Economics 4
effective income tax
percentage of total taxes paid divided by total income
Supplemental Nutrition Assistance Program (SNAP) is a federally funded program
-Once called food stamps -started in 1964, -poor people receive a debt like card that they use food
Interest rate risk
- is the danger that you might buy a long term bond at a 6% interest rate right before market rates suddenly rise, so had you waited, you could have received a similar bond that paid 9%
bonds are also issued by various levels of government. a municipal bond is issued by cities,
-a state bond by U.S. states, -a Treasury bond by the federal government through the U.S. Department of the Treasur
Firms can raise the financial capital they need to pay for such projects in four main ways:
(1) from early-stage investors; (2) by reinvesting profits; (3) by borrowing through banks or bonds (4) by selling stock
We need to analyze each of these investments in terms of three factors:
(1) the expected rate of return it will pay; (2) the risk that the return will be much lower or higher than expected (3) the investment's liquidity, which refers to how easily one can exchange money or financial assets for a good or service.
Figure 17.2 Corporate Profits After Tax
(Adjusted for Inventory and Capital Consumption) Prior to 2008, corporate profits after tax more often than not increased each year. There was a significant drop in profits during 2008 and into 2009. The profit trend has since continued to increase each year, though at a less steady or consistent rate. (Source: Federal Reserve Economic Data (FRED)https://research.stlouisfed.org/fred2/series/CPATAX)
Figure 15.7
(a) indicates, the largest number of households that enroll in Medicaid are those with children. Lower-income adults are the next largest group enrolled in Medicaid at 28%. The blind and disabled are 16% of those enrolled, and seniors are 9% of those enrolled. Figure 15.7 (b) shows how much actual Medicaid dollars the government spends for each group. Out of total Medicaid spending, the government spends more on seniors (20%) and the blind and disabled (44%). Thus, 64% of all Medicaid spending goes to seniors, the blind, and disabled. Children receive 21% of all Medicaid spending, followed by adults at 15%.
a bond has several parts.
- A bond is basically an "I owe you" note that an investor receives in exchange for capital (money).
Banks offer a range of accounts to serve different needs
- A checking account - A savings account
That rate of return can come in two forms.
- A firm can make a direct payment to its shareholders, called a dividend. - Alternatively, a financial investor might buy a share of stock in Wal-Mart for $45 and then later sell it to someone else for $60, for $15 gain. -We call the increase in the stock value (or of any asset) between when one buys and sells it a capital gain.
Financial capital markets have the power to repackage money as it moves from those who supply financial capital to those who demand it.
- Banks accept checking account deposits and turn them into long-term loans to companies. -Individual firms sell shares of stock and issue bonds to raise capital. - Firms make and sell an astonishing array of goods and services, but an investor can receive a return on the company's decisions by buying stock in that company. - Financial investors sell and resell stocks and bonds to one another. -Venture capitalists and angel investors search for promising small companies. -Mutual funds combine the stocks and bonds—and thus, indirectly, the products and investments—of many different companies.
To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices.
- Combining all these effects led to major decreases in incomes, demand, consumption, and employment, and to the Great Recession, which in the United States officially lasted from December 2007 to June 2009 -. During this time, the unemployment rate rose from 5% to a peak of 10.1%. - Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.
The range of possible returns from buying stock is mind-bending.
- Firms can decide to pay dividends or not -. A stock price can rise to a multiple of its original price or sink all the way to zero. - Even in short periods of time, well-established companies can see large movements in their stock prices. -in July 1, 2011, Netflix stock peaked at $295 per share; - one year later, on July 30, 2012, it was at $53.91 per share; in 2015, it had recovered to $414. -When Facebook went public, its shares of stock sold for around $40 per share -but in 2015, they were selling for slightly over $83.
Other stock market measures focus on where stocks are traded.
- For example, the New York Stock Exchange monitors the performance of stocks that are traded on that exchange in New York City. - The Nasdaq stock market includes about 3,600 stocks, with a concentration of technology stocks. Table 17.1 lists some of the most commonly cited measures of U.S. and international stock markets.
This tradeoff between return and risk complicates the task of any financial investor:
- Is it better to invest safely or to take a risk and go for the high return? -Ultimately, choices about risk and return will be based on personal preferences. -However, it is often useful to examine risk and return in the context of different time frames.
Income inequality
- compares the share of the total income (or wealth) in society that different groups receive. -For example look at the weath the top ten percent has compared to the bottom
When a firm decides to sell stock, which financial investors can buy and sell, we call it a public company.
- Shareholders own a public company. -Since the shareholders are a very broad group, the shareholders vote for a board of directors, who in turn hire top executives to run the firm on a day-to-day basis. -The more stock a shareholder owns, the more votes that shareholder is entitled to cast for the company's board.
As the world's leading consumer, if the United States goes into recession, it usually drags other countries down with it.l.
- The Great Recession was no exception. -With few exceptions, U.S. trading partners also entered into recessions of their own, of varying lengths, or suffered slower economic growth. -Like the United States, many European countries also gave direct financial assistance, so-called bailouts, to the institutions that make up their financial markets. - There was good reason to do this. -Financial markets bridge the gap between demanders and suppliers of financial capital. -These institutions and markets need to function in order for an economy to invest in new financial capita
Bank borrowing is more customized than issuing bonds, so it often works better for relatively small firms.
- The bank can get to know the firm extremely well - the bank can monitor sales and expenses quite accurately by looking at deposits and withdrawal
The high returns of stock market investments refer to a high average return that we can expect over a period of several years or decades.
- The high risk of such investments refers to the fact that in shorter time frames, from months to a few years, the rate of return may fluctuate a great deal. -Thus, a person near retirement age, who already owns a house, may prefer reduced risk and certainty about retirement income. -For young workers, just starting to make a reasonably profitable living, it may make sense to put most of their savings for retirement in mutual funds. - Mutual funds are able to take advantage of their buying and selling size and thereby reduce transaction costs for investors. -Stocks are risky in the short term, to be sure, but when the worker can look forward to several decades during which stock market ups and downs can even out, stocks will typically pay a much higher return over that extended period than will bonds or bank accounts. -Thus, one must consider tradeoffs between risk and return in the context of where the investor is in life.
The ways in which firms would prefer to raise funds are only half the story of financial markets.
- The other half is what those households and individuals who supply funds desire, -and how they perceive the available choices.
Around the globe, financial institutions were bankrupted or nearly so.
- The result was a large decrease in lending and borrowing, or a freezing up of available credit. -When credit dries up, the economy is on its knees. - The crisis was not limited to the United States. Iceland, Ireland, the United Kingdom, Spain, Portugal, and Greece all had similar housing boom and bust cycles, and similar credit freezes.
Why is this path to riches not as easy as it sounds?
- This module first discusses the problems with picking stocks -then discusses a more reliable but undeniably duller method of accumulating personal wealth.
These payments reflect differences in states' cost of living.
- Total spending on TANF was approximately $16.6 billion in 1997 -spending was at $12 billion, an almost 28% decrease in both state and federal governments. - with inflation decline is greater
he rate of return on a financial investment in a share of stock can come in two forms:
- as dividends paid by the firm and -as a capital gain achieved by selling the stock for more than you paid.
The U.S. government has implemented a number of programs rary Assistance for Needy Families (TANF
- assist those below the poverty line -To help those who have incomes just above the poverty line
Firms have two main borrowing methods:
- banks and bonds.
Purchasing a diversified group of stocks or bonds has become easier in the internet age,
- but it remains something of a task.
. n the case of junk bonds, a wise investor can reduce the risk
- by purchasing bonds from a wide range of different companies - since, even if a few firms go broke and do not pay, they are not all likely to go bankrupt.
The next module will consider a variety of government support programs
- focused specifically on the poor, including welfare, SNAP (Supplemental Nutrition Assistance Program), Medicaid, and the earned income tax credit (EITC).
Venture firms gather money
- from a variety of individual or institutional investors, including banks, institutions like college endowments, insurance companies that hold financial reserves, and corporate pension funds.
The bond
- has a maturity date when the borrower will pay back its face value as well as its last interest payment.
, bonds carry an interest rate risk.
- imagine you decide to buy a 10-year bond that would pay an annual interest rate of 8%. -Soon after you buy the bond, interest rates on bonds rise, so that now similar companies are paying an annual rate of 12%. - Anyone who buys a bond now can receive annual payments of $120 per year, but since your bond was issued at an interest rate of 8%, you have tied up $1,000 and receive payments of only $80 per year. -you are missing out on the higher payments that you could have rec
To reduce the poverty trap the government could design an antipoverty program
- instead of reducing government payments by $1 for every $1 earned, the government would reduce payments by some smaller amount instead. -Imposing requirements for work as a condition of receiving benefits and setting a time limit on benefits can also reduce the harshness of the poverty trap.
A corporation
- is a business that "incorporates"—that is owned by shareholders that have limited liability for the company's debt but share in its profits -Corporations may be private or public, and may or may not have publicly traded stock. -hey may raise funds to finance their operations or new investments by raising capital through selling stock or issuing bonds.
The earned income tax credit (EITC) method to assist working poor throughout the tax system
- is a method of assisting the working poor through the tax system
A corporate bond
- is issued by firms
The bottom line on investing in stocks
- is that the rate of return over time will be high, but the risks are also high, especially in the short run. -Liquidity is also high since one can sell stock in publicly held companies readily for spendable money.
Although these programs vary from state to state,\
- it is generally a true statement that in many states from the 1960s into the 1980s, if poor people worked, their level of income barely rose -after factoring in the reduction in government support payments
Congress created Medicaid in 1965
- joint health insurance program between both the states and the federal government.
he lines between checking and savings accounts have blurred in the last couple of decades,
- many banks offer checking accounts that will pay an interest rate similar to a savings account if you keep a certain minimum amount in the account, -or offer savings accounts that allow you to write at least a few checks per month.
Investing in, say, gold or coffee
- offers relatively little in the way of nonfinancial benefits to the user (unless the investor likes to caress gold or gaze upon a warehouse full of coffee). - Typically, investors in these commodities never even see the physical good. -Instead, they sign a contract that takes ownership of a certain quantity of these commodities, which are stored in a warehouse, and later they sell the ownership to someone else
Mutual funds can focus in certain areas:
- one mutual fund might invest only in company stocks based in Indonesia, - or only in bonds issued by large manufacturing companies, - or only in biotechnology companies' stock. - At the other end of the spectrum, a mutual fund might be quite broad. -At the extreme, some mutual funds own a tiny share of every firm in the stock market, and thus the mutual fund's value will fluctuate with the overall stock market's average.
The EITC is a hugely expensive government program
- provides assistance to the poor aand the near poor -cost 60 billion dollars - the EITC provided benefits to about 27 million families and individuals -worth about $2,296 per family (with children), -the TANF law worked as weLL, because the government expanded ECIT - which increased the returns to work for low-income Americans
The bottom line for bonds: .
- rate of return—low to moderate, depending on the borrower's risk; r -risk—low to moderate, depending on whether interest rates in the economy change substantially after the bond is issued -; liquidity—moderate, because the investor needs to sell the bond before the investor regains the cash
The expected rate of return
- refers to how much a project or an investment is expected to return to the investor, either in future interest payments, capital gains, or increased profitability. -It is usually the average return over a period of time, usually in years or even decades. -We normally measure it as a percentage rate.
The U.S. government is an extremely safe borrower
- so when the U.S. government issues Treasury bonds, it can pay a relatively low interest rate.
Anyone eligible for TANF is also eligible for SNAP
- states can expand eligibility for food aid if they wish to do so -in states with low TANF spending, a poor family might receive more aid from SNAP than from TANF -about 40 million people received food aid at an annual cost of about $76 billion in 2013 - with an average monthly benefit of about $287 per person per month
Stock represents firm ownership;
- that is, a person who owns 100% of a company's stock, by definition, owns the entire company. -The company's stock is divided into shares -corporations And have millions of stock shares - In most large and well-known firms, no individual owns a majority of the stock shares - large numbers of shareholders—each have only a small slice of the firm's overall ownership.
The second major issue is
- that when the government phases out its support payments more slowly, the antipoverty program costs more money. -it may be preferable in the long run to spend more money on a program that retains a greater incentive to work, rather than spending less money on a program that nearly eliminates any gains from working.
If the firm fails to make its loan payments,
- the bank (or banks) can often take the firm to court and require it to sell its buildings or equipment to make the loan payments.
A bond issued by the U.S. government or a large corporation may seem to be relatively low risk:
- the bond issuer has promised to make certain payments over time, and except for rare bankruptcy cases, these payments will occur -However if bankrupt a company can
If a firm issues bonds and fails to make the promised interest payments,
- the bondholders can take the firm to court and require it to pay, even if the firm needs to raise the money by selling buildings or equipment. - there is no guarantee the firm will have sufficient assets to pay off the bonds. - The bondholders may recoup only a portion of what it loaned the firm.
the current U.S. poverty line is the same as the Orshansky poverty line,
- the government adjusts the dollar amounts to represent the same buying power over time. -The U.S. poverty line in 2015 ranged from $11,790 for a single individual to $25,240 for a household of four people
When business owners choose financial capital sources,
- they also choose how to pay for them.
he near poor
- those who have incomes just above the poverty line,
Such programs are called the safety net
- to recognize that they offer some protection for those who find themselves without jobs or income.
The poverty trap is even stronger any simplified example
-, because a working mother will have extra expenses that a nonworking mother will not face, making the economic gains from working even smaller. - those who do not work fail to build up job experience and contacts, which makes working in the future even less likely.
a firm must often choose how to access financial capital
-. It may choose to borrow from a bank, issue bonds, or issue stock.
Another source of financial capital is a bond.
-A bond is a financial contract - a borrower agrees to repay the amount that it borrowed and also an interest rate over a period of time in the future.
When a firm issues bonds, the total amount it divides.
-A firm seeks to borrow $50 million by issuing bonds, might actually issue 10,000 bonds of $5,000 each. - individual investor could loan the firm $5,000, or any multiple of that amount
Difference between high and low risk investment
-A high-risk investment is one for which a wide range of potential payoffs is reasonably probable. -A low-risk investment may have actual returns that are fairly close to its expected rate of return year after year. -A high-risk investment will have actual returns that are much higher than the expected rate of return in some months or years and much lower in other months or years
standard recommendation from financial investors is diversification, which means buying stocks or bonds from a wide range of companies.
-A saver who diversifies is following the old proverb: "Don't put all your eggs in one basket." -In any broad group of companies, some firms will do better than expected and some will do worse— -but the diversification has a tendency to cancel out extreme increases and decreases in value
Examples of the different types of companies
-A small law firm run by one person, even if it employs some other lawyers, would be a sole proprietorship. -Partners may jointly own a larger law firm. - Most private companies are relatively small, but there are some large private corporations, with tens of billions of dollars in annual sales, that do not have publicly issued stock,
Obtaining additional education and saving money early in life obviously will not make you rich overnight.
-Additional education typically means deferring earning income and living as a student for more years. -Saving money often requires choices like driving an older or less expensive car, living in a smaller apartment or buying a smaller house, and making other day-to-day sacrifices. -For most people, the tradeoffs for achieving substantial personal wealth will require effort, patience, and sacrifice.
uying stocks or bonds issued by a single company is always somewhat risky.
-An individual firm may find itself buffeted by unfavorable supply and demand conditions -hurt by unlucky or unwise managerial decisions
bondholder.
-Anyone who owns a bond and receives the interest payments is called a bondholder
he housing boom and bust in the United States, and the resulting multi-trillion-dollar decline in home equity, began with the fall of home prices starting in 2007.
-As home values dipped, many home prices fell below the amount the borrower owed on the mortgage and owners stopped paying and defaulted on their loan. -Banks found that their assets (loans) became worthless. -Many financial institutions around the world had invested in mortgage-backed securities, or had purchased insurance on mortgage-backed securities.
Example of investment in commodities
-As one example, from 1981 to 2005, the gold prices generally fluctuated between about $300 and $500 per ounce, but then rose sharply to over $1,100 per ounce by early 2010. In January 2017, prices were hovering around $1,191 per ounce
The household investment choices listed here display a tradeoff between the expected return and the degree of risk involved. m.
-Bank accounts have very low risk and very low returns; -bonds have higher risk but higher returns; and stocks are riskiest of all but have the potential for still higher returns. I n effect, the higher average return compensates for the higher degree of risk. -If risky assets like stocks did not also offer a higher average return, then few investors would want the
However, much of this bailout money was borrowed, and this borrowed money contributed to another crisis in Europe.
-Because of the impact on their budgets of the financial crisis and the resulting bailouts, many countries found themselves with unsustainably high deficits. - They chose to undertake austerity measures, large decreases in government spending and large tax increases, in order to reduce their deficits. -Greece, Ireland, Spain, and Portugal have all had to undertake relatively severe austerity measures. -The ramifications of this crisis have spread. -Economists have even call into question the euro's viability into question.
the possible capital gains from rising housing prices are riskier than these national price averages.
-Certain regions of the country or metropolitan areas have seen drops in housing prices over time. -The median housing price for the United States as a whole fell almost 7% in 2008 and again in 2009, dropping the median price from $247,900 to $216,700. - As of 2016, home values had recovered and even exceeded their pre-recession levels.
present value
-Combining the bond's face value, interest rate, and maturity date, and market interest rates, allows a buyer to compute a bond's present value, -the most that a buyer would be willing to pay for a given bond. T -his may or may not be the same as the face value.
he Federal Deposit Insurance Corporation (FDIC) protects the savings of the average person.
-Every bank is required by law to pay a fee to the FDIC, based on the size of its deposits. -Then, if a bank should go bankrupt and not be able to repay depositors, the FDIC guarantees that all customers will receive their deposits back up to $250,000
Getting rich may seem straightforward enough.
-Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. T -hose companies are the ones that will pay high dividends or whose stock price will climb in the future. -Then, buy stock in those companies. - Presto! Multiply your money!
The fundamentals of those financial capital markets remain the same:
-Firms are trying to raise financial capital and households are looking for a desirable combination of rate of return, risk, and liquidity. -Financial markets are society's mechanisms for bringing together these forces of demand and supply.
SNAP can contribute to the poverty trap.
-For every $100 earned, the government assumes that a family can spend $30 more for food, and thus reduces its eligibility for food aid by $3
Housing prices have usually risen steadily over time.
-For example, the median sales price for an existing one-family home was $122,900 in 1990, but 232,000 at the end of December 2016, - Over these 24 years, home prices increased an average of 3.1% per year, which is an average financial return over this time.
The IPO is important for two reasons.
-For one, the IPO, and any stock issued thereafter, such as stock held as treasury stock (shares that a company keeps in their own treasury) or new stock issued later as a secondary offering, provides the funds to repay the early-stage investors, like the angel investors and the venture capital firms. -A venture capital firm may have a 40% ownership in the firm. When the firm sells stock, the venture capital firm sells its part ownership of the firm to the public. -A second reason for the importance of the IPO is that it provides the established company with financial capital for substantially expanding its operations.
he idea that stock prices are based on expectations about the future has a powerful and unexpected implication.
-If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. -what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. - Instead, you must find a company that analysts widely believe at present to have poor prospects, but that will actually turn out to be a shining star. -Brigades of stock market analysts and individual investors are carrying out such research 24 hours a day.
most of the time when one buys and sells corporate stock the firm receives no financial return at all.
-If you buy General Motors stock, you almost certainly buy them from the current share owner, and General Motors does not receive any of your money. -likeyou buy a house, the current owner receives your money, not the original house build - when you buy stock shares, you are buying a small slice of the firm's ownership from the existing owner—and the firm that originally issued the stock is not a part of this transaction
The second key choice is to start saving money early in life, and to give the power of compound interest a chance.
-Imagine that at age 25, you save $3,000 and place that money into an account that you do not touch. -In the long run, it is not unreasonable to assume a 7% real annual rate of return (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. -After 40 years, using the formula for compound interest, the original $3,000 investment will have multiplied nearly fifteen fold:
The first is to complete additional education and training.
-In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor's degree, median income was $54,340. -Learning is not only good for you, but it pays off financially, to
Many people in the world are poorer than americans
-In china nigeria, india and ghana a substantial part of the population lives off less than 2 dollar a day. - About half the world lives on less than $2.50 a day - 80 percent of the world lives on less than $10 per day -purchasing power differs from america
Having $45,000 does not make you a millionaire.
-Notice, however, that this tidy sum is the result of saving $3,000 exactly once. 0Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. 0This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but remember that only half of Americans have any money in mutual funds at all.
The sharp rise in housing prices was driven by a high level of demand for housing.
-Interest rates were low, so financial institutions encouraged people to borrow money to buy a house. -Banks became much more flexible in their lending, making what were called "subprime" loans. -Banks loaned money with low, or sometimes no down payment. -They offered loans with very low payments for the first two years, but then much higher payments after that. T -he idea was that housing prices would keep rising, so the borrower would just refinance the mortgage two years in the future, and thus would not ever have to make the higher payments. - Some banks even offered so-called NINJA loans, which meant a financial institution issued loan even though the borrower had no income, no job, nor assets.
When housing prices turned down, many households that had borrowed when prices were high found that what they owed the bank was more than what their home was worth.
-Many banks believed that they had diversified by selling their individual loans and instead buying securities based on mortgage loans from all over the country. -After all, banks thought back in 2005, the average house price had not declined at any time since the Great Depression in the 1930s. -These securities based on mortgage loans, however, turned out to be far riskier than expected. -The bust in housing prices weakened both bank and household finances, and thus helped bring on the 2008-2009 Great Recession.
n retrospect, these loans seem nearly crazy.
-Many borrowers figured, however, that as long as housing prices kept rising, it made sense to buy. -Many lenders used a process called "securitizing," in which they sold their mortgages to financial companies, which put all the mortgages into a big pool, creating large financial securities, and then re-sold these mortgage-backed securities to investors. - In this way, the lenders off-loaded the mortgage risks to investor.s -Investors were interested in mortgage-backed securities as they appeared to offer a steady stream of income, provided the borrowers repaid them. -Investors relied on the ratings agencies to assess the credit risk associated with the mortgage-backed securities. - In hindsight, it appears that the credit agencies were far too lenient in their ratings of many of the securitized loans. - Bank and financial regulators watched the steady rise in the market for mortgage-backed securities, but saw no reason at the time to intervene.
Returns form collectabiles
-Most collectibles provide returns both in the form of services or of a potentially higher selling price in the future. -You can use paintings by hanging them on the wall; jewelry by wearing it; baseball cards by displaying them. -You can also hope to sell them someday for more than you paid for them.
The World Bank sets two poverty lines for low-income countries around the world.
-One poverty line is set at an income of $1.25/day per person. -The other is at $2/day. - By comparison, the U.S. 2015 poverty line of $20,090 annually for a family of three works out to $18.35 per person per day
For example, imagine that you buy a house for $200,000, paying 10% of the price as a down payment and taking out a bank loan for the remaining $180,000.
-Over time, you pay off some of your bank loan, so that only $100,000 remains, and the house's value on the market rises to $250,000. -At that point, your equity in the home is the value of the home minus the value of the loan outstanding, which is $150,000. - For many middle-class Americans, home equity is their single greatest financial asset. T -he total value of all home equity held by U.S. households was $11.3 trillion at the end of 2015, according to Federal Reserve data.
T In 1996, Congress passed and President Bill Clinton signed into law
-Personal Responsibility and Work Opportunity Reconciliation Act or welfare reform act -The new law replaced AFDC with Tempo
Any young startup firm is a risk.
-Some startup firms are only a little more than an idea on paper. T -founders inevitably have better information about how hard they are willing to work, and whether the firm is likely to succeed, than anyone else. - When the founders invested their own money into the firm, they demonstrate a belief in its prospects -angel investors and venture capitalists try to overcome the imperfect information
For many small businesses, the original source of money is the business owner.
-Someone who starts a small business might borrow money or dip into his funds -many cities have angel investors who would put their own money into small companies, in exchange for a portion of ownership
separate financial capital suppliers and transform it into the funds of financial capital demanders desire
-Such financial markets include stocks, bonds, bank loans, and other financial investment -these financial investments appear to capital suppliers such as the households that are saving funds. -Households have a range of investment options: ba
When housing prices collapsed, the value of those financial assets collapsed as well. .
-The asset side of the banks' balance sheets dropped, causing bank failures and bank runs
To simplify the process, companies offer mutual funds, which consist of a variety of stocks or bonds from different companies.
-The financial investor buys mutual fund shares, and then receives a return based on how the fund as a whole performs. - In 2012, according to the Investment Company Factbook, about 44% of U.S. households had a financial investment in a mutual fund -including many people who have their retirement savings or pension money invested in this way.
Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices.
-additional education and training -saving monery early
The cumulative average annual growth rate in housing prices from 1981 to 2000 was 5.1%.
-The price of an average U.S. home then took off from 2003 to 2005, rising more than 10% per year. -No serious analyst believed this rate of growth was sustainable; after all, if housing prices grew at, say, 11% per year over time, the average price of a home would more than double every seven years. -at the time many serious analysts saw no reason for deep concern. - After all, housing prices often change in fits and starts, like all prices, and a price surge for a few years is often followed by prices that are flat or even declining a bit as local markets adjust.
The bottom line on investing in mutual funds is that the rate of return over time will be high.
-The risks are also high, but the risks and returns for an individual mutual fund will be lower than those for an individual stock. -As with stocks, liquidity is also high provided the mutual fund or stock index fund is readily tra
first you need to know how we measure stock market performance.
-There are a number of different ways to measure the overall performance of the stock market, based on averaging different subsets of companies' stock prices. - Perhaps the best-known stock market measure is the Dow Jones Industrial Average, which is based on 30 large U.S. companies' stock prices. -Another stock market performance gauge, the Standard & Poor's 500, follows the stock prices of the 500 largest U.S. companies. -The Wilshire 5000 tracks the stock prices of essentially all U.S. companies that have stock the public can buy and sell.
Venture capital firms do more than just supply money to small startups.
-They also provide advice on potential products, customers, and key employees. -a venture capital fund invests in a number of firms -investors in that fund receive returns according to how the fund as a whole performs.
. Relatively large and well-known firms often issue bonds instea
-They use bonds to raise new financial capital that pays for investments, or to raise capital to pay off old bonds, or to buy other firms. -Not an iron clad rule,: sometimes groups of banks make large loans and sometimes relatively small and lesser-known firms issue bonds
bond has a face value.
-This is the amount the borrower agrees to pay the investor at maturity.
If businesses cannot access financial capital, they cannot make physical capital investments.
-Those investments ultimately lead to job creation. -When credit dried up, businesses invested less, and they ultimately laid off millions of workers. -This caused incomes to drop, which caused demand to drop. In turn businesses sold less, so they laid off more workers. -Compounding these events, as economic conditions worsened, financial institutions were even less likely to make loans.
ou can calculate the amount you should be willing to pay now for future payments.
-To place a present discounted value on a future payment, decide what you would need in the present to equal a certain amount in the future. - This calculation will require an interest rate. -For example, if the interest rate is 25%, then a payment of $125 a year from now will have a present discounted value of $100 -that is, you could take $100 in the present and have $125 in the future
Who makes the decisions about when a firm will issue stock, or pay dividends, or re-invest profits?
-To understand the answers to these questions, it is useful to separate firms into two groups: private and public.
From the Great Depression until 1996,
-United States' most visible antipoverty program was Aid to Families with Dependent Children (AFDC -AFDC provided cash payments to mothers with children who were below the poverty line
a firm receives money from the stock sale only when the company sells its own stock to the public
-We call a firm's first stock sale to the public an initial public offering
yield bonds or junk bonds.
-We call bonds that offer high interest rates to compensate for their relatively high chance of default high - A number of today's well-known firms issued junk bonds in the 1980s when they were starting to grow, including Turner Broadcasting and Microsoft.
Can you give people the wrong kind of help?
-When people are given necessities, it may reduce their incentive to work
If stocks follow a random walk, then not even financial professionals will be able to choose those that will beat the average consistently.
-While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market -. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up performing worse than the market average. - For the average investor who reads the newspaper business pages over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. -Trying to pick the stocks that will gain a great deal in the future is a risky and unlikely way to become rich.
Advantage and disadvantage from borrowing from banks and bondsr
-a probelm is borrowing from banks or that a firm has to commit to scheduled intrest payments, even if it can't pay the interest -he great advantage of borrowing money is that the firm maintains control of its operations and is now - Issuing stock involves selling off company ownership to the public and becoming responsible to a board of directors and the shareholders.t subject to shareholde
Investment in a house is tangibly different from bank accounts, stocks, and bonds
-because a house offers both a financial and a nonfinancial return. - If you buy a house to live in, part of the return on your investment occurs from your consumption of "housing services"—that is, having a place to live. -(Of course, if you buy a home and rent it out, you receive rental payments for the housing services you provide, which would offer a financial return.) -Buying a house to live in also offers the possibility of a capital gain from selling the house in the future for more than you paid for it.
Why isn't actual information avalible?
-because corporate governance, the name economists give to the institutions that are supposed to watch over top executives, fails
The market value of individual companies can rise and fall substantially,
-both over short time periods and over the long run. -During extended periods of time like the 1970s or the first decade of the 2000s, the overall stock market return can be quite modest. -The stock market can sometimes fall sharply, as it did in 2008.
This decreased benefit for snap is not a complete disincentive to work
-but along with other programs that reduce money, it adds to the problem -snap attempts to address the poverty trap with work requirements and time limits.
by 2008 this home equity declined to $8.8 trillion, and it plummeted further still in 2009.
-by 2010, U.S. homeowners' wealth had shrunk $14 trillion with the value of other finical assets -affected millions of lives - people had to alter their retirement, housing, and other important consumption decisions. - every other large economy in the world suffered a decline in the market value of financial assets
We always can divide an interest rate of a bonf into three components
-compensation for delaying consumption - an adjustment for an inflationary rise in the overall level of prices -and a risk premium that takes the borrower's riskiness into account.
A final area of tangible assets
-consists of "collectibles" like paintings, fine wine, jewelry, antiques, or even baseball cards.
We can divide the mechanisms for savings available to households into several categories:
-deposits in bank accounts; bonds; stocks; money market mutual funds; -stock and bond mutual funds ;- and housing and other tangible assets like owning gold
Between the end of the recession in 2009 through the second quarter 2013, profits for the S&P 500 companies grew to 9.7 %
-despite the weak economy, -with cost cutting and reductions in input costs driving much of that amount, according to the Wall Street Journal
financial capital suppliers wish to use their savings in a way that will provide a return.
-dividuals cannot, however, take the few thousand dollars that they save in any given yearand negotiate to invest their money with that firm. -financial capital close this gap -find ways to take the inflow of funds from many
The poverty line is based on cash income,
-doesn't account for government programs like medicaid and food aid -low income families qualify for federal housing assistance
The poverty line is based on cash income,
-doesn't account for government programs like medicaid and food aid -low income families qualify for federal housing assistance -measured by the number of people who fall below a certain level of income called poverty line - Belows the income one needs for a basic standard of living
What doesn't labor markets that determine the pay workers receive account for?
-don't worry about what happens to families when employers got out of business - don't think about how high earners should pay a high share of taxes.
Comparisons of high and low incomes raise two different issues
-economic equality - poverty
Should the government adjust the poverty line to account for the value of such programs?
-economists and policymakers wonder if we should rethink the concept of poverty today
A antipoverty program raises other issues.
-even if it doesn't reduce the incentive to work as much as reducing government payments by $1 for every $1 earned, it still reduces the incentive to work. -even if it doesn't reduce the incentive to work as much as reducing government payments by $1 for every $1 earned, it still reduces the incentive to work. -some people who would be working 2,000 hours each year without this program might decide to work fewer hours but still end up with more income -their choice on the new budget line would be like S, above and to the right of the original choice P. -others may choose a point like R, which involves the same amount of work as P, or even a point to the left of R that involves more work
An investor who buys a bond
-expects to receive a rate of return -bonds vary in the rates of return that they offer, according to the riskiness of the borrower.
Companies and firms may have numerous attractive investment opportunities, but few current profits to invest
-firms need to find other methods besides profits -unless the firm can find a steady and reliable financial capital source to continue making real investments in tough times, the firm may not survive until better times arrive. -large firms can experience a year or two of earning low profits or even suffering losses
When a firm needs to buy new equipment or build a new facility, it often must go to the financial market to raise fun
-firms will add capacity during an economic expansion when profits are on the rise and consumer demand is high -business development Is important to sustained economic growth. -in the sluggish 2009 economy, U.S. firms invested $1.4 trillion in new equipment and structures, in the hope that these investments would generate profits in the years ahead.
participation increased by 70% between 2007 and 2011,
-from 26.6 million participants to 45 million -caused by the great recession and rising food prices
Many firms, do not have the financial resources within the firm to make all the desired investments
-from huge companies like General Motors to startup firms writing computer software -these firms need financial capital from outside investors -they are willing to pay interest for the opportunity to obtain a rate of return on the investment for that financial capital.
The federal government deploys a range of income security programs
-funds through departments such as Health and Human Services, Agriculture, and Housing and Urban Development -these three departments provided an estimated $62 billion of aid through programs such as supplemental feeding programs for women and children, subsidized housing, and energy assistance -The federal government also transfers funds to individual states through special grant programs.
Firms that are just beginning often
-have an idea or a prototype for a product or service to sell, but few customers, or even no customers at all, - thus are not earning profits. -face a difficult problem when it comes to raising financial capital: -How can a firm that has not yet demonstrated any ability to earn profits pay a rate of return to financial investors?
federal government funds the programs, but staes are resposible for admisninstraitng the porgram
-he federal government helps fund Medicaid -but each state is responsible for administering the program, -states determining the level of benefits -states determining eligibilit -t one-third of Medicaid spending is for low-income mothers with children. -more is spent on nursing home cost for the elderly
TANF benefits to poor families vary considerably across states.
-he highest monthly payment in Alaska to a single mother with two children was $923 -in Mississippi the highest monthly payment to that family was $170.
labor markets do create considerable income inequalities
-he median American family income was $57,939 -federal government classified almost nine million U.S. families as below the poverty line in that year.
What's an example of the poverty trap?
-if government provides assistance to the poor, but as the poor earn income to support themselves, the government reduces the level of assistance it provides -the person experiences no net gain for working -this is a poverty trap'
Many states recognized medicaid poverty trap problem
-in the 1980s and 1990s -expanded their Medicaid coverage to include not just the poor, -includes the near-poor earning up to 135% or even 185% of the poverty line. -Some states also guaranteed that children would not lose coverage if their parents worked.
The concept of a poverty line raises many tricky questions.
-in the united states should there be a poverty line -New jersey 100,000 poverty line and mississippi 50,000 -prices of various good differs between states
A private company is owned by the people who run it on a day-to-day basi
-individuals can run a private company. We call this a sole proprietorship. -If a group runs it, we call it a partnership.
Lehman Brothers was the fourth largest U.S. investment bank, with 25,000 employees
-irm had been in business for 164 years. -On September 15, 2008, Lehman Brothers filed for Chapter 11 bankruptcy protection.
The benefit of issuing stock
-is that a small and growing firm increases its visibility in the financial markets -can access large amounts of financial capital for expansion -without worrying about repaying this money.
The overall pattern
-is that stocks as a group have provided a high rate of return over extended periods of time, -but this return comes with risks.
. Default risk
-is the risk that the borrower fails to pay back the bond or loam
As a firm becomes at least somewhat established and its strategy appears likely to lead to profits in the near future
-knowing the individual managers and their business plans on a personal basis becomes less important -information has become more widely available regarding the company's products, revenues, costs, and profits -other outside investors who do not know the managers personally, are more willing to provide financial capital to the firm.
The bottom line on bank accounts looks like this:
-low risk means low rate of return but high liquidity.
The chief problem with attempting to buy stock in companie that will have higher prices in the future
-many other financial investors are trying to do the same thing. -in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, -because the stock price will already be high, based on the expected high level of future profits.
The bond yield
-measures the rate of return a bond is expected to pay over time. -Investors can buy bonds when they are issued and they can buy and sell them during their lifetimes. -When buying a bond that has been around for a few years, investors should know that the interest rate printed on a bond dissimilar to the bond yield, even on new bonds
here are many causes of the Lehman Brothers failure.
-ne area of apparent failure was the lack of oversight by the Board of Directors to keep managers from undertaking excessive risk -emphasis on short-term gains without enough consideration of the risks -the Lehman Brother's Board of Directors paid too little attention to the details of the operations of Lehman Brothers and also had limited financial service experience.
A family trying to pay for necessities on 17,916 per year.
-perhaps a single mother with two children -most cities have restaurants with a 17 dollar appetizer -the food budget for the entire family would be about $17 per day over the year -a family might have $6,000 to spend on food after other necessities
irms that appear to be safe borrowers,
-perhaps because of their sheer size - or because they have consistently earned profits over time, -will still pay a higher interest rate than the U.S. government.
Firms that appear to be riskier borrowers
-perhaps because they are still growing or their businesses appear shaky, will pay the highest interest rates when they issue bond -yeild or junk bonds
Why give debit cards and not just cash?
-politicians support snap on the belief, recipients have to spend their money on food. They can't waste it. -belief that cards must increase spending on food seems wrong-headed from an economic view
Medicaid
-program ensures that participants receive a basic level of benefits, -but because each state sets eligibility requirements - provides varying levels of service, the program differs from state to state.
TANF wants to avoid the poverty trap by requiring welfare recipients work and limits the length they can have benefits
-quite successful in its first few years -in 1995, the last year of AFDC,4.8 million families recived payment -the average number of families receiving payments under TANF was 1.8 million a decline of half
The bond has a coupon rate
-r interest rate, which is usually semi-annual, but can be paid at different times throughout the year. -(Bonds used to be paper documents with coupons that investors clipped and turned in to the bank to receive interest.)
The bottom line on investing in tangible assets:
-rate of return—moderate, especially if you can receive nonfinancial benefits from, for example, living in the house; -risk—moderate for housing or high if you buy gold or baseball cards; -liquidity—low, because it often takes considerable time and energy to sell a house or a piece of fine art and turn your capital gain into cash
The actual rate of return
-refers to the total rate of return, including capital gains and interest paid on an investment at the end of a time period.
The board of directors, elected by the shareholders, is supposed to be the first line of corporate governance and oversight for top executives
-second institution of corporate governance is the auditing firm the company hires to review the company's financial records and certify that everything looks reasonable -A third institution of corporate governance is outside investors, especially large shareholders like those who invest large mutual funds or pension funds. -In the case of Lehman Brothers, corporate governance failed to provide investors with accurate financial information about the firm's operations
the states utilize the money for any program with an antipoverty bent with Tanf
-state might use the money to give cash to poor families -reduce teenage pregnancy -even to raise the high school graduation rate.
ANF brought several dramatic changes in how welfare operated
-states set the level of welfare benefits -the government would also chip in under AFDC -the welfare program of the government depended on the number of poor people and state contribution.
Investors can also put money into other tangible assets
-such as gold, silver, and other precious metals, -or in duller commodities like sugar, cocoa, coffee, orange juice, oil, and natural gas. T -he return on these investments derives from the saver's hope of buying low, selling high, and receiving a capital gain.
Accumulating hundreds of thousands of dollars by retirement is a perfectly achievable goal for a well-educated person who starts saving early in life
-that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference between simple and compound interest, and the power of compound interest.
Moreover, there seemed little evidence that poor families eith TANF
-that poor families were suffering a reduced standard of living as a result of TANF— -nor is there evidence that poor families improve their total income levels
he great advantages of bank accounts are
-thatt financial investors have very easy access to their money -also money in bank accounts is extremely safe. -bank account offers more security than keeping a few thousand dollars in the toe of a sock in your underwear drawer.
Mollie orshansky proposed that the poverty line be
-the amount one requires to buy a nutritionally adequate diet, -given the size of the family, multiplied by three.
This chapter explores how the U.S. government defines poverty
-the balance between assisting the poor without discouraging work, and how federal antipoverty programs work. It also discusses income inequality -how economists measure inequality, why inequality has changed in recent decades -the range of possible government policies to reduce inequality -the danger of a tradeoff that too great a reduction in inequality may reduce incentives for producing output
If the firm is successful and profitable,
-the board of directors will need to decide upon a dividend payout or how to reinvest profits to further grow the company. -Issuing and placing stock is expensive, requires the expertise of investment bankers and attorneys - entails compliance with reporting requirements to shareholders and government agencies,
tanf
-the federal government gives a fixed amount of money to each state under
When a firm has a record of at least earning significant revenues, and better still of earning profits,
-the firm can make a credible promise to pay interest, and so it becomes possible for the firm to borrow money.
2006, housing equity in the United States peaked at $13 trillion
-the market prices of homes, less what was still owed on the loans they used to buy these houses, equaled $13 trillion -a very good number, since the equity represented the value of the financial asset most U.S. citizens owne
These expanded guarantees cost the government money
-they also helped to encourage those on welfare to enter the labor force -approximately 69.7 million people participated in Medicaid in 2014 -healthcare expenditures are are highest for the elderly population, which comprises approximately 25% of participants. -approximately 69.7 million people participated in Medicaid, half are children
If firms are earning profits (their revenues are greater than costs),
-they can choose to reinvest some of these profits in equipment, -structures, -and research and development.
September 2011, a group of protesters gathered in Zuccotti Park in New York City
-they disliked the increasing social and economic inequality in the united states. -called their protest occupation wall street. -argued that the concentration of wealth among the richest 1% in the United States was both economically unsustainable and inequitable -something needed to be changed
What about the danger of the poverty trap that every additional $1 earned will reduce government support payments by close to $1?
-to minimize this problem the earned income tax is phased out slowly -a single-parent family with two children in 2013, the credit is the same as earnings rise from $13,430 to $17,530. -r every $1 earned above $17,530, the amount received from the credit is reduced by 21.06 cents -until the credit phases out completely at an income level of $46,227.
A checking account
-typically pays little or no interest -but it facilitates transactions by giving you easy access to your money - either by writing a check or by using a debit card
A savings account
-typically pays some interest rate, but getting the money typically requires you to make a trip to the bank or an automatic teller machine (or you can access the funds electronically).
The amount of food aid for which a household is eligible
-varies by income, number of children, and other factors -households are expected to spend about 30% of their own net income on food, -If they spend more than 30 percent on foot, they are eligible for snap
The amount of money invested in venture capital fluctuates substantially from year to year:
-venture capital firms invested more than $48.3 billion in 2014, -early stage investor realize many startup fail -however a few success can make up for the futures -Investors take large risks to gain substantial returns on their investment
firms make decisions on how to on spending money in the present to earn profits in the future examples
-when a firm buys a machine that will last 10 years -builds a new plant that will last for 30 years -starts a research and development project.
The U.S. government is an extremely safe borrower,
-when the U.S. government issues Treasury bonds, it can pay a relatively low interest rate.
the evidence on prices of collectibles,
-while scanty, is that while they may go through periods where prices skyrocket for a time, -you should not expect to make a higher-than-average rate of return over a sustained period of time from investing in this way.
Any poverty line
-will be somewhat arbitrary
Federal government imposes two key requirements for TANF grants
-work requirements, if you receive TANF grants you work. -you can't receive TANF benefits for more than five years over your lifetime. -old AFDC program had no such work requirements or time limits.
In the United states the official definition of the word poverty comes from Mollie Orshansky
-worked for the social security Administration. -Wanted to define poverty based on the cost of a healthy diet. - an article called "Children of the Poor" in the social security bulletin
Mollie Orshansky previous job had been at the U.S. Department of Agriculture,
-worked in an agency called the Bureau of Home Economics and Human Nutrition - found that the average family spent one-third of its income on food
A bank loan for a firm
-works in much the same way as a loan for an individual who is buying a car or a house -The firm borrows an amount of mone - then promises to repay it, including some rate of interest, over a predetermined period of time.
the board of directors helps to ensure that the firm runs in the interests of the true owner in theory
-yet the top executives who run the firm have a strong voice in choosing the candidates who will serve on their board of director -ew shareholders are knowledgeable enough or have enough personal incentive to nomanite board members
Diversification can offset some of the risks of individual stocks rising or falling
. -Even investors who buy an indexed mutual fund designed to mimic some measure of the broad stock market, like the Standard & Poor's 500, had better prepare against some ups and downs -, like those the stock market experienced in the first decade of the 2000s. -In 2008 average U.S. stock funds declined 38%, reducing individual and household wealth. -This steep drop in value hit hardest those who were close to retirement and were counting on their stock funds to supplement retirement income.
he fundamental problem with predicting future stock winners is that,no one can predict the future news that alters expectations about profits
.-Because stock prices will shift in response to unpredictable future news, these prices will tend to follow what mathematicians call a "random walk with a trend." - The "random walk" part means that, on any given day, stock prices are just as likely to rise as to fall. " -With a trend" means that over time, the upward steps tend to be larger than the downward steps, so stocks do gradually climb
There are clear patterns in how businesses raise financial capital.
.-We can explain these patterns in terms of imperfect information, which as we discussed in Information, Risk, and Insurance, is a situation where buyers and sellers in a market do not both have full and equal information -.hose who are actually running a firm will almost always have more information about whether the firm is likely to earn profits in the future than outside investors who provide financial capital.
Figure 17.3 Banks as Financial Intermediaries
Banks are a financial intermediary because they stand between savers and borrowers. Savers place deposits with banks, and then receive interest payments and withdraw money. Borrowers receive loans from banks, and repay the loans with interest.
WORK IT OUT
Calculating the Bond Yield You have bought a $1,000 bond whose coupon rate is 8%. To calculate your return or yield, follow these steps: Assume the following: Face value of a bond: $1,000 Coupon rate: 8 % Annual payment: $80 per year Consider the risk of the bond. If this bond carries no risk, then it would be safe to assume that the bond will sell for $1,000 when it is issued and pay the purchaser $80 per year until its maturity, at which time the final interest payment will be made and the original $1,000 will be repaid. Now, assume that over time the interest rates prevailing in the economy rise to 12% and that there is now only one year left to this bond's maturity. This makes the bond an unattractive investment, since an investor can find another bond that perhaps pays 12%. To induce the investor to buy the 8% bond, the bond seller will lower its price below its face value of $1,000. Calculate the bond's price when its interest rate is less than the market interest rate. The expected payments from the bond one year from now are $1,080, because in the bond's last year the bond's issuer will make the final interest payment and then also repay the original $1,000. Given that interest rates are now 12%, you know that you could invest $964 in an alternative investment and receive $1,080 a year from now; that is, $964(1 + 0.12) = $1080. Therefore, you will not pay more than $964 for the original $1,000 bond. Consider that the investor will receive the $1,000 face value, plus $80 for the last year's interest payment. The yield on the bond will be ($1080 - $964)/$964 = 12%. The yield, or total return, means interest payments, plus capital gains. Note that the interest or coupon rate of 8% did not change. When interest rates rise, bonds previously issued at lower interest rates will sell for less than face value. Conversely, when interest rates fall, bonds previously issued at higher interest rates will sell for more than face value.
Figure 15.6
Expenditure Comparison of TANF, SNAP, HUD, and Other Income Security Programs, 1988-2013 (est.) Total expenditures on income security continued to rise between 1988 and 2010, while payments for TANF have increased from $13 billion in 1998 to an estimated $17.3 billion in 2013. SNAP has seen relatively small increments. These two programs comprise a relatively small portion of the estimated $106 billion dedicated to income security in 2013. Note that other programs and housing programs increased dramatically during the 2008 and 2010 time periods. (Source: Table 12.3 Section 600 Income Security,
Figure 17.2 shows corporate profits after taxes (
Figure 17.2 shows corporate profits after taxes (adjusted for inventory and capital consumption). Despite the steep decline in quarterly net profit in 2008, profits have recovered and surpassed pre-recession levels
An intermediary is one who stands between two other parties.
For example, a person who arranges a blind date between two other people is one kind of intermediary
When a large number of shareholders own a company, there are three questions to ask:
How and when does the company obtain money from its sale? What rate of return does the company promise to pay when it sells stock? Who makes decisions in a company owned by a large number of shareholders?
Calculating a Budget Constraint Line
Jason earns $9.00 an hour, and a government antipoverty program provides a floor of $10,000 guaranteed income. The government reduces government support by $0.50 for each $1.00 earned. What are the horizontal and vertical intercepts of the budget constraint line? Assume the maximum hours for work or leisure is 2,500 hours. Step 1. Determine the amount of the government guaranteed income. In this case, it is $10,000. Step 2. Plot that guaranteed income as a horizontal line on the budget constraint line. Step 3. Determine what Jason earns if he has no income and enjoys 2,500 hours of leisure. In this case, he will receive the guaranteed $10,000 (the horizontal intercept). Step 4. Calculate how much Jason's salary will be reduced due to the reduction in government income. In Jason's case, it will be reduced by one half. He will, in effect, net only $4.50 an hour. Step 5. If Jason works 1,000 hours, at a maximum what income will Jason receive? Jason will receive $10,000 in government assistance. He will net only $4.50 for every hour he chooses to work. If he works 1,000 hours at $4.50, his earned income is $4,500 plus the $10,000 in government income. Thus, the total maximum income (the vertical intercept) is $10,000 + $4,500 = $14,500. The new budget line, with the antipoverty program in place, is the horizontal and heavy line that is flat at $18,000. -If a new mother doesn't work at all, that is what she gets. -if she works full time and give up time with kids, she still get the same thing -if she works 2,300 hours in the year, does household income rise to $18,400 -all of her year's work means that household income rises by only $400, might as well not work -to reach 20,000 she would need to work 20 hours.
Figure 15.4
Loosening the Poverty Trap: Reducing Government Assistance by 50 Cents for Every $1 Earned On the original labor-leisure opportunity set, the lower budget set shown by the smaller dashed line in the figure, the preferred choice P is 500 hours of leisure and $16,000 of income. Then, the government created an antipoverty program that guarantees $18,000 in income even to those who work zero hours, shown by the larger dashed line. In addition, every $1 earned means phasing out 50 cents of benefits. This program leads to the higher budget set, which the diagram shows. The hope is that this program will provide incentives to work the same or more hours, despite receiving income assistance. However, it is possible that the recipients will choose a point on the new budget set like S, with less work, more leisure, and greater income, or a point like R, with the same work and greater income
Figure 15.7
Medicaid Enrollment and Spending Part (a) shows the Medicaid enrollment by different populations, with children comprising the largest percentage at 47%, followed by adults at 28%, and the blind and disabled at 16%. Part (b) shows that Medicaid spending is principally for the blind and disabled, followed by the elderly. Although children are the largest population that Medicaid covers, expenditures on children are only at 21%.
Figure 15.3
The Poverty Trap in Action The original choice is 500 hours of leisure, 2,000 hours of work at point A, and income of $16,000. With a guaranteed income of $18,000, this family would receive $18,000 whether it provides zero hours of work or 2,000 hours of work. Only if the family provides, say, 2,300 hours of work does its income rise above the guaranteed level of $18,000—and even then, the marginal gain to income from working many hours is small.
Figure 15.2
The U.S. Poverty Rate since 1960 The poverty rate fell dramatically during the 1960s, rose in the early 1980s and early 1990s, and, after declining in the 1990s through mid-2000s, rose to 15.9% in 2011, which is close to the 1960 levels. In 2013, the poverty dropped slightly to 14.5%. (Source: U.S. Census Bureau)
expected rate of return
The increase in profit a firm anticipates it will obtain by purchasing capital (or engaging in research and development); expressed as a percentage of the total cost of the investment (or R&D) activity.
Figure 17.4 Interest Rates on Six-Month, One-Year, and Five-Year Certificates of Deposit
The interest rates on certificates of deposit have fluctuated over time. The high interest rates of the early 1980s are indicative of the relatively high inflation rate in the United States at that time. Interest rates fluctuate with the business cycle, typically increasing during expansions and decreasing during a recession. Note the steep decline in CD rates since 2008, the beginning of the Great Recession.
Figure 17.7 The Median Average Sales Price for New Single-Family Homes, 1990-2015
The median price is the price where half of sales prices are higher and half are lower. The median sales price for a new one-family home was $122,900 in 1990. It rose as high as $248,000 in 2007, before falling to $232,000 in 2008. In 2015, the median sales price was $294,000. Of course, this national figure conceals many local differences, like the areas where housing prices are higher or lower, or how housing prices have risen or fallen at certain times. (Source: U.S. Census)
Index fund
We call a mutual fund that seeks only to mimic the market's overall performance an something
These are very real, very important questions in the United States now, .
Why were people so upset? How much wealth is concentrated among the top 1% in our society? How did they acquire so much wealth
debit card
a card that lets the person make purchases, and the financial insitution immediately deducts cost from that person's checking account
savings account
a bank account that pays an interest rate, but withdrawing money typically requires a trip to the bank or an automatic teller machine
checking account
a bank account that typically pays little or no interest, but that gives easy access to money, either by writing a check or by using a "debit card"
municipal bonds
a bond issued by cities that wish to borrow
corporate bond
a bond issued by firms that wish to borrow
treasury bond
a bond issued by the federal government through the U.S. Department of the Treasury
present value
a bond's current price at a given time
corporation
a business owned by shareholders who have limited liability for the company's debt yet a share of the company's profits; may be private or public and may or may not have publicly-traded stock
partnership
a company run by a group as opposed to an individual
sole proprietorship
a company run by an individual as opposed to a group
dividend
a direct payment from a firm to its shareholders
Medicaid
a federal-state joint program enacted in 1965 that provides medical insurance for certain (not all) low-income people, including the near-poor as well as those below the poverty line, and focusing on low-income families with children, the low-income elderly, and the disabled
Supplemental Nutrition Assistance Program (SNAP)
a federally funded program, started in 1964, in which each month poor people receive SNAP cards they can use to buy food
bond
a financial contract through which a borrower like a corporation, a city or state, or the federal government agrees to repay the amount that it borrowed and also a rate of interest over a period of time in the future
capital gain
a financial gain from buying an asset, like a share of stock or a house, and later selling it at a higher price
private company
a firm owned by the people who run it on a day-to-day basis
public company
a firm that has sold stock to the public, which in turn investors then can buy and sell
shares
a firm's stock, divided into individual portions
income
a flow of money received, often measured on a monthly or an annual basis
Lorenz curve
a graph that compares the cumulative income actually received to a perfectly equal distribution of income; it shows the share of population on the horizontal axis and the cumulative percentage of total income received on the vertical axis
risk
a measure of the uncertainty of that project's profitability
certificate of deposit (CD)
a mechanism for a saver to deposit funds at a bank and promise to leave them at the bank for a time, in exchange for a higher interest rate
earned income tax credit (EITC)
a method of assisting the working poor through the tax system
index fund
a mutual fund that seeks only to mimic the market's overall performance
stock
a specific firm's claim on partial ownership
estate tax
a tax imposed on the value of an inheritance
progressive tax system
a tax system in which the rich pay a higher percentage of their income in taxes, rather than a higher absolute amount
financial intermediary
an institution, like a bank, that receives money from savers and provides funds to borrowers
compound interest
an interest rate calculation on the principal plus the accumulated interest
simple interest
an interest rate calculation only on the principal amount
poverty trap
antipoverty programs set up so that government benefits decline substantially as people earn more income—as a result, working provides little financial gain
Figure 17.4 shows the annual rate of interest paid on a six-month, one-year, and five-year CD since 1984,
as reported by Bankrate.com. The interest rates that savings accounts pay are typically a little lower than the CD rate, because financial investors need to receive a slightly higher rate of interest as compensation for promising to leave deposits untouched for a period of time in a CD, and thus forfeiting some liquidity.
high yield bonds
bonds that offer relatively high interest rates to compensate for their relatively high chance of default
Table 15.1
compares poverty rates for different groups in 2011. As you will see when we delve further into these numbers, poverty rates are relatively low for whites, for the elderly, for the well-educated, and for male-headed households. Poverty rates for females, Hispanics, and African Americans are much higher than for whites. While Hispanics and African Americans have a higher percentage of individuals living in poverty than others, most people in the United States living below the poverty line are white.
quintile
dividing a group into fifths, a method economists often use to look at distribution of income
venture capital
financial investments in new companies that are still relatively small in size, but that have potential to grow substantially
mutual funds
funds that buy a range of stocks or bonds from different companies, thus allowing an investor an easy way to diversify
The safety net includes a number of other programs:
government-subsidized school lunches and breakfasts for children from low-income families; - the -Special Supplemental Food Program for Women, Infants and Children (WIC), which provides food assistance for pregnant women and newborns; -the Low Income Home Energy Assistance Program, which provides help with home heating bills; -housing assistance, which helps pay the rent; - Supplemental Security Income, which provides cash support for the disabled and the elderly poor.
a poor family is spending $2,500 per year on food, and then it starts receiving $1,000 per year in SNAP aid
he family might react by spending $3,500 per year on food (income plus aid), -or it might react by continuing to spend $2,500 per year on food, but use the $1,000 in food aid to free up $1,000 that it can now spend on other goods. -t is reasonable to think of SNAP cards as an alternative method, along with TANF and the earned income tax credit, of transferring income to the working poo
A large company might issue bonds for $10 million -
he firm promises to make interest payments at an annual rate of 8%, or $800,000 per year -then, after 10 years, will repay the $10 million it originally borrowed
Figure 15.5
illustrates that the earned income tax credits, child tax credits, and the TANF program all cost the federal government money—either in direct outlays or in loss of tax revenues. CTC stands for the government tax cuts for the child tax credit.
Figure 17.3
illustrates the position of banks as a financial intermediary, with a pattern of deposits flowing into a bank and loans flowing out, and then repayment of the loans flowing back to the bank, with interest payments for the original savers.
when a firm decides to issue stock,
it must recognize that investors will expect to receive a rate of return
diversification
investing in a wide range of companies to reduce the level of risk
he trend in the stock market
is generally up over time, but with some large dips along the way.
it is useful to have a poverty line whose basic definition does not change much over time.
it is useful to have a poverty line whose basic definition does not change much over time. -If Congress voted every few years to redefine poverty, - then it would be difficult to compare rates over time. -After all, would a lower poverty rate change the definition, or that people were actually better off? -Government statisticians at the U.S. Census Bureau have ongoing research programs to address questions like these.
poverty rate
percentage of the population living below the poverty line
shareholders
people who own at least some shares of stock in a
For many established companies a
primary source of capital is reinvesting their own profits is one primary source of financial capital
The EITC is one of the largest assistance program for low-income groups,
projections for 2013 expected 26 million households to take advantage of it at an estimated cost of $50 billion. -a single parent with two children would have received a tax credit of $5,372 up to an income level of $17,530 in 2013 - has been popular with the public and general economist, because it increases the payment recived for work -The amount of the tax break increases with the amount of income earned, up to a point.
Comparisons of high and low incomes
raise two different issues -economic equality - poverty
liquidity
refers to how easily one can exchange money or financial assets for a good or service
junk bonds
see high yield bonds
Figure 17.7
shows U.S. Census data for the median average sales price of a house in the United States over this time period.
Figure 17.5
shows bond yield for two kinds of bonds: 10-year Treasury bonds (which are officially called "notes") and corporate bonds issued by firms that have been given an AAA rating as relatively safe borrowers by Moody's, an independent firm that publishes such ratings. Even though corporate bonds pay a higher interest rate, because firms are riskier borrowers than the federal government, the rates tend to rise and fall together. Treasury bonds typically pay more than bank accounts, and corporate bonds typically pay a higher interest rate than Treasury bonds.
Figure 17.2
shows corporate profits after taxes (adjusted for inventory and capital consumption). Despite the steep decline in quarterly net profit in 2008, profits have recovered and surpassed pre-recession levels
Figure 17.6
shows that stock prices did not rise much in the 1970s, but then started a steady climb in the 1980s. From 2000 to 2013, stock prices bounced up and down, but ended up at about the same Level.
Figure 15.2
shows the U.S. poverty rate over time; that is, the percentage of the population below the poverty line in any given year. The poverty rate declined through the 1960s, rose in the early 1980s and early 1990s, but seems to have been slightly lower since the mid-1990s. However, in no year in the last four decades has the poverty rate been less than 11% of the U.S. population—that is, at best about one American in nine is below the poverty line. In recent years, the poverty rate appears to have peaked at 15.9% in 2011 before dropping to 14.5% in 2013.
Figure 17.4
shows the annual rate of interest paid on a six-month, one-year, and five-year CD since 1984, as reported by Bankrate.com. The interest rates that savings accounts pay are typically a little lower than the CD rate, because financial investors need to receive a slightly higher rate of interest as compensation for promising to leave deposits untouched for a period of time in a CD, and thus forfeiting some liquidity.
Figure 17.6
shows the path of the Standard & Poor's 500 index (which is measured on the left-hand vertical axis) and the Dow Jones Index (which is measured on the right-hand vertical axis). Broad stock market measures, like the ones we list here, tend to move together. The S&P 500 Index is the weighted average market capitalization of the firms selected to be in the index. The Dow Jones Industrial Average is the price weighted average of 30 industrial stocks tracked on the New York Stock Exchange.
bondholder
someone who owns bonds and receives the interest payments
redistribution
taking income from those with higher incomes and providing income to those with lower incomes
Poverty
that defines the income one needs for a basic standard of living.
face value
the amount that the bond issuer or borrower agrees to pay the investor
maturity date
the date that a borrower must repay a bond
initial public offering (IPO)
the first sale of shares of stock by a firm to outside investors
safety net
the group of government programs that provide assistance to the poor and the near-poor
corporate governance
the name economists give to the institutions that are supposed to watch over top executives in companies that shareholders own
coupon rate
the interest rate paid on a bond; can be annual or semi-annual
equity
the monetary value a homeowner would have after selling the house and repaying any outstanding bank loans used to buy the house
bond yield
the rate of return a bond is expected to pay at the time of purchase
poverty
the situation of being below a certain level of income one needs for a basic standard of living
poverty line
the specific amount of income one requires for a basic standard of living
wealth
the sum of the value of all assets, including money in bank accounts, financial investments, a pension fund, and the value of a home
actual rate of return
the total rate of return, including capital gains and interest paid on an investment at the end of a time period
near-poor
those who have incomes just above the poverty line
income inequality
when one group receives a disproportionate share of total income or wealth than others
When the Dow Jones average rises from 5,000 to 10,000,
you know that the average price of the stocks in that index has roughly doubled.