price Index - PPI Mean?
A family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time. PPIs measure price change from the perspective of the seller
What Does Opportunity Cost Mean?
1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.
2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% - 2%).
1. The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages.
Here's another example: if a gardener decides to grow carrots, his or her opportunity cost is the alternative crop that might have been grown instead (potatoes, tomatoes, pumpkins, etc.).
In both cases, a choice between two options must be made. It would be an easy decision if you knew the end outcome; however, the risk that you could achieve greater "benefits" (be they monetary or otherwise) with another option is the opportunity cost.

What Does Capital Mean?
1. Financial assets or the financial value of assets, such as cash.
2. The factories, machinery and equipment owned by a business.
Capital is an extremely vague term and its specific definition depends on the context in which it is used. In general, it refers to financial resources available for use.
What Does Investment Mean?
An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price.
The building of a factory used to produce goods and the investment one makes by going to college or university is both examples of investments in the economic sense.
In the financial sense investments include the purchase of bonds, stocks or real estate property.
Be sure not to get 'making an investment' and 'speculating' confused. Investing usually involves the creation of wealth whereas speculating is often a zero-sum game; wealth is not created. Although speculators are often making informed decisions, speculation caot usually be categorized as traditional investing.
What Does Marketing Mean?
The activities of a company associated with buying and selling a product or service. It includes advertising, selling and delivering products to people. People who work in marketing departments of companies try to get the attention of target audiences by using slogans, packaging design, celebrity endorsements and general media exposure. The four 'Ps' of marketing are product, place, price and promotion.
Many people believe that marketing is just about advertising or sales. However, marketing is everything a company does to acquire customers and maintain a relationship with them. Even the small tasks like writing thank-you letters, playing golf with a prospective client, returning calls promptly and meeting with a past client for coffee can be thought of as marketing. The ultimate goal of marketing is to match a company's products and services to the people who need and want them, thereby ensure profitability
What Does Accounting Mean?
To provide a record such as funds paid or received for a person or business. Accounting summarizes and submits this information in reports and statements. The reports are intended both for the firm itself and for outside parties
what does Development Economics Mean? A branch of economics that focuses on improving the economies of developing countries. Development economics considers how to promote economic growth in such countries by improving factors like health, education, working conditions, domestic and international policies and market conditions. It examines both macroeconomic and microeconomic factors relating to the structure of a developing economy and how that economy can create effective domestic and international growth. Development economics seeks to determine how poor countries can be transformed into prosperous ones. Strategies for transforming a developing economy tend to be unique, because the social and political background of countries can vary dramatically. Some prominent development economists include Jeffrey Sachs, Hernando de Soto Polar, and Nobel laureates Simon Kuznets, Amartya Sen and Joseph Stiglitz.
What Does Economic Growth Mean?
An increase in the capacity of an economy to produce goods and services, compared from one period of time to another. Economic growth can be measured in nominal terms, which include inflation, or in real terms, which are adjusted for inflation. For comparing one country's economic growth to another, GDP or GNP per capita should be used as these take into account population differences between countries.
Economic growth is usually associated with technological changes. An example is the large growth in the U.S. economy during the introduction of the Internet and the technology that it brought to U.S. industry as a whole. The growth of an economy is thought of not only as an increase in productive capacity but also as an improvement in the quality of life to the people of that economy.
What Does Economic Growth Rate Mean?
A measure of economic growth from one period to another in percentage terms. This measure does not adjust for inflation; it is expressed in nominal terms.
In practice, it is a measure of the rate of change that a nation's gross domestic product goes through from one year to another. Gross national product can also be used if a nation's economy is heavily dependent on foreign earnings.

The economic growth rate provides insight into the general direction and magnitude of growth for the overall economy. In the United States, for example, the long-term economic growth rate is around 2-5%, this lower rate is seen in most highly industrialized countries. Fast-growing economies, on the other hand, see rates as high as 10% although this rate of growth is not likely to be sustainable over the long term.
What Does Net Income - NI Mean?
1. A company's total earnings (or profit). Net income is calculated by taking revenues and adjusting for the cost of doing business, depreciation, interest, taxes and other expenses. This number is found on a company's income statement and is an important measure of how profitable the company is over a period of time. The measure is also used to calculate earnings per share.
Often referred to as "the bottom line" since net income is listed at the bottom of the income statement. In the U.K., net income is known as "profit attributable to shareholders".
2. An individual’s income after deductions, credits and taxes are factored into gross income. Deductions and credits are subtracted from gross income to arrive at taxable income, which is used to calculate income tax. Net income is income tax subtracted from taxable income.
1. Net income is calculated by starting with a company's total revenue. From this, the cost of sales, along with any other expenses that the company incurred during the period, is removed to reach earnings before tax. Tax is deducted from this amount to reach the net income number. Net income, like other accounting measures, is susceptible to manipulation through such things as aggressive revenue recognition or by hiding expenses. When basing an investment decision on net income numbers, it is important to review the quality of the numbers that were used to arrive at this value.
2. For example, suppose that your gross income is $50,000 and you have $20,000 in deductions and credits. This leaves you with a taxable income of $30,000. Then, suppose that another $5,000 of income tax is subtracted; the remaining $25,000 will be your net income.
What Does Gross Income Mean?
1. An individual's total personal income before taking taxes or deductions into account.
2. A company's revenue minus cost of goods sold. Also called "gross margin" and "gross profit"
What Does Cost Of Goods Sold - COGS Mean?
The direct costs attributable to the production of the goods sold by a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs. COGS appears on the income statement and can be deducted from revenue to calculate a company's gross margin. Also referred to as "cost of sales".
What Does Operating Income Mean? The amount of profit realized from a business's operations after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses and then removes depreciation. These operating expenses are costs which are incurred from operating activities and include things such as office supplies and heat and power. Operating Income is typically a synonym for earnings before interest and taxes (EBIT) and is also commonly referred to as "operating profit" or "recurring profit".
Calculated as:
What Does Revenue Mean?
The amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise. It is the "top line" or "gross income" figure from which costs are subtracted to determine net income.
Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold.
Revenue is also known as "REVs".
What Does Budget Mean? An estimation of the revenue and expenses over a specified future period of time. A budget can be made for a person, family, group of people, business, government, country, multinational organization or just about anything else that makes and spends money. A budget is a microeconomic concept that shows the tradeoff made when one good is exchanged for another. A surplus budget means profits are anticipated, while a balanced budget means that revenues are expected to equal expenses. A deficit budget means expenses will exceed revenues. Budgets are usually compiled and re-evaluated on a periodic basis. Adjustments are made to budgets based on the goals of the budgeting organization. In some cases, budget makers are happy to operate at a deficit, while in other cases, operating at a deficit is seen as financially irresponsible.
Strategic plaing is an organization's process of defining its strategy, or direction, and making decisions on allocating its resources to pursue this strategy, including its capital and people. In order to determine where it is going, the organization needs to know exactly where it stands, then determine where it wants to go and how it will get there. The resulting document is called the "strategic plan." While strategic plaing may be used to effectively plot a company's longer-term direction, one caot use it to reliably forecast how the market will evolve and what issues will surface in the immediate future. Therefore, strategic iovation and tinkering with the "strategic plan" have to be a cornerstone strategy for an organization to survive the turbulent business climate. Strategic plaing is the formal consideration of an organization's future course. All strategic plaing deals with at least one of three key questions:

"What do we do?""For whom do we do it?""How do we excel?"

In business strategic plaing, some authors phrase the third question as "How can we beat or avoid competition?" (Bradford and Duncan, page 1). But this approach is more about defeating competitors than about excelling.

In many organizations, this is viewed as a process for determining where an organization is going over the next year or—more typically—3 to 5 years (long term), although some extend their vision to 20 years. What Does Finance Mean? The science that describes the management of money, banking, credit, investments, and assets. Basically, finance looks at anything that has to do with money and the market. What Does Demand Mean?
An economic principle that describes a consumer’s desire and willingness to pay a price for a specific good or service. Holding all other factors constant, the price of a good or service increases as its demand increases and vice versa. Think of demand as your willingness to go out and buy a certain product. For example, market demand is the total of what everybody in the market wants.
Businesses often spend a considerable amount of money in order to determine the amount of demand that the public has for its products and services. Incorrect estimations will either result in money left on the table if it’s underestimated or losses if it’s overestimated.
What Does Supply Mean?
A fundamental economic concept that describes the total amount of a specific good or service that is available to consumers. Supply can relate to the amount available at a specific price or the amount available across a range of prices if displayed on a graph. This relates closely to the demand for a good or service at a specific price; all else being equal, the supply provided by producers will rise if the price rises because all firms look to maximize profits. Supply and demand trends form the basis of the modern economy. Each specific good or service will have its own supply and demand patterns based on price, utility and personal preference. If people demand a good and are willing to pay more for it, producers will add to the supply. As the supply increases, the price will fall given the same level of demand. Ideally, markets will reach a point of equilibrium where the supply equals the demand (no excess supply and no shortages) for a given price point; at this point ,consumer utility and producer profits are maximized.
What Does Equilibrium Mean?
The state in which market supply and demand balances each other and, as a result, prices become stable. Generally, when there is too much supply for goods or services, the price goes down, which results in higher demand. The balancing effect of supply and demand results in a state of equilibrium. The equilibrium price is where the supply of goods matches demand. When a major index experiences a period of consolidation or sideways momentum, it can be said that the forces of supply and demand are relatively equal and that the market is in a state of equilibrium.
What is Depreciation? Depreciation is defined as an accounting methodology which allows an organization to spread the cost of a fixed asset over the expected useful life of that asset. The cost of the fixed asset immediately comes out of the cash account of the organization and is entered as an asset for the organization. At the end of each period of the useful life of the asset a part of the cost is expensed. This amount is added to the accumulated depreciation for the asset. The net value of the asset on the books of the organization is the asset account less the accumulated depreciation account. A fixed asset is considered depreciable if it will wear out or become obsolete over a period of years. The period of years is called the life or the useful life of the item. The life that is assigned to an item will depend on industry standards, management standards, and governmental regulations. Generally, depreciable items include buildings, manufacturing equipment, office equipment, and vehicles. Land is not considered a depreciable item as it does not wear out or become obsolete. Some fixed assets may be expected to have a market value at the end of their useful life. This expected value is called the salvage value. Some organizations set this value on a per asset basis, some use a percentage of the purchase price, some assume that all assets will have zero salvage value, and some use a combination of these methods. Organizations usually set a price at which a fixed asset is considered depreciable. Any asset purchased at less than the set price is immediately expensed. This eliminates the need to track every waste basket, stapler, hammer, wrench, desk lamp, etc. Some organizations set this as low as $100.00. Other organizations set it at $10,000.00 or more. Once this limit has been set it should be adhered to and should not be reset every year How to Calculate Depreciation Depreciation expense is calculated utilizing either a straight line depreciation method or an accelerated depreciation method. The straight line method calculates depreciation by spreading the cost evenly over the life of the fixed asset. Accelerated depreciation methods such as declining balance and sum of year’s digits calculate depreciation by expensing a large part of the cost at the begiing of the life of the fixed asset. The required variables for calculating depreciation are the cost and the expected life of the fixed asset. Salvage value may also be considered. Examples of depreciation calculations for both straight line and accelerated methods are provided below. Straight Line Depreciation Method The straight line depreciation method divides the cost by the life.
SL = Cost / Life Example: A desk is purchased for $487.65. The expected life is 5 years. Calculate the aual depreciation as follows:
487.65 / 5 = 97.53 each year for 5 years $97.53 would be expensed.
What if there is a salvage value? Declining Balance Depreciation Method The declining balance depreciation method uses the depreciable basis of an asset multiplied by a factor based on the life of the asset. The depreciable basis of the asset is the book value of the fixed asset -- cost less accumulated depreciation. The factor is the percentage of the asset that would be depreciated each year under straight line depreciation times the accelerator. For example, an asset with a four year life would have 25% of the cost depreciated each year. Using double declining balance or 200%, which is the most common, would mean that depreciation expense in the first year would be twice that or 50%. So to calculate the depreciation expense each year the depreciable basis would be multiplied by 50%. Ex: A copy machine is purchased for $3,217.89. The expected life is 4 years. Using double declining balance the depreciation would be calculated as follows: factor = 2 * (1/4) = 0.50

Year

Depreciable
Basis

Depreciation
Calculation

Depreciation
Expense

Accumulated
Depreciation

1

3,217.89

3,217.89 * 0.5

1,608.95

1,608.94

2

1,608.94

1,608.94 * 0.5

804.47

2,413.41

3

804.48

804.48 * 0.5

402.24

2,815.65

4

402.24

402.24 * 0.5

201.12

3,016.77

Sum of the Years Digits The first step is to sum the digits or numbers starting with the life and going back to one. For example, an asset with a life of 5 would have a sum of digits as follows: 5+ 4+ 3 +2 + 1 = 15
To find the percentage for each year divide the year's digit by the sum. In the example above the percentage would be calculated as follows:

Year 1

5 / 15 = 33.34%

Year 2

4 / 15 = 26.67%

Year 3

3 / 15 = 20 %

Year 4

2 / 15 = 13.33 %

Year 5

1/ 15 = 6.67%

Example: A conference table is purchase for 1,467.89. The expected life is 5 years. Since this is a 5 year asset the yearly factors have been calculated above.

Year

Depreciation
Calculation

Depreciation
Expense

1

1,467.89 * 33.34 %

489.40

2

1,467.89 * 26.67 %

391.49

3

1,467.89 * 20 %

293.58

4

1,467.89 * 13.33 %

195.67

5

1,467.89 * 6.67 %

97.91

"Ten Principles of Economics"

How People Make Decisions

People Face Tradeoffs. To get one thing, you have to give up something else. Making decisions requires trading off one goal against another. The Cost of Something is What You Give Up to Get It. Decision-makers have to consider both the obvious and implicit costs of their actions. Rational People Think at the Margin. A rational decision-maker takes action if and only if the marginal benefit of the action exceeds the marginal cost. People Respond to Incentives. Behavior changes when costs or benefits change.

How the Economy Works as A Whole

Trade Can Make Everyone Better Off. Trade allows each person to specialize in the activities he or she does best. By trading with others, people can buy a greater variety of goods or services. Markets Are Usually a Good Way to Organize Economic Activity. Households and firms that interact in market economies act as if they are guided by an "invisible hand" that leads the market to allocate resources efficiently. The opposite of this is economic activity that is organized by a central plaer within the government. Governments Can Sometimes Improve Market Outcomes. When a market fails to allocate resources efficiently, the government can change the outcome through public policy. Examples are regulations against monopolies and pollution.

How People Interact

A Country's Standard of Living Depends on Its Ability to Produce Goods and Services. Countries whose workers produce a large quantity of goods and services per unit of time enjoy a high standard of living. Similarly, as a nation's productivity grows, so does its average income.Prices Rise When the Government Prints Too Much Money. When a government creates large quantities of the nation's money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services. Society Faces a Short-Run Tradeoff Between Inflation and Unemployment. Reducing inflation often causes a temporary rise in unemployment. This tradeoff is crucial for understanding the short-run effects of changes in taxes, government spending and monetary policy.

Economics Basics: Monopolies, Oligopolies and Perfect Competition

Economists assume that there are a number of different buyers and sellers in the marketplace. This means that we have competition in the market, which allows price to change in response to changes in supply and demand. Furthermore, for almost every product there are substitutes, so if one product becomes too expensive, a buyer can choose a cheaper substitute instead. In a market with many buyers and sellers, both the consumer and the supplier have equal ability to influence price. In some industries, there are no substitutes and there is no competition. In a market that has only one or few suppliers of a good or service, the producer(s) can control price, meaning that a consumer does not have choice, caot maximize his or her total utility and has have very little influence over the price of goods.

A monopoly is a market structure in which there is only one producer/seller for a product. In other words, the single business is the industry. Entry into such a market is restricted due to high costs or other impediments, which may be economic, social or political. For instance, a government can create a monopoly over an industry that it wants to control, such as electricity. Another reason for the barriers against entry into a monopolistic industry is that oftentimes, one entity has the exclusive rights to a natural resource. For example, in Saudi Arabia the government has sole control over the oil industry. A monopoly may also form when a company has a copyright or patent that prevents others from entering the market. Pfizer, for instance, had a patent on Viagra.

In an oligopoly, there are only a few firms that make up an industry. This select group of firms has control over the price and, like a monopoly, an oligopoly has high barriers to entry. The products that the oligopolistic firms produce are often nearly identical and, therefore, the companies, which are competing for market share, are interdependent as a result of market forces. Assume, for example, that an economy needs only 100 widgets. Company X produces 50 widgets and its competitor, Company Y, produces the other 50. The prices of the two brands will be interdependent and, therefore, similar. So, if Company X starts selling the widgets at a lower price, it will get a greater market share, thereby forcing Company Y to lower its prices as well.

There are two extreme forms of market structure: monopoly and, its opposite, perfect competition. Perfect competition is characterized by many buyers and sellers, many products that are similar in nature and, as a result, many substitutes. Perfect competition means there are few, if any, barriers to entry for new companies, and prices are determined by supply and demand. Thus, producers in a perfectly competitive market are subject to the prices determined by the market and do not have any leverage. For example, in a perfectly competitive market, should a single firm decide to increase its selling price of a good, the consumers can just turn to the nearest competitor for a better price, causing any firm that increases its prices to lose market share and profits.

AP Macroeconomics Formulas and Definitions:

Key Formulas

Rule of 70: Used to determine how many years it takes for a value to double, given a particular aual growth rate. For example, if you put $20,000 in the bank and it earns yearly interest of 7%, then it will take 10 years (70/7) for your income to double. 70/x = # years to double where x equals growth rate.Y = C + I + G + NX – the spending approach to calculating GDP.S = I in a closed economy (no trade) and S = I + NX in an open economyCalculating Nominal GDP: Multiple the number of each good produced times the price of each good: Photdog*Qhotdog + Phamburger*Qhamburger.Calculating Real GDP: this proceeds just as calculating nominal GDP, but instead of current prices you use base prices: Photdog(base year)*Qhotdog(current year) + Phamburger (base year)*Qhamburger (current year). Side implications: In the base year Nominal GDP = Real GDP, with inflation Nominal GDP > Real GDP.GDP deflator: A measure of the cost of living (substitute for the CPI). GDP deflator = (Nominal GDP/Real GDP)*100. Remember that this is an index. Side implication: In the base year the GDP Deflator = 100.Constructing the CPI: step 1: compute the cost of a market basket in each year (prices times quantities), step 2: choose a base year. Step 3: Calculate the CPI for the current year by: (Cost current year)/(cost in base year)*100. Side implication: in the base year the CPI = 100. With inflation, CPI increases.The inflation rate via the CPI: (CPI current year – CPI previous year)/CPI previous year all times 100. Note that this is just a percentage change. The inflation rate is the percentage change in the CPI from one period to the next. You could also calculate the percentage change in the GDP (implicit) price deflator from year to year to derive at an alternative measure of inflation.Correcting for inflation: Let’s adjust for inflation so we can, in a more meaningful way, compare the dollar values of different points in time. Convert a figure in 1990 to its current value: current value = value in 1990 * (CPI in 2000/CPI in 1995). For example, Babe Ruth earned $80,000 in 1931. Translating to current dollars means: current value = 80,000 * (107.6/8.7) = $989,000. So $80,000 back then is equivalent to $989,000 today…THIS ONE IS CRUCIAL!!!!!!

10. Real interest rate = nominal interest rate – inflation rate.

11. Production function: Y = AF(L,K,H,N)

12. Productivity: Y/L = AF(1,K/L, H/L, N/L)

13. Unemployment Rate = (Number of Unemployed/Labor Force)*100. Key, first get the labor force – all the folks who are actively seeking employment!

14. Labor force participation rate: (Labor force/adult population)*100.

15. Money Multiplier = 1/R where R = reserve ratio. Application: an initial injection of $1000 of new money into an economy with a reserve ratio of 10% (.1) will generate $1000*(10) = $10,000 in total money.

16. Quantity equation of money: MV = PY – a moneterist’s view of what explains changes in P (they are correct, in the long run changes in P is driven by changes in M because V is stable and Y is determined outside the model). If given three of the four variables, you should be able to use this equation to find the unknown variable.

17. MPC + MPS = 1. Know these definitions and this property!

18. Expenditures Multiplier = 1/(1 – MPC) OR 1/MPS. It tells you how much total spending an initial injection of spending in the economy will generate. For example, if the MPC = .8 and the government spends $100 million, then the total increase in spending in the economy = $100 * 5 = 500 million.

Key Definitions:

Aggregate demand: A schedule or curve which shows the total quantity of goods and services demanded (purchased) at different price levels.Aggregate supply: the total amount spent for final goods and services in the economy.Absolute advantage: the comparison among producers of a good according to their productivity (NOT their opportunity costs).Allocative efficiency: the apportionment of resources among firms and industries to obtain the production of the products most wanted by society (consumers); the output of each product at which its marginal cost and price (marginal benefit) are equal.Automatic stabilizers: changes in fiscal policy that stimulate AD when the economy goes into a rece4ssion without policymakers having to take any deliberate action.Business cycle: recurrent ups and downs over a period of years in the level of economic activity.Capital: human-made resources (machinery and equipment) used to produce goods and services; goods which do not directly satisfy human wants.Catch up effect: the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich.Ceteris paribus: "other things equal" used as a reminder that all variables other than the ones being studied are assumed to be constant.

10. Circular flow diagram: a visual model of the economy that shows how dollars flow through markets among households and firms.

11. Classical dichotomy: the theoretical separation of nominal and real variables.

12. Comparative advantage: a lower relative cost than another producer.

13. CPI: an index which measures the prices of a fixed market basked of consumer goods bought by a typical consumer.

14. Consumption schedule (curve): a schedule showing the amounts households plan to spend for consumer goods at different levels of income.

15. Contractionary fiscal policy: a decrease in AD brought about by a decrease in government spending for goods and services, an increase in net taxes, or some combination of the two.

16. Contractionary monetary policy: a decrease in AD brought about by a decrease in the money supply, which in turn results from the Fed selling government securities, increasing the discount rate, or increasing the reserve requirement.

17. Cost push inflation: inflation resulting from a decrease in AS (from higher wage rates and raw material prices) and accompanied by a decrease in real output and employment.

18. Crowding out effect: the rise in interest rates and the resulting decrease in investment spending in the economy caused by increased borrowing in the money market by the government.

19. Cyclical unemployment: Unemployment caused by insufficient AD.

20. Demand deposit: a deposit in a commerical bank against which checks may be written.

21. Demand pull inflation: inflation resulting from an increase in AD

22. Depreciation of the dollar: a decrease in the value of the dollar relative to another currency; a dollar now buys a smaller amount of the foreign currency.

23. Discount rate: the interest rate which the FED charge on the loans they make to commercial banks.

24. Economic efficiency: getting the most from our scarce resources: for a given amount of input producing the greatest amount of goods and services. Or, producing a certain amount of goods and services with the least amount of inputs.

25. Economic resources: land, labor, capital, and entrepreneurial ability which are used in the production of goods and services.

26. Equality versus efficiency tradeoff: the decrease in economic efficiency which may accompany a decrease in income inequality.

27. Equity: the property of distributing economic prosperity fairly among the members of society.

28. Excess reserves: the amount by which a bank’s actual reserves exceeds its required reserves.

29. Expenditures approach: the method which adds all the expenditures made for final goods and services to measure the GDP (the alternative is to add up incomes – the income approach).

30. Exports: goods and services produced in a nation and sold to customers in other nations.

31. Fallacy of composition: incorrectly reasoning that what is true for the individual (or part) is therefore necessarily true for the group (or whole)

32. Federal funds rate: the interest rate banks charge one another on overnight loans made out of their excess reserves.

33. Fiat money: anything that is money because government has decreed it to be money (it has no intrinsic value)

34. Fiscal policy: changes in government spending and tax collections designed to achieve a full employment and noninflationary domestic output.

35. 45 degree line: a line along which the value of the GDP (measured horizontally) is equal to the value of Aggregate expenditures (measured vertically). All points on this line are equilibrium points!

36. Fractional reserve banking: a banking system in which banks hold only a fraction of deposits as reserves.

37. Frictional unemployment: unemployment caused by workers voluntarily changing jobs and by temporary layoffs; unemployed workers "between jobs"

38. Full employment: when the unemployment rate is equal to the full employment unemployment rate there is only frictional and structural unemployment; cyclical unemployment equals zero. At this point we are also at potential output.

39. GDP: the total market value of all final goods and services produced during a given time period within the boundaries of the U.S., whether by American or foreign-supplied resources.

40. GDP deflator: the price index for all final goods and services used to adjust the money GDP into real GDP. (a substitute for the CPI).

41. GNP: the total market value of all final goods and services produced within a given time period by American residents, whether these people are located in the U.S. or abroad.

42. Imports: spending on goods and services produced in a foreign nation.

43. Inflation: a rise in the general level of prices in the economy (percentage change in either the CPI or the GDP deflator)

44. Investment: spending on capital equipment, inventories, and structures. NOT the purchase of financial assets (stocks and bonds).

45. Invisible hand: the tendency of firms and households seeking to further their self interests in competitive markets to further the best interest of society as a whole.

46. Productivity: total output divided by the quantity of labor employed to product the output.

47. Law of increasing opportunity cost: as the amount of a product produced is increased, the opportunity cost of producing an additional unit of the product increases.

48. Liquidity: money or things which can be quickly and easily converted into money with little or no loss of purchasing power.

49. LRAS: the AS curvfe associated with a time period in which input prices and output prices move freely.

50. M1: the narrowly defined money supply; currency and checkable deposits.

51. M2: a more broadly defined money supply; equal to M1 plus noncheckable savings deposits, money market deposits, mutual funds, and small time deposits.

52. M3: very broadly defined money supply: includes M2 plus large time deposits.

53. Macroeconomics: the study of economy-wide phenomona, including inflation, unemployment, and economic growth.

54. Marginal analysis: decision making which involves a comparison of marginal (extra) benefits and marginal costs.

55. Marginal propensity to consume (MPC): fraction of any change in income spent for goods and services; equal to the change in consumption divided by the change in disposable income.

56. Marginal propensity to save (MPS): fraction of any change in income that is saved; equal to the change in savings divided by the change in disposable income.

57. Menu costs: the costs of changing prices

58. Microeconomics: the part of economics concerned with such individual units within the economy as Industries, firms, and households; and with individual markets, particular prices, and specific goods and services.

59. Monetary neutrality: the proposition that changes in the money supply do not affect real variables

60. Moneterism: the macroeconomic view that the main cause of changes in aggregate output and the price level are fluctuations in the money supply; advocates a monetary rule.

61. Monetary policy: changing the money supply to assist the economy to achieve a full employment, noninflationary level of total output.

62. Money: any item which is generally acceptable to sellers in exchange for goods and services.

63. Natural rate hypothesis: the idea that the economy is stable in the long run at the natural rate of unemployment; views the long run Philips curve as vertical at the natural rate of unemployment.

64. Normative economics: that part of economics pertaining to value judgements about what the economy should be like; concerned with economic goals and policies.

65. Okun’s law: the generalization that any one percentage point rise in the unemployment rate above the full employment unemployment rate will increase the GDP gap by 2.5 percent of the potential GDP of the economy. So…start in long run equilibrium – as the unemployment rate increases by 1% we see GDP growth decrease by 2.5 percent.

66. Opportunity cost: the amount of other products which must be forgone or sacrificed to produce a unit of a product.

67. Philips curve: a curve showing the relationship between the unemployment rate and the inflation rate. In the short run it shows a negative (inverse) relationship. In the long run there is no relationship.

68. Positive economics: the analysis of facts or data to establish scientific generalizations about economic behavior (as opposed to normative economics).

69. Potential GDP: the real output an economy is able to produce when it fully employs its available resources.

70. Production possibilities frontier: a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and the available production technology.

71. Productive efficiency: the production of a good in the least costly way (minimum ATC)

72. Rational expectations theory: the hypothesis that business firms and households expect monetary and fiscal policies to have certain effects on the economy and take, in pursuit of their own self interests, actions which make these policies ineffective.

73. Ricardian equivalence theorm: the idea that an increase in the public debt will have little or no effect on real output and employment because taxpayers will save more in anticipation of future higher taxes to pay the higher interest expense on the debt. Meant to show fiscal policy is ineffective: I won’t consume more when you lower my taxes because I know you are going to raise them in the future…

74. Say’s Law: the macroeconomic generalization that the production of goods and services (supply) creates an equal aggregate demand for these goods and services. The implication is that we can never have a recession due to a shortfall in AD (this law was shown to be false!)

75. Shoeleather costs: the resources wasted when inflation encourages people to reduce their money holdings and make trips to the bank more frequently.

76. Stagflation: inflation accompanied by stagnation in the rate of growth of output and a high unemployment rate in the economy. Caused by a decrease in AS.

77. Structural unemployment: unemployment caused by changes in the structure of demand for goods and in technology; workers who are unemployed because their skills are not demanded by employers, they lack sufficient skills to obtain employment, or they caot easily move to locations where jobs are available.

78. Terms of trade: the rate at which units of one product can be exchanged for units of another product; the amount of one good or service given up to obtain one unit of another good or service.