Economics Chapter 10 Lesson 1-3 and Chapter 11 Lesson 1 Study Guide

Slideshow A

The financial system is the process by which money flows from savers to users. When people save, they make funds available for others to use. Businesses borrow these funds to produce new goods and services and therefore creating more jobs. Saving then makes economic growth possible.

4 Characteristics of Money

portable, durable, divisible, limited supply

Credit cards

A credit card allows you to borrow money directly from a bank up to a previously determined limit. You are usually allowed to pay the loan back in a 20- to 30-day grace period without having to pay any interest. If you fail to pay the loan off on time, interest can be charged on the borrowed funds at rates often approximating 20-25 percent. Credit cards are one of a bank's most profitable services. Most credit card holders fail to pay the account in full before the end of the grace period. Because the monthly interest rate is so high, a careless consumer can easily end up with the equivalent of a perpetual, or never-ending, loan from the bank on a relatively small balance.

Debit cards

A debit card looks just like a credit card, but it is electronically tied to your checking account. To make a purchase, you simply swipe the card, which is faster than writing a check. Because the money is transferred immediately from your account to the merchant's account, there is a lot less paperwork for you, the bank, and the merchant. Merchants like debit cards because the purchase will not go through if there is not enough money in your DDA, and they don't have to deal with bounced checks. However, your risk of losses on a lost or stolen debit card is not limited, as they are with a credit card. A stranger could have access to all of your money! The risk and the cost of fraud lie directly on consumers.

Advantages/ Disadvantages of the Gold Standard

A gold standard has two major advantages. First, people may feel more secure about their currency. Second, the standard is supposed to prevent the government from creating too much money, because gold is a limited resource. And if paper currency is relatively scarce, it should keep its value. Since it is rare that all of a country's paper notes would be redeemed at the same time, the United States never held a gold reserve equal to the value of its notes. A growing economy needs its money supply to grow as well, and so, under a gold standard, increasing its stocks of gold. If gold is scarce, the growth of the money supply may slow, and perhaps stop, limiting economic growth. That is one major disadvantage of the gold standard. Another risk is that a large number of people may decide to convert their currency at the same time, and drain the gold reserves.

Smart Cards

A smart card is similar to a credit card in size and appearance, but has a built-in microprocessor instead of a magnetic security strip. The microprocessor has many more safety features and is therefore safer than a credit card. The information on the card includes much more data about you and can be used as an identification card as well as for electronic purchases from a merchant. Smart cards are widely used in Europe and are just beginning to gain acceptance in the United States. Because they require an entirely different type of card reader, the changeover from the magnetic strip technology to embedded microchips will be slower than many people would like.

National Banking System

As the war dragged on, people feared that the greenbacks—like the Continental dollars used almost a century earlier to finance the Revolutionary War—might become worthless. When the greenbacks did lose some of their value, people avoided using them, forcing Congress to find another way to pay for the war. In 1863, Congress enacted the National Currency Act, which created a National Banking System (NBS) made up of national banks. A national bank is a privately owned bank that receives its operating charter from the federal government. These banks issued their own notes, called national currency, or national bank notes, backed with bonds that the banks bought from the federal government. The government hoped that rigorous bank inspections and other high standards would give people confidence in the new banking system and its currency. The new system also would help the Union cause because banks that joined the NBS had to buy Union bonds. Initially, only a few state-chartered banks joined the system, because it was easier for them to print their money at local printers. Finally, in 1865, the federal government forced state banks to become part of the National Banking System by placing a 10 percent tax on all privately issued bank notes. Because state-chartered banks could not afford the tax, they withdrew their notes, leaving only the greenbacks and currency issued by the NBS in circulation. Thus, the need to finance the Civil War changed paper money from issues by state banks to issues backed by the federal government.

financial intermediaries

BANKS AND CREDIT UNIONS-accept deposits and lend monies FINANCE COMPANIES-make loans to consumers and buy installment contracts from merchants who sell goods on credit LIFE INSURANCE COMPANIES-collect cash through insurance premiums and loan surplus funds to others PENSION FUNDS-collect contributions from employees, pay out benefits, and invest holdings in stocks and bonds

Financing capital formation

Capital formation depends on saving and borrowing. When you borrow, you invest some of the borrowed money in homes, cars, or other large purchases. When businesses borrow, they invest in tools, equipment, machinery, labor and other things that grow their business. When governments borrow, they invest in highways, hospitals, universities, infrastructure, and other public goods. What this means is that we all benefit from an efficient financial institution.

Slideshow E

Compound interest is better than simple interest. If you deposited 10,000 and earned a simple interest of 5%-you would earn 500.00 per year. In 3 years you would have an additional 1500 earned interest. If you deposit 10,000 and earned 5% compound interest annually, you would earn 500.00 the first year. In the second year, you would earn interest on 10,500 and gain an additional 525.00. In the third year, you would earn interest on 11,025 which is 551. 25. So with simple interest you would have 11500.00 in three years and 11,576.26 with compounded interest. It may not seem like much but over time, it would grow tremendously.

Banking and the Great Depression

Despite the creation of the Fed, many banks were only marginally sound during the 1920s. One reason was that the number of banks had soared between the Civil War and 1921, when the total exceeded 31,000. Although some consolidation occurred over the next decade, there were still too many small struggling banks at the start of the Great Depression in 1929.

Purpose of Continental Dollars

During the Revolutionary War, nearly 250 million Continental dollars were printed. But by the end of the Revolution, Continental currency had become worthless, and people did not trust the government to issue anything except coins.

Problems with early money

Even when banks were honest, problems with their currency arose. First, each bank issued its own currency in different sizes, colors, and denominations. As a result, hundreds of different kinds of notes could be in circulation in any given city. Second, banks were tempted to issue too many notes because they could print more money whenever they wanted. Third, counterfeiting became a major problem. With so many different types of notes in circulation, some counterfeiters did not even bother to copy notes issued by existing banks. Instead, they just made up fictitious ones. By the beginning of the Civil War, more than 1,600 banks were issuing more than 10,000 different kinds of paper currency. Each bank was supposed to have backing for its notes in the form of gold or silver, but this was seldom the case. As a result, when people tried to use their notes, merchants would often check the latest listing of good and bad currencies before deciding whether to accept them. Politically powerful local bankers resisted any calls for a better system until an event that would forever change commercial banking in the United States—the Civil War.

Consistency

Invest over long periods Just as important as amount invested Should save something monthly It will add up more than you realize

Loans, Investments, and fees

Loans to consumers and businesses are an important part of a bank's profits. For example, a bank might pay 2 percent on deposits, and lend the balance after reserves at 6 percent for home repairs or mortgages. The difference between these two rates—2 percent and 6 percent—is the "spread," 4 percent. The spread creates profits that the bank may use to pay its employees and other bills. A bank will also earn money on its investments, which could cover a wide range of activities. If a bank has extra funds that are not loaned out, it could buy U.S bonds, for example. Finally, the category of fees is also a significant source of bank funds. For example, there may be fees for maintaining an account, application fees when applying for a loan, withdrawal fees for using an automated teller machine (ATM) from another bank, fees for overdrawing your checking account, and fees for bouncing checks.

3 Functions of Money

Medium of exchange—A medium of exchange is something accepted by all parties as payment for goods and services. Throughout history, people have used various materials as a medium of exchange, including colored shells, tobacco, gold, silver, and even salt. Measure of value—Money serves as a measuring stick used to express the worth of something in terms that most people understand. In the United States, this worth is expressed in dollars and cents. Store of value—The feature of money that allows purchasing power to be saved until needed. For example, you can spend your money on something now, or wait and spend your money later.

How a bank gets its money

Most banks are established as a corporation, for two reasons. First, a corporation can raise funds by selling stock to anyone who wants to be a part-owner, or shareholder, in the bank. Second, a corporation is responsible for its debt, but none of its shareholders are. This is called "limited liability." If the corporation gets in trouble, its shareholders are protected. The bank may continue attracting deposits and making loans until it is "loaned out," or unable to make any more loans. If the Fed lowers the reserve requirement to 10 percent, every new loan can be as much as 90 percent of each deposit. On the other hand, if the Fed raises the requirement to 25 percent, the bank will need to find more reserves to back the existing loans. Finally, the bank will have to report its reserves and its demand deposits to the Fed on a regular basis. Banks are heavily regulated by the Fed, the Comptroller of the Currency, the FDIC, and possibly even some state banking officials. Bankers are not very happy about this, but the regulation has prevented massive failures like those we saw during the Great Depression.

How do people save?

Open a savings account Buy bonds Purchase Certificates of Deposit (CDs)-a document showing an interest bearing loan has been made to the bank. Economists call these financial assets. Financial Assets can be stocks or documents that represent a claim on the income and property of the borrower. Some examples would be CDs, bonds, T-Bills, mortgages...etc.

Early paper money

Paper currency was another popular form of fiat money in the colonies. Some state laws allowed individuals to print their own paper currency if they promised to redeem the currency for gold or silver. Some states even printed money in the form of tax anticipation notes and used them to pay salaries, buy supplies, and meet other government expenditures until they received taxes and could redeem the notes. The Continental Congress issued paper money to finance the Revolutionary War. In 1775, it printed Continental dollars, a form of fiat paper currency with no gold or silver backing. By the end of the war, nearly one-quarter billion Continental dollars had been printed—a volume so large that it was virtually worthless by the end of the revolution.

Creation of the FED

Reform came in 1913 when Congress created the Federal Reserve System, now often called the "Fed," as the nation's central bank. A central bank is a banker's bank, which can lend to other banks in times of need. The Fed was set up in some ways like a corporation. Any bank that joined had to purchase shares of stock in the system. All national banks were required to do so, and state-chartered banks were eligible to buy shares as well. As share-holders—or part-owners—banks own the Federal Reserve System, not the federal government. The Fed's own currency, called Federal Reserve Notes, eventually replaced all other types of federal currency. Because the Fed had the resources to lend to other banks during periods of difficulty, it became the nation's first true central bank.

Risk return relationship

Risk is the degree to which the outcome is uncertain but a probable outcome can be predicted Certificates of Deposit: low-risk security sold by banks with a specific-fixed maturity term, prohibiting on-demand withdrawals, and a fixed interest rate. Treasury bills: risk-free security issued by the U.S. government with a maturity of less than one year. Investment-grade bonds: a bond with a credit rating of BBB- or higher by S&P or Baa3 or higher by Moody's Ex-Verizon Preferred stock: security that grants partial ownership in a corporation and a higher priority dividend than that of common-stock owners Common stock: security that grants partial ownership in a corporation with some privileges relating to overall governance of the firm Speculative stock: it has a high probability of declining in value relative to its low probability of above-average returns

Slideshow

Saving makes economic growth possible because it makes funds available for others to use. Methods of saving include opening a savings account, buying bonds, and purchasing a certificate of deposit (CD). A person's financial assets include all documents that represent a claim on the income and property of the borrower, including stocks, savings, CDs, Treasury bills, and mortgages. The financial system includes savings, financial intermediaries, borrowers, and financial assets. Capital formation depends on saving and borrowing. The main financial institutions in our economic system are banks, credit unions, finance companies, life insurance companies, and pension funds.

savings accounts and time deposits

Savings accounts and time or "term" deposits restrict withdrawals. You may be able to make a certain number of withdrawals from a savings account, and fewer on time deposits. In return, a bank will usually pay slightly higher interest rates on money that you can't withdraw at will. If you close your account, you can have your money back, but you will forfeit most of the interest you expected to earn. Opening a savings account will help you get into the habit of saving, and build a credit rating if you want to apply for a credit card. Your best strategy might be to open a savings account and add to it with regular deposits—even if your deposits are small. You may be surprised how small amounts can build up over time and serve you in emergencies.

How did we get the term "dollar?"

Spanish pesos were known as "pieces of eight," because they were divided into eight subparts known as "bits." Because the pesos resembled the Austrian talers, they were nicknamed "talers," which in German sounded exactly like the word dollars. This term became so popular that the dollar became the basic monetary unit, or standard unit of currency, in the U.S. money system.

Influence of the Spanish Peso

Spanish pesos were known as "pieces of eight," because they were divided into eight subparts known as "bits." Because the pesos resembled the Austrian talers, they were nicknamed "talers," which in German sounded exactly like the word dollars. This term became so popular that the dollar became the basic monetary unit, or standard unit of currency, in the U.S. money system. Rather than dividing the dollar into eighths as the Spanish had done with the peso, it was decided to divide it into tenths, which was easier to understand. Still, some of the terminology associated with the Spanish peso remains, as when people sometimes call a 25-cent coin—one quarter of a dollar—"two bits."

Diversification

Spread your funds over a wide variety of investments so that losses in one have a limited impact on overall portfolio Example-buy 100 shares of 10 different stocks rather than 1000 shares of one stock Don't just invest in stocks...put some money in other things like CDs, T-Bills, (is a short-term debt obligation backed by the U.S. government with a maturity of less than one year, sold in denominations of $1,000 up to a maximum purchase of $5 million.) government bonds (a bond issued by a national government, generally with a promise to pay periodic interest payments and to repay the face value on the maturity date.) A downturn in stock prices would not affect the value of your CD or T-Bill or Bond since all those are set at purchase. The more you have to invest, the more you should diversify.

Simplicity

Stay with what you understand Ignore any investment that seems too complicated Get rich slow, not get rich quick If it is too good to be true, it is probably not true Most people build wealth because of simple dogged determination and not luck

Slideshow D

Successful investors invest consistently, on a regular basis, and over long periods of time. Simplicity is a key to successful investing; ignore complicated investments that you don't understand, and avoid investments that seem too good to be true. Consider the risks and the rates of return before investing, and choose a risk level that is comfortable for you. Your reasons for investing will affect the types of investments that are right for you.

History of Barter System

Take a moment to think what life would be like in a barter economy, a moneyless economy that relies on trade. The exchange of goods and services would be more difficult because the products some people have to offer are not always acceptable to others, or easy to divide for payment. For example, how could a milkman with a pail of milk obtain a pair of shoes if the cobbler wanted a basket of fish? Unless there is a "mutual coincidence of wants"— a situation in which two people want exactly what the other has and are willing to trade what they have for it—it is difficult for trade to take place. Life is simpler in an economy with money. The milkman sells the milk for cash and then exchanges that cash for a pair of shoes. The cobbler takes the cash and looks for someone selling fish. Money, as it turns out, makes life easier for everybody in ways we may have never considered.

Federal Reserve Notes

The Federal Reserve Notes that were first introduced in 1914 have become the most visible component of our money supply. All of the other federal currencies—National Bank Notes, Silver Certificates, Gold Certificates, and even the U.S. Notes, or "greenbacks"—have slowly retired and were replaced by Federal Reserve Notes.

Early Colonial Money

The money used by early settlers in the American colonies was similar to that found in early societies. Some of it consisted of commodity money—money that has an alternative use as an economic good, or commodity. Many products—including corn, hemp, gunpowder, and musket balls—served as commodity money. They could be used to settle debts and make purchases. At the same time, colonists could consume these products, if necessary. Commonly accepted commodity money was tobacco, for which the Governor of Colonial Virginia set a value of three English shillings per pound in 1618. Two years later, the colonists used some of this commodity money to bring wives to the colonies. Other colonies established fiat money—money by government decree. For example, in 1637, Massachusetts established a monetary value for wampum—a form of currency the Wampanoag Native Americans made out of white and purple mussel shells. The Wampanoag and the settlers used these shells in trade. White shells were more plentiful than purple ones, so one English penny was made equal to six white or three purple shells. The colonial settlers could even pay their taxes with wampum.

Slideshow C

The third part consists of borrowers who use those funds for various purposes. A business might borrow so that it can produce capital equipment needed for economic growth, or it might want to produce goods and services to sell consumers. A university might borrow so that it can build student housing. An individual might borrow so that he can buy a car or a house. The fourth part consists of the financial assets—bonds, certificates of deposits, and other documents that show that borrowing has taken place and that there is a claim on the income and assets of the borrower. Collectively, these four parts make up the financial system—a network of savers, investors, financial institutions, and financial assets that work together to transfer savings from savers to investors.

Slideshow B

This graphic on the previous slide shows the circular flow of finance that makes saving, investing, and economic growth possible. This illustration of the financial system has four parts: The first part consists of savers who provide the savings that borrowers will use. A saver uses their surplus funds for a variety of reasons. They might be someone like you who wants to put surplus funds in a weekly paycheck in a bank or credit union. It might be a city government that is making contributions into an employee retirement fund. It could be a corporation that is investing surplus cash until it is needed to meet a payroll. The second part consists of financial intermediaries -institutions like banks, credit unions, life insurance companies, pension funds, and finance companies that collect the funds that savers provide so that they can be loaned to borrowers.

Checking Accounts and ddas

This is one of the most useful services. Checking accounts let you make purchases in any amount up to the limit of your deposit, and let you make a payment by mail. The bank has to honor the withdrawal on demand, or when presented with a check, so they are also known as DDAs for "Demand Deposit Accounts." Because they generate a lot of paper, the banking industry is steadily moving toward electronic banking. Right now, for example, your check may be processed by a cashier and handed right back to you—with the rest of the "paperwork" done electronically. Many banks also prefer to present your monthly summary electronically, rather than put a paper copy in the mail.

EFT (electronic funds transfer)

This term generally describes any system that uses computer and electronic technology in place of checks and other paper transactions. Some EFT services include those provided by ATMs that let you bank any time, direct deposits of payrolls by companies, pay-by-phone systems, debit card purchases, electronic check conversions that convert a paper check into an electronic payment at a store, or virtually any other transaction that involves the electronic movement of funds. The term applies to so many different situations that it no longer describes a unique activity.

History and Function of Greenbacks?

To fight the Civil War, both the Union and the Confederacy needed to raise enormous sums. Congress tried to borrow money by selling bonds, but failed to raise as much money as the Union war effort required. So Congress decided to print paper currency for the first time. In 1861 it authorized the printing of $60 million in new currency that had no gold or silver backing. Congress simply declared that the notes were legal tender—and must be accepted as payment. These new notes were soon dubbed "greenbacks" because of the green ink on the reverse side, which made them easy to distinguish from state notes, which were usually blank on the back.