Chapter 3 Economics

How the US Got Into This Economic Mess

1. Greed: lenders and investors wanted more profit. Greed is what makes our economy work. We have forced companies to continue to produce and have higher profits. 2. Adjustable rate mortgage sales paid huge returns in short term. During the Clinton years, mortgages were made easier for low income and minority families to be to obtain. They were given ARM mortgages. This is where the interest rate floats 1-2 points above or below the going rate and fluctuates with prime. As interest rates go up, the ARM goes up, and therefore the mortgage payments go up. As the interest rate goes down, the ARM goes down, and the mortgage payment goes down. 3. Consumer debt: consumers had large amounts of personal debt. The average American carries $15,000.00 in high interest debt. This does not include automobiles. Most of these loans are amortized loans. This is where the interest is paid first with your payments. The first 7 years most of the payment goes to interest. 4. Mortgage backed bonds: created by banks to produce profits. Promised 20% return. 5. 300% increase in oil prices: demand and cartel 6. Inflation: Inflation in all areas due to oil price increase everything is made with, is delivered using, or depends on oil. 7. Adjustable Rate Mortgage Defaults: ARM defaults increased dramatically due to increased interest and payments. Interest and payments went up 3 to 4 points. People could not make up the difference in their payments and stopped paying their mortgages. 8. Bond defaults: when mortgage holders defaulted so did the mortgage backed bonds. The value of the bonds crashed. 1 in 4 people now have mortgage hat is higher than the value of their home. 9. Bank collapse: The bonds lost their value and banks began to collapse. There was no money to loan to businesses or individuals. Credit crisis and crunch. 10. Expectations: Expectations decreased and stock market fell wiping out billions in company values. When expectations are positive, then you spend, take vacations, and buy cars. When expectations are negative, then you save money and dont spend. No one person could have seen this coming. They could see certain areas, but not the domino effect that would occur.

Stock market is up 94% from 2 years ago today (3/10/11). The next crisis predicted is said to be on the retail side. Mortgages and foreclosures on retail property (mini malls).

Market Participants
More than 300 million consumers, about 30 million business firms, and thousands of governmental agencies participate directly in the US economy. Goals All these economic actors participate in the market in order to achieve specific goals. 1. Consumers: strive to maximize their own happiness 2. Businesses: try to maximize profits 3. Government agencies: attempt to maximize social welfare They strive to achieve those goals by buying the best possible mix of gods, services, or factors of production. To maximize the returns on our limited resources, we participate in the market. Market = any place where goods and services are bought and sold. Factor market = any place where factors of production (land, equipment, capital, entrepreneurship) are bought and sold. Product market = any place where finished goods and services are bought and sold.

Supply and Demand

The two sides of each market transaction are called supply and demand. We are supplying resources to the market when we look for a job that is, when we offer our labor in exchange for income. But we are demanding goods when we shop in a supermarket that is, when we are prepared to offer dollars in exchange for something to eat. Every market transaction involves an exchange and thus some element of both supply and demand.

Demand Demand: how many you want at a given price. The less it costs then the more you want of it. The more it costs, then the less you want of it. A demand exists only if someone is willing and able to pay for the good. Opportunity cost: The most desired goods or services that are forgotten in order to obtain something else. Demand schedule: A table showing the quantities of a good a consumer is willing and able to buy at alternative prices in a given time period. Demand curve: A curve describing the quantities of a good a consumer is willing and able to buy at alternative prices in a given time period. Law of demand: The quantity of a good demanded in a given time period increases as its price falls, ceteris paribus. Ceteris paribus: the assumption of nothing else changing. Shifts in Demand The demand schedule and curve remain unchanged only so long as the underlying determinants of demand remain constant. Shift in demand: A change in the quantity demanded at any given time. A shift will occur when the relationship changes. Movements vs. Shifts Movements along a demand curve are a response to price changes for that good. Shifts of the demand curve occur when the determinants of demand change. Changes in quantity demanded: movements along a given demand curve in response to price changes of that good (summertime gas prices) Changes in demand: shifts of the demand curve due to changes in tastes, income, other goods, or expectations (expectations up or down would shift the curve)

SUPPLY The market supply of a good reflects the collective behavior of all firms that are willing and able to sell that good at various prices. On the supply side, the more a supplier is paid for an item then the more they will supply. (EX: corn. Corn is used in gasoline as ethanol. Farmers are switching and growing more corn). Law of supply: The quantity of a good supplied in a given time period increases as its price increases, ceteris paribus. Shifts in Supply Changes in quantity supplied: movements along a given supply curve. Moves along the curve itself. Changes in supply: shifts of the supply curve. The entire curve is shifted. Market supply is an expression of sellers intentions, of the ability and willingness to sell, not a statement of actual sales. Equilibrium price: The price at which the quantity of a good demanded in a given time period equals the quantity supplied. Where the supply curve and demand curve cross on graph. The equilibrium price and quantity reflect a compromise between buyers and sellers. No other compromise yields a quantity demanded that is exactly equal to the quantity supplied. One the equilibriums met is very difficult to change unless there is a shift in the relationship. Surplus: area on graph above the equilibrium. Shortage: area on graph below the equilibrium. Market shortage: The amount by which the quantity demanded exceeds the quantity supplied at a given price: excess demand. Market surplus: The amount by which the quantity supplied exceeds the quantity demanded at a given price: excess supply. Whenever the market price is set above or below the equilibrium price, either a market surplus or a market shortage will emerge.

Price ceilings an upper limit imposed on the price of a good or service. Price ceilings have three predictable effects; they 1. Increase the quantity demanded 2. Decrease the quantity supplied 3. Create a market shortage

Price floors: a minimum price imposed by the government for a good or service (minimum wage). The price floor has three predictable effects; it 1. Increases the quantity supplied 2. Reduces the quantity demanded 3. Creates a market surplus Market mechanism: The use of market prices and sales to signal desired outputs (or resource allocations).